The Erie Insurance Group also operates 25 field offices in 12 states. Of these field offices, 16 provide both agency support and claims services and are referred to as branch offices, while seven provide only claims services and are referred to as claims offices, and two provide only agency support and are referred to as sales offices. Seven field offices are owned by the Erie Insurance Group, while the remaining 18 field offices, one office building and one warehouse facility are leased from unaffiliated parties.
A forward-looking statement speaks only as of the date on which it is made and reflects our analysis only as of that date. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changes in assumptions, or otherwise.
See Item 8. “Financial Statements and Supplementary Data - Note 2, Significant Accounting Policies, of Notes to Consolidated Financial Statements” contained within this report for a discussion of adopted and/or recently issued accounting standards, none of which are expected to have a material impact on our future financial condition, results of operations or cash flows.
The Erie Insurance Group represents the consolidated results of Indemnity and the results of its variable interest entity, the Exchange. The Erie Insurance Group operates predominantly as a property and casualty insurer through its regional insurance carriers that write a broad range of personal and commercial coverages. Our property and casualty insurance companies include the Exchange and its wholly owned subsidiaries, Erie Insurance Company (“EIC”), Erie Insurance Company of New York (“ENY”), Erie Insurance Property and Casualty Company (“EPC”) and Flagship City Insurance Company (“Flagship”). These entities operate collectively as the “Property and Casualty Group.” The Erie Insurance Group also operates as a life insurer through the Exchange’s wholly owned subsidiary, Erie Family Life Insurance Company (“EFL”), which underwrites and sells individual and group life insurance policies and fixed annuities.
The Exchange is a reciprocal insurance exchange organized under Article X of Pennsylvania's Insurance Company Law of 1921 under which individuals, partnerships, and corporations are authorized to exchange reciprocal or inter-insurance contracts with each other, or with individuals, partnerships, and corporations of other states and countries, providing indemnity among themselves from any loss which may be insured against under any provision of the insurance laws except life insurance. Each applicant for insurance to the Exchange signs a subscriber’s agreement, which contains an appointment of Indemnity as their attorney-in-fact to transact the business of the Exchange on their behalf.
Pursuant to the subscriber’s agreement and for its services as attorney-in-fact, Indemnity earns a management fee calculated as a percentage of the direct premiums written by the Exchange and the other members of the Property and Casualty Group, which are assumed by the Exchange under an intercompany pooling arrangement.
The following table represents a breakdown of the composition of the income attributable to the Indemnity shareholder interest and the income attributable to the noncontrolling interest (Exchange). For purposes of this discussion, EFL’s investments are included in the life insurance operations.
The following table reconciles operating income and net income for the Indemnity shareholder interest for the years ended December 31:
The property and casualty insurance operation’s premium growth strategy focuses on growth by expansion of existing operations including a careful agency selection process and increased market penetration in existing operating territories. Expanding the size of our existing agency force of nearly 2,200 independent agencies, with over 11,000 licensed property and casualty representatives, will contribute to future growth as new agents build their books of business with the Property and Casualty Group.
The property and casualty insurance operations insure preferred and standard risks while maintaining a disciplined underwriting approach. The Property and Casualty Group’s principal personal lines products based upon 2014 direct written premiums were private passenger automobile (43%) and homeowners (27%), and the principal commercial lines products were commercial multi-peril (13%), commercial automobile (7%), and workers compensation (7%). Pennsylvania, Maryland, Virginia, North Carolina and Ohio made up 74% of the property and casualty lines insurance business direct written premium in 2014.
Members of the Property and Casualty Group pool the underwriting results under an intercompany pooling agreement. Under the pooling agreement, the Exchange retains a 94.5% interest in the net underwriting results of the Property and Casualty Group, while EIC retains a 5.0% interest, and ENY retains a 0.5% interest.
Factors affecting losses and loss expenses include the frequency and severity of losses, the nature and severity of catastrophic losses, the quality of risks underwritten, and underlying claims and settlement expenses.
Our actuaries review assumed reserve estimates annually for both current and prior accident years. The Property and Casualty Group ceased writing voluntary assumed business in 2003. Outstanding liabilities for the voluntary and involuntary assumed business are immaterial compared to the overall reserves. Our ceded reserves primarily relate to massive injury lifetime medical claims; the ceded estimates for these claims are adjusted when there is a change to the direct reserve estimate. The remainder of the ceded reserves is reviewed by our actuaries annually.
The quarterly reserve reviews incorporate a variety of actuarial methods and judgments and involve rigorous analysis. A comprehensive review is performed of the various estimation methods and reserve levels produced by each. The various
methods generate different estimates of ultimate losses by product line and product coverage combination. Thus, reserves are comprised of a set of point estimates of the ultimate losses developed from the various methods. These multiple reserve point estimates are reviewed by our reserving actuaries and reserve best estimates are selected. The selected reserve estimates are discussed with management.
Numerous factors are considered in setting reserve levels, including, but not limited to, the assessed reliability of key loss trends and assumptions that may significantly influence the current actuarial indications, the maturity of the accident year, pertinent claims frequency and severity trends observed over recent years, the level of volatility within a particular line of business and the improvement or deterioration of actuarial rate indications in the current period as compared to prior periods. Certain methods are considered more credible for each product/coverage combination depending on the maturity of the accident quarter, the mix of business and the particular internal and external influences impacting the claims experience or the method.
Bornhuetter-Ferguson - Bornhuetter-Ferguson is a method of combining the results of the expected-loss-ratio method and the paid or incurred development method. It places more weight on the paid or incurred development method as the accident period matures. The Bornhuetter-Ferguson method is generally used for less mature accident periods on the long-tail coverages because a low percentage of losses are paid or incurred in the early period of development.
Massive injury lifetime medical claims (such as certain auto no-fault and workers compensation claims) - These claims develop over a long period of time and are relatively few in number. We utilize the individual claim method to evaluate each claim’s ultimate losses.
Occasionally, unusual aberrations in loss development patterns are caused by external and internal factors such as changes in claim reporting and/or settlement patterns, unusually large losses, process changes, legal or regulatory changes and other influences. In these instances, analyses of alternate development factor selections are performed to evaluate the effect of these factors and actuarial judgment is applied to make appropriate assumptions needed to develop a best estimate of ultimate losses.
Claims with atypical emergence patterns - Characteristics of certain subsets of claims, such as those with high severity, have the potential to distort patterns contained in historical paid loss and reported loss data. When testing indicates this to be the case for a particular subset of claims, our actuaries segregate these claims from the data and analyze them separately.
The property and casualty reserves with the greatest potential for variation are the massive injury lifetime medical reserves. These claims arise from the automobile no-fault law in Pennsylvania before 1986 and workers compensation policies which provide unlimited medical benefits. The estimate of ultimate liabilities for these claims is subject to significant judgment due to variations in claimant health, mortality over time and health care cost trends. These claims have been segregated from the total population of claims. Ultimate losses for these claims are estimated on a claim-by-claim basis. We are currently reserving for 245 claimants requiring lifetime medical care, of which 97 involve massive injuries. The annual payment is projected into the future based upon particular assumptions of the future inflation rate and life expectancy of the claimant. The most significant variable in estimating this liability is medical cost inflation. The life expectancy (mortality rate) assumption underlying the estimate reflects the gender specific disabled pensioner mortality table. Actual experience, however, may emerge in a manner that is different relative to the original assumptions, which could have a significant impact on our reserve estimates.
