The following discussion of financial condition and results of operations highlights significant factors influencing the Erie Insurance Group (“we,” “us,” “our”). This discussion should be read in conjunction with the audited financial statements and related notes and all other items contained within this Annual Report on Form 10-K as these contain important information helpful in evaluating our financial condition and results of operations.
severe weather conditions or other catastrophic losses, including terrorism and pandemic events;
Net income increased in 2013 when compared to 2012 due to an underwriting gain experienced in the property and casualty insurance operations in 2013 compared to an underwriting loss in 2012 and increased income from our investment operations. The 2013 underwriting results in the property and casualty insurance operations were positively impacted by lower levels of catastrophe losses compared to 2012, offset somewhat by lower levels of favorable development on prior accident year loss reserves in 2013 compared to 2012. Our income from investment operations improved in 2013 compared to 2012 due primarily to an increase in net realized gains on investments.
Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.
DAC is periodically reviewed for recoverability. For traditional life products, if the benefit reserves plus anticipated future premiums and interest earnings for a line of business are less than the current estimate of future benefits and expenses (including any unamortized DAC), a charge to income is recorded for additional DAC amortization or for increased benefit reserves. For universal life products and deferred annuities, if the current present value of future expected gross profits is less than the unamortized DAC, a charge to income is recorded for additional DAC amortization. There were no impairments to DAC in 2014, 2013 or 2012.
Direct business, including reserves for catastrophe losses and salvage and subrogation
Net realized gains and losses on investments include the changes in fair value of common stocks designated as trading securities, and gains and losses resulting from the actual sales of all security categories.
$231 million, or 41%, of the total fixed maturity portfolio for Indemnity and $1.5 billion, or 16%, of the fixed maturity portfolio for the Exchange at December 31, 2014. The overall credit rating of the municipal portfolio without consideration of the underlying insurance is AA.
The pension contribution for 2015 was estimated in accordance with the Pension Protection Act of 2006. Contributions anticipated in future years depend upon certain factors that cannot be reasonably predicted. Any contributions required in future years will be an amount equal to the greater of the target normal cost for the plan year or the amount necessary to fund the plan to 100% plus interest to the date the contribution is made. The obligations for our unfunded benefit plans, including the Supplemental Employee Retirement Plan (SERP) for our executive and senior management, are not included in gross contractual obligations. The recorded accumulated benefit obligation for this plan at December 31, 2014, is $10 million. We expect to have sufficient cash flows from operations to meet the future benefit payments as these become due.
Reinsurance recoverables include estimated amounts from reinsurers on long-term liabilities subject to the credit worthiness of the reinsurer.
Reclassification adjustment for gross (gains) losses included in net income, net of tax benefit (expense) of $10, $(3) and $23, respectively
See accompanying notes to Consolidated Financial Statements. See Note 22, “Indemnity Supplemental Information,” for supplemental consolidating statements of financial position information.
Limited partnerships - Limited partnerships include U.S. and foreign private equity, mezzanine debt, and real estate investments. The majority of our limited partnership holdings are considered investment companies and are recorded using the equity method of accounting. For these limited partnerships the general partners record assets at fair value, including any other-than-temporary impairments of these individual investments. We also own some real estate limited partnerships that do not meet the criteria of an investment company. These partnerships prepare audited financial statements on a cost basis. We have elected to report these limited partnerships under the fair value option, which is based on the net asset value (NAV) from our partner’s capital statement reflecting the general partner’s estimate of fair value for the fund’s underlying assets. Limited partnerships reported under the fair value option are disclosed in Note 6, “Fair Value” as other investments. Fair value provides consistency in the evaluation and financial reporting for these limited partnerships and limited partnerships accounted for under the equity method.
Because of the timing of the preparation and delivery of financial statements for limited partnership investments, the use of the most recently available financial statements provided by the general partners results in a quarter delay in the inclusion of the limited partnership results in our Consolidated Statements of Operations. Due to this delay, these financial statements do not yet reflect the market conditions experienced in the fourth quarter of 2014 for all partnerships other than the real estate limited partnerships that are reported under the fair value option.