Auto no-fault (massive injury lifetime medical claims) - The automobile massive injury gross reserve carried by the Property and Casualty Group totaled $330 million at December 31, 2014, compared to $345 million at December 31, 2013. The slight decrease in the pre-1986 automobile massive injury reserves in 2014, compared to 2013, was due to continued payments on these claims. A 100-basis point increase in the medical cost inflation assumption would result in an increase in the Property and Casualty Group’s gross year-end reserve of $64 million. This increase in the medical cost inflation assumption would also increase the reinsurance recoverable related to these reserves by $25 million, resulting in a $39 million increase in the net reserve.
We also perform analyses to evaluate the adequacy of past total reserve levels for the Property and Casualty Group. Previously established estimates for reserves were not materially different than those determined in these retrospective analyses. At December 31, 2014, our current estimate of direct loss reserves, including salvage and subrogation for accident years 2013 and prior is $120 million, or 3.2% less than the reserve amount we had established at December 31, 2013. At December 31, 2013, our estimate of direct loss reserves, including salvage and subrogation recoveries for accident years 2012 and prior was
Reserves for traditional life insurance future policy benefits are computed primarily by the net level premium method. Generally, benefits are payable over an extended period of time and related reserves are calculated as the present value of future expected benefits to be paid reduced by the present value of future expected net premiums. Such reserves are established based upon methods and underlying assumptions in accordance with GAAP and applicable actuarial standards. Principal assumptions used in the establishment of policy reserves are mortality, lapses, expenses, and investment yields. Mortality assumptions are based upon tables typically used in the industry, modified to reflect actual experience and to include a provision for the risk of adverse deviation where appropriate. Lapse, expense, and investment yield assumptions are based upon actual company experience and may include a provision for the risk of adverse deviation. Assumptions on these policies are locked in at the time of issue and are not subject to change unless a premium deficiency exists. A premium deficiency exists if, based upon revised assumptions, the existing contract liabilities together with the present value of future gross premiums are not sufficient
to cover the present value of future expected benefits and maintenance costs and to recover unamortized acquisition costs. Historically, our reserves plus expected gross premiums have been demonstrated to be sufficient. There were no premium deficiencies in 2014, 2013 or 2012.
Reserves for universal life and deferred annuity plans are primarily based upon the contract account balance without reduction for surrender charges.
An active market is one in which transactions for the assets being valued occur with sufficient frequency and volume to provide reliable pricing information.
Level 2 includes those financial instruments that are valued using industry-standard models that consider various inputs, such as the interest rate and credit spread for the underlying financial instruments. All significant inputs are observable, or derived from observable information in the marketplace, or are supported by observable levels at which transactions are executed in the marketplace. Financial instruments in this category primarily include corporate bonds, municipal bonds, structured securities, redeemable preferred stock and certain nonredeemable preferred stock.
Level 3 securities are valued based upon unobservable inputs, reflecting our estimates of value based upon assumptions used by market participants. Securities are assigned to Level 3 in cases where non-binding broker quotes are significant to the valuation and there is a lack of transparency as to whether these quotes are based upon information that is observable in the
Estimates of fair values for our investment portfolio are obtained primarily from a nationally recognized pricing service. Our Level 1 category includes those securities valued using an exchange traded price provided by the pricing service. The methodologies used by the pricing service that support a Level 2 classification of a financial instrument include multiple verifiable, observable inputs including benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data. Pricing service valuations for Level 3 securities are based upon proprietary models and are used when observable inputs are not available in illiquid markets. In limited circumstances we adjust the price received from the pricing service when, in our judgment, a better reflection of fair value is available based upon corroborating information and our knowledge and monitoring of market conditions such as a disparity in price of comparable securities and/or non-binding broker quotes. In other circumstances, certain securities are internally priced because prices are not provided by the pricing service.
Investments are evaluated monthly for other-than-temporary impairment loss. Some factors considered in evaluating whether or not a decline in fair value is other-than-temporary include:
intent to sell or more likely than not be required to sell (debt securities); and
ability and intent to retain the investment for a period of time sufficient to allow for a recovery in value (equity securities).
The majority of our limited partnership holdings are considered investment companies where the general partners record assets at fair value. These limited partnerships are recorded using the equity method of accounting. 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. Fair value provides consistency in the evaluation and financial reporting for these limited partnerships and limited partnerships accounted for under the equity method.
DAC on life insurance and investment-type contracts are amortized in proportion to gross premiums or gross profits, depending on the type of contract. DAC related to traditional life insurance products is amortized in proportion to premium revenues over the premium-paying period of related policies using assumptions consistent with those used in computing policy liability reserves. These assumptions are not revised after policy issuance unless the DAC balance is deemed to be unrecoverable from future expected profits. In any period where the actual policy terminations are higher (lower) than anticipated policy terminations, DAC amortization will be accelerated (decelerated) in that period.
The actuarial assumptions used to determine investment, mortality, and expense margins and surrender charges for universal life products and deferred annuities are reviewed periodically, are based upon best estimates and do not include any provision for the risk of adverse deviation. If actuarial analysis indicates that expectations have changed, the actuarial assumptions are updated and the investment, mortality, and expense margins and surrender charges are unlocked. If this unlocking results in a decrease in the present value of future expected gross profits, DAC amortization for the period will increase. If this unlocking results in an increase in the present value of future expected gross profits, DAC amortization for the current period will decrease.
Deferred tax assets represent the tax benefit of future deductible temporary differences and operating loss and tax credit carry-forwards. Deferred tax assets are measured using the enacted tax rates expected to be in effect when such benefits are realized. We perform an analysis of our deferred tax assets to determine recoverability on a quarterly basis for each legal entity, by character of the income (ordinary or capital). Deferred tax assets are reduced by a valuation allowance, if based upon the weight of available evidence, it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. In determining the need for a valuation allowance, we consider carry-back capacity, reversal of existing temporary differences, future taxable income and tax planning strategies. The determination of the valuation allowance for our deferred tax assets requires us to make certain judgments and assumptions regarding future operations that are based upon our historical experience and our expectations of future performance. Our judgments and assumptions are subject to change given the inherent uncertainty in predicting future performance, which is impacted by such things as financial market conditions, policyholder behavior, competitor pricing, new product introductions, and specific industry and economic conditions.
Our pension obligation is developed from actuarial estimates. Several statistical and other factors, which attempt to anticipate future events, are used in calculating the expense and liability related to the plans. Key factors include assumptions about the discount rates and expected rates of return on plan assets. We review these assumptions annually and modify them considering historical experience, current market conditions, including changes in investment returns and interest rates and expected future trends.
Unrecognized actuarial gains and losses arise from several factors, including experience and assumption changes in the obligations and from the difference between expected returns and actual returns on plan assets. These unrecognized gains and losses are recorded in the pension plan obligation and accumulated other comprehensive income (loss) on the Consolidated Statements of Financial Position. These amounts are systematically recognized to net periodic pension expense in future periods, with gains decreasing and losses increasing future pension expense. If actuarial net gains or losses exceed 5% of the greater of the projected benefit obligation and the market-related value of plan assets, the excess is recognized through the net periodic pension expense equally over the estimated service period of the employee group, which is currently 14 years.
The expected long-term rate of return for the pension plan represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. The expected long-term rate of return is less susceptible to annual revisions, as there are typically no significant changes in the asset mix. To determine the expected long-term rate of return assumption, we utilized models based upon rigorous historical analysis and forward-looking views of the financial markets based upon key factors such as historical returns for the asset class' applicable indices, the correlations of the asset classes under various market conditions and consensus views on future real economic growth and inflation. The expected future return for each asset class is then combined by considering correlations between asset classes and the volatilities of each asset class to produce a reasonable range of asset return results within which our expected long-term rate of return assumption falls. A change of 25 basis points in the expected long-term rate of return assumption, with other assumptions held constant, would have an estimated $1.3 million impact on net pension benefit cost in the following year, of which Indemnity’s share would be approximately $0.6 million.
We use a four year averaging method to determine the market-related value of plan assets, which is used to determine the expected return component of pension expense. Under this methodology, asset gains or losses that result from returns that differ from our long-term rate of return assumption are recognized in the market-related value of assets on a level basis over a four year period. The market-related asset experience during 2014 that related to the actual investment return being different from that assumed during the prior year was a gain of $42 million. Recognition of this gain will be deferred and recognized over a four year period, consistent with the market-related asset value methodology. Once factored into the market-related asset value, these experience gains and losses will be amortized over a period of 14 years, which is the remaining service period of the employee group.
Estimates of fair values of the pension plan assets are obtained primarily from our trustee and custodian of our pension plan. Our Level 1 category includes a money market fund that is a mutual fund for which the fair value is determined using an exchange traded price provided by the trustee and custodian. Our Level 2 category includes commingled pools. Estimates of fair values for securities held by our commingled pools are obtained primarily from the trustee and custodian. The methodologies used by the trustee and custodian that support a financial instrument Level 2 classification include multiple verifiable, observable inputs including benchmark yields, reported trades, broker/dealer quotes, issuers spreads, two-sided markets, benchmark securities, bids, offers, and reference data. There were no Level 3 investments in 2014 or 2013.
We expect our net pension benefit costs to increase from $26 million in 2014 to $39 million in 2015. This increase is due to both the lower discount rate and the adoption of the newly issued mortality tables, partially offset by a change in other plan assumptions that were updated to reflect our most recent actual experience. Indemnity’s share of the net pension benefit costs after reimbursements will increase from $12 million in 2014 to approximately $17 million in 2015.
The actuarial assumptions we used in determining our pension obligation may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates, or longer or shorter life spans of participants. While we believe that the assumptions used are appropriate, differences in actual experience or changes in assumptions may materially affect our financial position, results of operations, or cash flows. See Item 8. “Financial Statements and Supplementary Data - Note 15, Postretirement Benefits, of Notes to Consolidated Financial Statements” contained within this report for additional details on the pension plans.
Management fee revenue increased $110 million, or 8.7%, in 2014, compared to 2013. Direct written premium of the Property and Casualty Group increased 8.6% in 2014, compared to 2013, due to a 4.3% increase in policies in force and a 4.2% increase in the year-over-year average premium per policy for all lines of business. The year-over-year policy retention ratio was 90.3% at December 31, 2014, 90.6% at December 31, 2013, and 90.9% at December 31, 2012. See the “Property and Casualty Insurance Operations” segment that follows for a complete discussion of property and casualty direct written premium, which has a direct bearing on Indemnity’s management fee. The management fee rate was set at 25%, the maximum rate, for 2014, 2013 and 2012. The management fee rate for 2015 was set at 25% by our Board of Directors. Changes in the management fee rate can affect the Indemnity shareholder interest's revenue and net income from this segment significantly. See also, the “Transactions/Agreements between Indemnity and Noncontrolling Interest (Exchange), Board Oversight” section within this report.
Commissions - Commissions increased $73 million in 2014 compared to 2013, and increased $75 million in 2013 compared to 2012, primarily as a result of the 8.6% and 9.6% respective increases in direct written premiums of the Property and Casualty Group. Commission growth outpaced direct written premium growth in 2014 and 2013 primarily due to an increase in agent incentive costs related to profitable growth. Also impacting the increase in 2013 was an adjustment that reduced commission expense by $6 million in 2012. This amount represented the reimbursement by the North Carolina Reinsurance Facility (NCRF) for commissions Indemnity paid to agents on the surcharges collected on behalf of the NCRF which was incorrectly recorded as a benefit to the Exchange in prior periods.
The Property and Casualty Group operates in 12 Midwestern, Mid-Atlantic, and Southeastern states and the District of Columbia and primarily writes private passenger automobile, homeowners, commercial multi-peril, commercial automobile, and workers compensation lines of insurance. A summary of the results of our property and casualty insurance operations is as follows:
Premiums generated from new business increased 5.8% to $695 million in 2014, compared to 15.6%, or $656 million, in 2013. Underlying the trend in new business premiums was a 2.9% increase in new business policies written in 2014, compared to 13.6% in 2013, while the year-over-year average premium per policy on new business increased 2.9% at December 31, 2014, compared to 1.8% at December 31, 2013.
The Property and Casualty Group implemented rate increases in 2014, 2013, and 2012 in order to meet loss cost expectations.
As the Property and Casualty Group writes policies with annual terms only, rate actions take 12 months to be fully recognized in written premium and 24 months to be fully recognized in earned premiums. Since rate changes are realized at renewal, it takes 12 months to implement a rate change to all policyholders and another 12 months to earn the increased or decreased premiums in full. As a result, certain rate actions approved in 2013 were reflected in 2014, and recent rate actions in 2014 will be reflected in 2015. The Property and Casualty Group continuously evaluates pricing and product offerings to meet consumer demands.
Personal lines - Total personal lines premiums written increased 7.9% to $3.9 billion in 2014, from $3.6 billion in 2013, driven by an increase of 4.3% in total personal lines policies in force and an increase of 3.5% in the total personal lines year-over-year average premium per policy.
Private passenger auto new business premiums written increased 7.3% in 2014, compared to 22.8% in 2013. New business policies written for private passenger auto increased 3.7% in 2014, compared to 19.5% in 2013, while the new business year-over-year average premium per policy for private passenger auto increased 3.6% at December 31, 2014, compared to 2.8% at December 31, 2013.
Homeowners renewal premiums written increased 11.2% in 2014, compared to 12.2% in 2013. The year-over-year average premium per policy on homeowners renewal business increased 6.7% at December 31, 2014, compared to 8.4% in 2013. The homeowners year-over-year policyholder retention ratio was 89.8% at December 31, 2014, 90.1% at December 31, 2013, and 90.9% at December 31, 2012.
Commercial lines - Total commercial lines premiums written increased 10.4%, to $1.6 billion in 2014, from $1.5 billion in 2013, driven by a 4.4% increase in total commercial lines policies in force and a 5.7% increase in the total commercial lines year-over-year average premium per policy.
New business premiums written on commercial lines increased 5.5% in 2014, compared to 6.3% in 2013, driven by increases in new business policies written seen across all major commercial lines of business and average premium per policy. Commercial lines new business policies written increased 2.2% in 2014, compared to 4.6% in 2013, while the year-over-year average premium per policy on commercial lines new business increased 3.2% at December 31, 2014, compared to 1.6% at December 31, 2013.
commercial multi-peril line of business, and to a lesser extent in the commercial auto and workers compensation lines of business. The year-over-year average premium per policy on commercial lines renewal business increased 6.0% in 2014, compared to 7.2% in 2013. The year-over-year policy retention ratio for commercial lines was 86.5% at December 31, 2014, 86.7% at December 31, 2013, and 86.2% at December 31, 2012.
Future trends-premium revenue - We plan to continue our efforts to grow Property and Casualty Group premiums and improve our competitive position in the marketplace. Expanding the size of our agency force through a careful agency selection process and increased market penetration in our existing operating territories will contribute to future growth as existing and new agents build their books of business with the Property and Casualty Group. At December 31, 2014, we had nearly 2,200 agencies with over 11,000 licensed property and casualty representatives. The Property and Casualty Group began writing private passenger automobile, home insurance, and personal excess liability insurance in Kentucky in the fourth quarter of 2014.