The Exchange had capitalized software development costs in-process of $4 million at December 31, 2014, not yet subject to amortization.
As of December 31, 2014, Indemnity has access to a $100 million bank revolving line of credit with a $25 million letter of credit sublimit that expires on November 3, 2018. As of December 31, 2014, a total of $98 million remains available under the facility due to $2 million outstanding letters of credit, which reduce the availability for letters of credit to $23 million. Indemnity had no borrowings outstanding on its line of credit as of December 31, 2014. Bonds with a fair value of
Loss reserves are set at ultimate cost, except for workers compensation loss reserves, which have been discounted using an interest rate of 2.5% for all periods presented. This discounting reduced unpaid losses and loss expenses by $89 million,
At December 31, 2014, the plan awards for the 2012-2014 performance period were fully vested. Distributions will be made in 2015 once peer group financial information becomes available. The estimated plan award based upon the peer group information as of September 30, 2014 is $9 million. At December 31, 2013, the awards for the 2011-2013 period were fully vested. The average share price on the date the shares were delivered to plan participants for the 2011-2013 performance period was $75.36. The plan award of 54,371 shares of Class A common stock with a market value of approximately
receive more than 5,000 shares in a calendar year. Share awards are settled through the repurchase of our Class A common stock on the open market. We do not issue new shares of common stock to satisfy plan awards.
We have a stock compensation plan for our outside directors to further align the interests of directors with those of our shareholders that provides for a portion of the directors’ annual compensation in shares of our Class A common stock. Each director vests in the grant 25% every three months over the course of a year. Dividends paid by us are reinvested into each directors’ account as additional share credits which vest immediately. Upon ending board service, directors are paid shares of our Class A common stock equal to the number of share credits in their deferred stock account. Our practice is to repurchase shares of our Class A common stock in the open market to satisfy these awards. We do not issue new shares of common stock to directors. The annual charge related to these awards totaled $2 million, $1 million and $0.5 million in 2014, 2013 and 2012, respectively.
In 2013, we also repurchased 3,477 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $255,454. Of this amount, 444 and 3,033 shares were purchased in January 2013 and July 2013, respectively, for $30,927, or $69.65 per share, and $224,527, or $74.03 per share, respectively, to settle payments due to a retired executive under our long-term incentive plan. These shares were delivered to the plan participant in January 2013 and July 2013.
Less: Net loss attributable to noncontrolling interest in consolidated entity - Exchange
We are involved in litigation arising in the ordinary course of conducting business. In accordance with current accounting standards for loss contingencies and based upon information currently known to us, we establish reserves for litigation when it is probable that a loss associated with a claim or proceeding has been incurred and the amount of the loss or range of loss can be reasonably estimated. When no amount within the range of loss is a better estimate than any other amount, we accrue the minimum amount of the estimable loss. To the extent that such litigation against us may have an exposure to a loss in excess of the amount we have accrued, we believe that such excess would not be material to our consolidated financial condition, results of operations, or cash flows. Legal fees are expensed as incurred. We believe that our accruals for legal proceedings are appropriate and, individually and in the aggregate, are not expected to be material to our consolidated financial condition, operations, or cash flows.
Statutory net income and capital and surplus of the Exchange and its subsidiaries as determined in accordance with SAP prescribed or permitted by insurance regulatory authorities are as follows:
The amount of dividends that can be paid to the Exchange without the prior approval by the Pennsylvania Insurance Commissioner by EFL, a Pennsylvania-domiciled life insurer, is limited by statute to the greater of: (a) 10% of statutory surplus as shown in the last annual statement on file with the commissioner, or (b) net income as reported in the last annual statement, but shall not include pro-rata distribution of any class of the insurer’s own securities. Accordingly, the maximum dividend payout that the Exchange could receive in 2015 without prior Pennsylvania Commissioner approval is $30 million. There were no dividends paid to the Exchange in 2014, 2013 or 2012.
Management fees and expense allocation amounts due from the Exchange were $331 million and $296 million at December 31, 2014 and 2013, respectively. The receivable from EFL for expense allocations and interest on the surplus note totaled