The Property and Casualty Group maintains property catastrophe reinsurance coverage from unaffiliated reinsurers to mitigate future potential catastrophe loss exposures and no longer participates in the voluntary assumed reinsurance business, which lowers the variability of the Property and Casualty Group’s underwriting results. The property catastrophe reinsurance coverage during 2014 included a first treaty providing coverage of up to 30% of a loss of $100 million in excess of the Property and Casualty Group’s loss retention of $300 million per occurrence, a second treaty providing coverage of up to 90% of a loss of $500 million in excess of $400 million, a third treaty providing coverage of up to 85% of a loss of $200 million in excess of $900 million, and a fourth treaty providing coverage of up to 100% of a loss of $25 million in excess of $1.1 billion. The property catastrophe reinsurance coverage that became effective for January 1, 2015 included a first property catastrophe reinsurance treaty providing coverage of up to 35% of a loss of $100 million in excess of the Property and Casualty Group’s loss retention of $300 million per occurrence, a second treaty providing coverage of up to 90% of a loss of $500 million in excess of $400 million, a third treaty providing coverage of up to 86% of a loss of $200 million in excess of $900 million, and a fourth treaty providing coverage of up to 100% of a loss of $25 million in excess of $1.1 billion.
While the Property and Casualty Group is exposed to terrorism losses in commercial lines, including workers compensation, these lines are afforded a limited backstop above insurer deductibles for foreign acts of terrorism under the federal Terrorism Risk Insurance Program Reauthorization and Extension Act of 2015 that continues through December 31, 2020. There is no federal assistance for personal lines terrorism losses. Although current models suggest the most likely occurrences would not have a material impact on the Property and Casualty Group, there is a chance that if future terrorism attacks occur, the Property and Casualty Group could incur large losses.
Catastrophe losses for the current accident year, as defined by the Property and Casualty Group, totaled $395 million in 2014, $162 million in 2013, and $489 million in 2012, and contributed 7.5 points, 3.4 points and 11.0 points to the respective loss ratios. For 2014, catastrophe losses primarily resulted from many smaller events across our footprint and one large hail event in Pennsylvania.
Direct business, including reserves for catastrophe losses and salvage and subrogation - The following table presents the overall prior year loss development of direct reserves, including reserves for catastrophe losses and the effects of salvage and subrogation recoveries, for our personal and commercial lines' operations by accident year:
Favorable development of $54 million related to the homeowners line of business primarily resulting from improved claims frequency trends, which impacted the 2011 accident year, better than expected severity trends, which impacted the 2007 through 2011 accident years, and the closing of one large claim which impacted the 2010 accident year.
Favorable development of $42 million related to the commercial multi-peril line of business primarily resulting from better than expected severity trends, which impacted the 2007 through 2011 accident years, and the closing of two large claims which impacted the 2006 through 2010 accident years.
Assumed reinsurance - The Property and Casualty Group experienced adverse development on prior accident year loss reserves for its assumed involuntary reinsurance business totaling $4 million in 2014, compared to favorable development of
Policy acquisition and other underwriting expenses - Our policy acquisition and other underwriting expense ratio decreased 0.3% points to 28.5% in 2014, from 28.8% in 2013, and decreased 0.3 points in 2013 from 29.1% in 2012. Additionally, 2012 included an adjustment of $4 million which contributed 0.1 points to the combined ratio at December 31, 2012. This adjustment represents the reimbursement by the North Carolina Reinsurance Facility (NCRF) for commissions Indemnity paid to agents on the surcharges collected on behalf of the NCRF which was incorrectly recorded as a benefit to the Exchange in prior periods. The management fee rate was 25.0% in 2014, 2013 and 2012.
EFL is a Pennsylvania-domiciled life insurance company which underwrites and sells individual and group life insurance policies and fixed annuities and operates in 11 states and the District of Columbia. EFL began writing life insurance and annuity products in Kentucky in the fourth quarter of 2014. A summary of the results of our life insurance operations is as follows:
Gross policy revenues increased 5.1% to $127 million in 2014, compared to $121 million in 2013, and $116 million in 2012. EFL uses, and has used, a variety of reinsurance programs to reduce claims volatility and for other financial benefits. While the amount of risk that EFL retains can vary based upon the type of policy issued and the year it was issued, EFL generally does not retain more than $1 million of risk on any individual life. Ceded reinsurance premiums totaled $41 million in 2014 and 2013, and $43 million in 2012.
Annuity and universal life premiums that are recorded as deposits totaled $65 million, $59 million, and $58 million in 2014, 2013 and 2012, respectively, and therefore are not reflected in individual and group life premiums in the table above.
$7 million in 2013, compared to 2012, while earnings for the Exchange decreased by $37 million and increased by $23 million during the same respective periods. These changes in earnings for both Indemnity and the Exchange were the result of lower earnings from each investment sector in 2014, and primarily due to higher earnings from real estate investments in 2013.
We generate revenues from our fixed maturity, equity security and limited partnership investment portfolios to support our underwriting business. The Indemnity and Exchange portfolios are managed with the objective of maximizing after-tax returns on a risk-adjusted basis, while the EFL portfolio is managed to be closely aligned to its liabilities and to maintain a sufficient yield to meet profitability targets.
During 2014, Indemnity increased its investments in non-investment grade fixed maturities from less than 1% of total invested assets at December 31, 2013 to 9% of total invested assets at December 31, 2014. The increase during 2014 was primarily funded by cash flows from limited partnership distributions. The Exchange also increased its investment in non-investment grade fixed maturities during 2014 from 2% of total invested assets at December 31, 2013 to 5% of total invested assets at December 31, 2014. The increase during 2014 was primarily funded by cash flows from the sale of common stock and limited partnership distributions.
We continually review our investment portfolio to evaluate positions that might incur other-than-temporary declines in value. We record impairment writedowns on investments in instances where the fair value of the investment is substantially below cost, and we conclude that the decline in fair value is other-than-temporary, which includes consideration for intent to sell.
We individually analyze all positions with emphasis on those that have, in our opinion, declined significantly below cost. In compliance with impairment guidance for debt securities, we perform further analysis to determine if a credit-related impairment has occurred. Some of the factors considered in determining whether a debt security is credit impaired include potential for the default of interest and/or principal, level of subordination, collateral of the issue, compliance with financial covenants, credit ratings and industry conditions. We have the intent to sell all credit-impaired debt securities, therefore the
entire amount of the impairment charges are included in earnings and no impairments are recorded in other comprehensive income. For available-for-sale equity securities, a charge is recorded in the Consolidated Statements of Operations for positions that have experienced other-than-temporary impairments. (See the “Investment Operations” section herein for further information.) We believe our investment valuation philosophy and accounting practices result in appropriate and timely measurement of value and recognition of impairment.
Under our investment strategy, we maintain a fixed maturity portfolio that is of high quality and well diversified within each market sector. This investment strategy also achieves a balanced maturity schedule. Our fixed maturity portfolio is managed with the goal of achieving reasonable returns while limiting exposure to risk. Our municipal bond portfolio accounts for
In 2014, investments in limited partnerships decreased for both Indemnity and the Exchange from the investment levels at December 31, 2013. Changes in partnership values are a function of contributions and distributions, adjusted for market value changes in the underlying investments. The decrease in limited partnership investments was due to net distributions received from the partnerships which were partially offset by increases in underlying asset values. Indemnity has made no new limited partnership commitments since 2006, and the balance of its limited partnership investments is expected to decline over time as additional distributions are received. The results from our limited partnerships are based upon financial statements received from our general partners, which are generally received on a quarter lag. As a result, the market values and earnings recorded at December 31, 2014 reflect the partnership activity experienced during the twelve month period ending September 30, 2014.
Loss reserves are established to account for the estimated ultimate costs of losses and loss expenses for claims that have been reported but not yet settled and claims that have been incurred but not reported. While we exercise professional diligence to establish reserves at the end of each period that are fully reflective of the ultimate value of all claims incurred, these reserves are, by nature, only estimates and cannot be established with absolute certainty.
The reserves that have the greatest potential for variation are the massive injury lifetime medical claim reserves. The Property and Casualty Group is currently reserving for 245 claimants requiring lifetime medical care, of which 97 involve massive injuries. The reserve carried by the Property and Casualty Group for the massive injury claimants, which includes automobile massive injury and workers compensation massive injury reserves, totaled $274 million at December 31, 2014, which is net of $138 million of anticipated reinsurance recoverables, compared to $291 million at December 31, 2013, which was net of
$148 million of anticipated reinsurance recoverables. The pre-1986 automobile and workers compensation massive injury gross reserves both decreased at December 31, 2014, compared to December 31, 2013, primarily due to continued payments on the pre-1986 automobile massive injury claims and the settlement of two workers compensation massive injury claims, offset somewhat by the addition of two new workers compensation massive injury claims, respectively.
The estimation of ultimate liabilities for these claims is subject to significant judgment due to variations in medical cost inflation, claimant health, and mortality over time. It is anticipated that these massive injury lifetime medical claims will require payments over the next 30 to 40 years. Actual experience, however, may emerge in a manner that is different relative to the original assumptions, which could have a significant impact on our reserve estimates. A 100-basis point increase in the medical cost inflation assumption would result in an increase in the combined automobile and workers compensation massive injury gross reserves of $84 million and a $41 million increase in the reinsurance recoverable and the workers compensation discount, resulting in a $43 million increase in the net reserve. Massive injury claims payments totaled $12 million,
$15 million, and $13 million in 2014, 2013 and 2012, respectively.
The funded status of our postretirement benefit plans is recognized in the statement of financial position, with a corresponding adjustment to accumulated other comprehensive income, net of tax. At December 31, 2014, shareholders’ equity decreased by $60 million, net of tax, of which $5 million represents amortization of the prior service cost and net actuarial loss and
Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet the short- and long-term cash requirements of its business operations and growth needs. Our liquidity requirements have been met primarily by funds generated from premiums collected and income from investments. Our insurance operations provide liquidity in that premiums are collected in advance of paying losses under the policies purchased with those premiums. Cash outflows for the property and casualty insurance operations are generally variable since settlement dates for liabilities for unpaid losses and the potential for large losses, whether individual or in the aggregate, cannot be predicted with absolute certainty. Accordingly, after satisfying our operating cash requirements, excess cash flows are used to build our investment operation's portfolios in order to increase future investment income, which then may be used as a source of liquidity if cash from our insurance operations would not be sufficient to meet our obligations. Cash provided from these sources is used primarily to fund losses and policyholder benefits, fund the costs of our management operations including commissions, salaries and wages, pension plans, share repurchases, dividends to shareholders, and the purchase and development of information technology. We expect that our operating cash needs will be met by funds generated from operations.
Volatility in the financial markets presents challenges to us as we do occasionally access our investment portfolio as a source of cash. Some of our fixed income investments, despite being publicly traded, are illiquid. Volatility in these markets could impair our ability to sell certain of our fixed income securities or cause such securities to sell at deep discounts. Additionally, our limited partnership investments are significantly less liquid. We believe we have sufficient liquidity to meet our needs from other sources even if market volatility persists throughout 2015.
Net cash provided by operating activities totaled $779 million in 2014, $903 million in 2013, and $577 million in 2012. Decreased cash from operating activities in 2014 was driven primarily by increases in losses and loss expense paid, commissions and bonuses paid to agents, and other underwriting and acquisition costs, combined with a decrease in limited partnership distributions received. Somewhat offsetting this decrease in cash provided was an increase in premiums collected by the Exchange, driven by the increase in premiums written, and an increase in net investment income received, combined with a decrease in income taxes paid, compared to 2013. The increase in 2013, compared to 2012, was primarily due to an increase in premiums collected by the Exchange driven by the increase in premiums written, a decrease in losses and loss expense paid, and a slight increase in limited partnership distributions received. Somewhat offsetting this increase in cash was an increase in income taxes and other underwriting and acquisition costs paid, and a slight decrease in net investment income received, compared to 2012.
$167 million. Changes in investing activities in 2013 primarily included an increase in certain fixed maturity purchases and decreased cash generated from the sale of common stocks, offset somewhat by a decrease in other common stock purchases, compared to 2012.
For a discussion of net cash used in financing activities, see the following “Cash flow activities - Indemnity,” for the primary drivers of financing cash flows related to the Indemnity shareholder interest.
$150 million with no time limitation. This repurchase authority includes, and is not in addition to, any unspent amounts remaining under the prior authorization. Indemnity had approximately $18 million of repurchase authority remaining under this program at December 31, 2014, based upon trade date.
1) Indemnity’s cash and cash equivalents, which total approximately $92 million at December 31, 2014, 2) a $100 million bank revolving line of credit held by Indemnity, and 3) liquidation of assets held in Indemnity’s investment portfolio, including common stock, preferred stock, and investment grade bonds which totaled approximately $411 million at December 31, 2014. Volatility in the financial markets could impair Indemnity’s ability to sell certain of its fixed income securities or cause such securities to sell at deep discounts. Additionally, Indemnity has the ability to curtail or modify discretionary cash outlays such as those related to shareholder dividends and share repurchase activities.
$114 million were pledged as collateral on the line at December 31, 2014. These securities have no trading restrictions and are reported as available-for-sale fixed maturities in the Consolidated Statements of Financial Position. The bank requires compliance with certain covenants, which include leverage ratios. Indemnity was in compliance with its bank covenants at December 31, 2014.
1) the Exchange’s cash and cash equivalents, which total approximately $422 million at December 31, 2014, 2) a $300 million bank revolving line of credit held by the Exchange, and 3) liquidation of assets held in the Exchange’s investment portfolio, including common stock, preferred stock, and investment grade bonds which totaled approximately $12.1 billion at December 31, 2014. Volatility in the financial markets could impair the Exchange’s ability to sell certain of its fixed income securities or cause such securities to sell at deep discounts.
Indemnity has no rights to the assets, capital, or line of credit of the Exchange and, conversely, the Exchange has no rights to the assets, capital, or line of credit of Indemnity. We believe we have the funding sources available to us to support our cash flow requirements in 2015.
Cash outflows for the Property and Casualty Group are variable as fluctuations in settlement dates for claims payments vary and cannot be predicted with absolute certainty. While volatility in claims payments could be significant, the cash flow requirements for claims have not historically had a significant effect on our liquidity. Based upon a historical 15 year average, approximately 35% of losses and loss expenses included in reserves for the Property and Casualty Group are settled within the first 12 months, and approximately 80% are settled within the first five years. Amounts that are paid after the first five years reflect long-tail lines such as workers compensation and auto bodily injury.
We have certain obligations and commitments to make future payments under various contracts. As of December 31, 2014, the aggregate obligations were as follows:
Life gross long-term liabilities represent estimated benefit payments from insurance policies and annuity contracts including claims currently payable. Actual obligations in any single year will vary based upon actual mortality, morbidity, lapse, and withdrawal experience. The sum of these obligations exceeds the liability on the Consolidated Statements of Financial Position of $1.8 billion due to expected future premiums and investment income that, along with invested assets backing the liabilities, will be used to fund these obligations.
Off-balance sheet arrangements include those with unconsolidated entities that may have a material current or future effect on our financial condition or results of operations, including material variable interests in unconsolidated entities that conduct certain activities. We have no material off-balance sheet obligations or guarantees, other than limited partnership investment commitments.
Our property and casualty insurers are rated by rating agencies that provide insurance consumers with meaningful information on the financial strength of insurance entities. Higher ratings generally indicate financial stability and a strong ability to pay claims. The ratings are generally based upon factors relevant to policyholders and are not directed toward return to investors. The insurers of the Property and Casualty Group are currently rated by A.M. Best Company as follows:
The members of the Property and Casualty Group and EFL are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid without prior approval by insurance regulatory authorities. The Exchange’s property and casualty insurance subsidiaries have a maximum of $35 million available for such dividends in 2015 without prior approval by the Pennsylvania Insurance Commissioner for Pennsylvania-domiciled subsidiaries and the New York Superintendent of Insurance for the New York domiciled subsidiary. No dividends were paid from the property and casualty insurance subsidiaries in 2014, 2013, or 2012.
The maximum dividend EFL could pay the Exchange in 2015 without prior approval is $30 million. No dividends were paid by EFL in 2014, 2013 or 2012.
The role of our Enterprise Risk Management ("ERM") function is to ensure that all significant risks are clearly identified, understood, proactively managed and consistently monitored to achieve strategic objectives for all stakeholders of the Erie Insurance Group. See Item 1A “Risk Factors” contained in this report for a list of risk factors related to the Erie Insurance Group.
Insurers are required to regularly conduct an Own Risk and Solvency Assessment (“ORSA”) starting in 2015. ORSA regulation requires insurance companies to document their risk management framework, assess individual material risks, and test group capital and solvency. This will allow regulators to form an enhanced view of an insurer’s ability to withstand stress.
The Exchange leases certain office space to Indemnity, including the home office and four field office facilities, with one field office owned by EFL. Rents are determined considering returns on invested capital and building operating and overhead costs. Rental costs of shared facilities are allocated based upon square footage occupied.
Indemnity has significant receivables from the Exchange that result in a concentration of credit risk. These receivables include management fees due for services performed by Indemnity for the Exchange under the subscriber’s agreement, and costs Indemnity pays on behalf of the Exchange. We periodically evaluate credit risks related to the receivables from the Exchange. Indemnity also pays certain costs for, and is reimbursed monthly by, EFL. The receivable from the Exchange for management fees and costs Indemnity pays on behalf of the Exchange is settled monthly.
Indemnity holds a surplus note for $25 million from EFL that is payable on demand on or after December 31, 2018; however, no principal or interest payments may be made without prior approval by the Pennsylvania Insurance Commissioner. Interest payments are scheduled to be paid semi-annually. Indemnity recognized interest income on the note of $2 million in both 2014 and 2013.
We have audited the accompanying consolidated statements of financial position of Erie Indemnity Company as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income, shareholders' equity and noncontrolling interest, and cash flows for each of the three years in the period ended December 31, 2014. Our audits also included the financial statement schedules listed in the Index at 15 (a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Erie Indemnity Company's internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission 2013 framework and our report dated February 26, 2015 expressed an unqualified opinion thereon.
See accompanying notes to Consolidated Financial Statements. See Note 18, "Indemnity Accumulated Other Comprehensive Loss," for amounts reclassified out of accumulated other comprehensive income (loss) into the Consolidated Statements of Operations. See Note 22, “Indemnity Supplemental Information,” for supplemental statements of operations information.
Change in unrealized holding gains (losses) on available-for-sale securities, net of tax (expense) benefit of $(42), $125, and $(121), respectively
Trading securities, at fair value (cost of $2,289 and $2,198, respectively)
Dividends declared - Class A ($2.586, $2.4125 and $4.25 per share, respectively)
See accompanying notes to Consolidated Financial Statements. See Note 20, “Supplementary Data on Cash Flows,” and Note 22, “Indemnity Supplemental Information,” for supplemental cash flow information.
Indemnity’s primary function is to perform certain services for the Exchange relating to the sales, underwriting, and issuance of policies on behalf of the Exchange. This is done in accordance with a subscriber’s agreement (a limited power of attorney) executed by each subscriber (policyholder), which appoints Indemnity as their common attorney-in-fact to transact business on their behalf and to manage the affairs of the Exchange. Pursuant to the subscriber’s agreement and for its services as attorney-in-fact, Indemnity earns a management fee calculated as a percentage of the direct premiums written by the Exchange and the other members of the Property and Casualty Group (defined below), which are assumed by the Exchange under an intercompany pooling arrangement.
The Exchange, together with its wholly owned subsidiaries, Erie Insurance Company (“EIC”), Erie Insurance Company of New York (“ENY”), Erie Insurance Property and Casualty Company (“EPC”), and Flagship City Insurance Company (“Flagship”), operate as a property and casualty insurer and are collectively referred to as the “Property and Casualty Group”. The Property and Casualty Group operates in 12 Midwestern, Mid-Atlantic, and Southeastern states and the District of Columbia and primarily writes private passenger auto (43%), homeowners (27%), commercial multi-peril (13%), commercial automobile (7%), and workers compensation (7%) lines of insurance based upon 2014 direct written premiums.
Erie Family Life Insurance Company (“EFL”), a wholly owned subsidiary of the Exchange, operates as a life insurer that underwrites and sells individual and group life insurance policies and fixed annuities.
The Property & Casualty Group and EFL began writing private passenger automobile, home insurance, personal excess liability insurance, and life insurance and annuity products in Kentucky in the fourth quarter of 2014.
The consolidated financial statements of Erie Indemnity Company reflect the results of Indemnity and its variable interest entity, the Exchange, which we refer to collectively as the “Erie Insurance Group” (“we,” “us,” “our”).
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. ASU 2014-09 clarifies the
that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the
Common stock securities classified as available-for-sale represent certain exchange traded funds with underlying holdings of fixed maturity securities.
Other-than-temporary impairment charges on non-redeemable preferred securities, hybrid securities with equity characteristics and common stock are included in earnings consistent with the treatment for equity securities.
Deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and the reported amounts in the consolidated financial statements, using the statutory tax rates in effect for the year in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date under the law. Valuation allowances on deferred tax assets are estimated based upon our assessment of the realizability of such amounts.
experience, trends, and other relevant factors. The uncertainties involved with the reserving process include internal factors, such as changes in claims handling procedures, as well as external factors, such as economic trends and changes in the concepts of legal liability and damage awards. Accordingly, final loss settlements may vary from the present estimates, particularly when those payments may not occur until well into the future.
Agent bonuses are based upon an individual agency’s property and casualty underwriting profitability and also include a component for growth in agency property and casualty premiums if the agency’s underwriting profitability targets for our book of business are met. The estimate for agent bonuses, which are based upon the performance over 36 months, is modeled on a monthly basis using actual underwriting data by agency for the prior two years combined with the current year-to-date actual data.
Property and casualty insurance - Property and casualty assumed and ceded reinsurance premiums are earned over the terms of the reinsurance contracts. Premiums ceded to other companies are reported as a reduction of premium income. Reinsurance contracts do not relieve the Property and Casualty Group from its obligations to policyholders.
only. Management fees are recorded as revenue upon policy issuance or renewal, as substantially all of the services required to be performed by us have been satisfied at that time. Certain activities are performed and related costs are incurred by us subsequent to policy issuance in connection with the services provided to the Exchange; however, these activities are inconsequential and perfunctory. Management fee revenue is eliminated upon consolidation.
Class A and Class B basic earnings per share and Class B diluted earnings per share are calculated under the two-class method. The two-class method allocates earnings to each class of stock based upon its dividend rights. Class B shares are convertible into Class A shares at a conversion ratio of 2,400 to 1. See Note 17, “Indemnity Capital Stock.”
Class A diluted earnings per share are calculated under the if-converted method, which reflects the conversion of Class B shares to Class A shares. Diluted earnings per share calculations include the dilutive effect of assumed issuance of stock-based awards under compensation plans using the treasury stock method. See Note 16, "Incentive and Deferred Compensation Plans."
A reconciliation of the numerators and denominators used in the basic and diluted per-share computations is presented as follows for each class of Indemnity common stock:
Valuation techniques used to derive the fair value of our available-for-sale and trading securities are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources. Unobservable inputs reflect our own assumptions regarding fair market value for these securities. Although the majority of our prices are obtained from third party sources, we also perform an internal pricing review for securities with low trading volumes under current market conditions. Financial instruments are categorized based upon the following characteristics or inputs to the valuation techniques:
The following table presents our consolidated fair value measurements on a recurring basis by asset class and level of input at December 31, 2014:
(1) These amounts are reported in the Consolidated Statements of Operations. There was $1 million included in net realized investment gains (losses) and $16 million included in equity in earnings of limited partnerships for the year ended December 31, 2014 on Level 3 securities.
For Indemnity, there were no transfers between Level 1 and Level 2, or from Level 2 to Level 3, for the year ended December 31, 2014. Level 3 to Level 2 transfers totaled $4 million related to two fixed maturity holdings due to the use of observable market data to determine the fair value at December 31, 2014.
For the Exchange, Level 1 to Level 2 transfers totaled $36 million and Level 2 to Level 1 transfers totaled $25 million due to trading activity levels related to four preferred stock holdings and three preferred stock holdings, respectively, for the year ended December 31, 2014. Level 2 to Level 3 transfers totaled $56 million for nine fixed maturity holdings and one preferred stock holding due to the use of unobservable inputs to determine the fair value. Level 3 to Level 2 transfers totaled $24 million for three fixed maturity holdings and one preferred stock holding due to the use of observable market data to determine the fair value at December 31, 2014.
(1) These amounts are reported in the Consolidated Statements of Operations. There was $6 million included in net realized investment gains (losses) and $12 million included in equity in earnings of limited partnerships for the year ended December 31, 2013 on Level 3 securities.
For the Exchange, Level 1 to Level 2 transfers totaled $6 million and Level 2 to Level 1 transfers totaled $51 million due to trading activity levels related to one preferred stock holding and five preferred stock holdings, respectively, for the year ended December 31, 2013. Level 2 to Level 3 transfers totaled $39 million related to seven fixed maturity holdings and one preferred stock holding, and Level 3 to Level 2 transfers totaled $47 million for six fixed maturity holdings. These transfers in and out of Level 3 were primarily the result of using non-binding and binding broker quotes, respectively, to determine the fair value at December 31, 2013.
When a non-binding broker quote was the only input available, it was classified within Level 3. The unobservable inputs are not reasonably available to us and therefore have not been included in the tables below. These investments totaled $92 million for the Exchange at December 31, 2014, and $1 million for Indemnity and $21 million for the Exchange at December 31, 2013.
Collateralized-debt-obligation securities - The unobservable inputs used in the fair value measurement of certain collateralized-debt-obligation securities are the repayment at maturity of underlying collateral available to pay note holders, the projected maturity of the underlying security, and a discount rate appropriate for the security. Significant changes in any of those inputs in isolation would result in a significantly higher or lower fair value measurement. Generally, a change in the assumption used for the performance of the underlying collateral is accompanied by an opposite change in the maturity and a directionally opposite change in the discount rate used to value the security.
(1) When a non-binding broker quote was the only price available, the security was classified as Level 3.
Other investments measured at fair value represent real estate funds included on the balance sheet as limited partnership investments that are reported under the fair value option. The fair value of these investments is based on the net asset value (NAV) information provided by the general partner.
The following table summarizes the cost and fair value of our available-for-sale securities at December 31, 2014:
The amortized cost and estimated fair value of fixed maturities at December 31, 2014, are shown below by remaining contractual term to maturity. Mortgage-backed securities are allocated based upon stated maturity dates. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Equity in earnings of limited partnerships accounted for under the equity method
$4 billion at December 31, 2014 (as recorded in the September 30, 2014 limited partnership financial statements). For the twelve month period comparable to that presented in the preceding table (fourth quarter of 2013 and first three quarters of 2014), total partnership valuation adjustment losses were $1 billion and total partnership net income was $7 billion.
Per the limited partnership financial statements, total partnership assets were $50 billion and total partnership liabilities were
The following table outlines the total capitalized software development costs subject to amortization and the related amortization expense:
Included in the gross carrying amount above are costs not yet subject to amortization of $11 million, $9 million and $7 million in 2014, 2013 and 2012, respectively.
$114 million were pledged as collateral on the line at December 31, 2014.
As of December 31, 2014, the Exchange has access to a $300 million bank revolving line of credit with a $25 million letter of credit sublimit that expires on October 25, 2018. As of December 31, 2014, a total of $299 million remains available under the facility due to $1 million outstanding letters of credit, which reduce the availability for letters of credit to $24 million. The Exchange had no borrowings outstanding on its line of credit as of December 31, 2014. Bonds with a fair value of
The deferred income tax expense in 2013 and 2012 was primarily driven by unrealized gains on investments.
Neither the Indemnity nor the Exchange had a valuation allowance recorded at December 31, 2014 or December 31, 2013. The IRS has examined our tax filings through tax year ended 2009 and is currently examining our federal income tax returns for 2010, 2011 and 2012.
$85 million and $85 million at December 31, 2014, 2013 and 2012, respectively. The reserves for losses and loss expenses are reported net of receivables for salvage and subrogation, which totaled $171 million, $149 million and $150 million at December 31, 2014, 2013 and 2012, respectively.
In 2014, the favorable development on prior accident year direct loss reserves was primarily related to better than expected severity trends in personal auto, commercial multi-peril, and workers compensation lines of business combined with changes on individual claims, primarily workers compensation massive injury lifetime medical claims, personal auto massive injury lifetime medical claims, and the settlement of a commercial multi-peril individual large claim. Favorable development on prior accident year loss reserves was minimal in 2013. In 2012, the favorable development on prior accident year direct loss reserves was primarily the result of improved claims frequency and severity trends combined with the closing of several large claims in our homeowners, commercial multi-peril, and commercial auto lines of business, offset somewhat by adverse development in our workers compensation line of business as a result of increased severity trends.
The following table provides the components of our life policy and deposit contract liability balances for the years ended December 31:
Members of the Property and Casualty Group participate in an intercompany reinsurance pooling agreement. Under the pooling agreement, all insurance business of the Property and Casualty Group is pooled in the Exchange. EIC and ENY share in the underwriting results of the reinsurance pool through retrocession. Since 1995, the Board of Directors has set the allocation of the pooled underwriting results at 5.0% participation for EIC, 0.5% participation for ENY, and 94.5% participation for the Exchange. The purpose of the pooling agreement is to spread the risks of the members of the Property and Casualty Group collectively across the different lines of business and geographic regions in which each operates. This agreement may be terminated by any party as of the end of any calendar year by providing not less than 365 days advance written notice. Intercompany pooling accounts are settled in cash within 30 days after the end of each quarterly accounting period.
$200 million in excess of $900 million, and a fourth treaty providing coverage of up to 100% of a loss of $25 million in excess of $1.1 billion. There have been no losses subject to these treaties.
Prior to 2003, the employee pension plan purchased annuities from EFL for certain plan participants that were receiving benefit payments under the pension plan. These are nonparticipating annuity contracts under which EFL has unconditionally contracted to provide specified benefits to beneficiaries; however, the pension plan remains the primary obliger to the beneficiaries. A contingent liability of $25 million at December 31, 2014, exists in the event EFL does not honor the annuity contracts.
Pension plan costs represent the total cost for the Erie Insurance Group before reimbursements to Indemnity from the Exchange and EFL.
$17 million were made to the defined benefit pension plan in January 2015. The following table sets forth the funded status of the pension plans and the amounts recognized in the Consolidated Statements of Financial Position at December 31:
The estimated net actuarial loss and prior service cost for the pension plans that will be amortized from accumulated other comprehensive income into pension cost during 2015 is $13 million and $1 million, respectively.
The charges recognized as amendments were the result of factoring in the prior service cost for four new plan participants in 2013.
Estimates of fair values of the pension plan assets are obtained primarily from our trustee and custodian of our pension plan. Our Level 1 category includes a money market fund that is a mutual fund for which the fair value is determined using an exchange traded price provided by the trustee and custodian. Our Level 2 category includes commingled pools. Estimates of
Our long-term incentive plan (“LTIP”) is a performance based incentive plan designed to reward executive and senior vice presidents who can have a significant impact on our long-term performance and to further align the interests of such employees with those of our shareholders. The LTIP permits grants of performance shares or units, to be satisfied with shares of our Class A common stock or cash payment as determined by the ECDC. The ECDC determines the form of the award to be granted at the beginning of each performance period, which is generally a three-year period. The number of shares of the Company’s common stock authorized for grant under the LTIP is 1.5 million shares, with no one person able to receive more than
Earned compensation costs are allocated to related entities and reimbursed to Indemnity in cash once the payout is made. The total compensation cost charged to operations related to these LTIP awards was $13 million in 2014, $8 million in 2013, and
$5 million in 2012. The related tax benefits recognized in income were $4 million in 2014, $3 million in 2013, and $2 million in 2012.
At December 31, 2014, there was $11 million of total unrecognized compensation cost for non-vested LTIP awards related to open performance periods. Unrecognized compensation is expected to be recognized over a period of two years.
Vesting conditions are determined at the time the award is granted and may include continuation of employment for a specific period, satisfaction of performance goals and the defined performance period, and the satisfaction of any other terms and conditions as determined to be appropriate. The plan is to remain in effect until December 31, 2022, unless earlier amended or terminated by our Board of Directors. In 2014, 8,750 restricted stock units were granted under the plan. The total compensation charged to operations related to these ECP awards was $0.3 million in 2014. Unrecognized compensation expense of $1 million is expected to be recognized over a period of four years. There were no awards granted during 2013.
Amounts reclassified from accumulated other comprehensive income (loss), net of tax(1)
Indemnity has contractual commitments to invest up to $24 million related to its limited partnership investments at December 31, 2014. These commitments are split between private equity securities of $10 million, mezzanine debt securities of $9 million, and real estate activities of $5 million. These commitments will be funded as required by the limited partnership agreements.
The Exchange, including EFL, has contractual commitments to invest up to $459 million related to its limited partnership investments at December 31, 2014. These commitments are split between private equity securities of $141 million, mezzanine debt securities of $156 million, and real estate activities of $162 million. These commitments will be funded as required by the limited partnership agreements.
We review all litigation on an ongoing basis when making accrual and disclosure decisions. For certain legal proceedings, we cannot reasonably estimate losses or a range of loss, if any, particularly for proceedings that are in their early stages of development or where the plaintiffs seek indeterminate damages. Various factors, including, but not limited to, the outcome of potentially lengthy discovery and the resolution of important factual questions, may need to be determined before probability can be established or before a loss or range of loss can be reasonably estimated. If the loss contingency in question is not both probable and reasonably estimable, we do not establish an accrual and the matter will continue to be monitored for any developments that would make the loss contingency both probable and reasonably estimable. In the event that a legal proceeding results in a substantial judgment against, or settlement by, us, there can be no assurance that any resulting liability or financial commitment would not have a material adverse effect on the financial condition, results of operations, or cash flows of the Indemnity shareholder interest or the consolidated financial statements of Erie Indemnity Company.
In August 2012, we were notified that we would be subject to an audit of our compliance with the unclaimed property laws of a number of jurisdictions both within and outside our operating territory. The audit commenced in April 2013 and is ongoing. We continue to cooperate with the auditors, responding to several requests for information and supplying data runs, as requested. Additionally, EFL has been named in a lawsuit filed by the State Treasurer of West Virginia. The Complaint alleges that EFL has failed to comply with the West Virginia Uniform Unclaimed Property Act. EFL filed a motion to dismiss and a favorable decision was rendered in December 2013 with the Court dismissing the Complaint with prejudice. The State Treasurer appealed the dismissal of the lawsuit in January 2014. Briefing was completed in the fall of 2014. Oral argument before the West Virginia Supreme Court is scheduled for April 8, 2015.
Accounting principles used to prepare statutory financial statements differ from those used to prepare financial statements under GAAP. Prescribed statutory accounting practices (“SAP”) include state laws, regulations, and general administration rules, as well as a variety of publications from the National Association of Insurance Commissioners (“NAIC”). The statutory financial statements of the Exchange and its subsidiaries, EIC, EPC, Flagship, and EFL, are prepared in accordance with accounting practices prescribed and permitted by the Pennsylvania Insurance Department. ENY prepares its statutory financial statements in accordance with accounting practices prescribed by the New York Insurance Department.
The amount of dividends that can be paid to the Exchange without the prior approval by the Pennsylvania Insurance Commissioner by EIC, EPC, and Flagship, the Exchange’s Pennsylvania-domiciled property and casualty insurance subsidiaries, is limited to not more than the greater of: (a) 10% of statutory surplus as reported in the last annual statement, or (b) net income as reported in the last annual statement. The amount of dividends that EIC’s New York-domiciled property and casualty subsidiary, ENY, can pay without the prior approval by the New York Superintendent of Insurance is limited to the lesser of: (a) 10% of statutory surplus as reported in the last annual statement, or (b) 100% of adjusted net investment income during such period. In 2015, the maximum dividend payout that the Exchange could receive from its property and casualty insurance subsidiaries would be $35 million. No dividends were paid by these property and casualty insurance subsidiaries in 2014, 2013 or 2012.
Cash settlements for payments on the account of the Exchange totaled $378 million, $351 million and $343 million in 2014, 2013 and 2012, respectively, and $37 million, $32 million and $30 million in 2014, 2013 and 2012, respectively, for EFL. These reimbursements are settled on a monthly basis.
Less: Net income attributable to noncontrolling interest in consolidated entity - Exchange
No items were identified in the period subsequent to the financial statement date that required adjustment or disclosure.