The Company owns real property for investment purposes as provided in Schedule I “Summary of Investments Other Than Investments in Related Parties.” This investment property, located in Allentown, Pennsylvania, is leased to EIC and a nonaffiliated business. Rental income for 2004 was $0.4 million. The executive and administrative offices of the Company are located in the headquarters office of Erie Insurance Group in Erie, Pennsylvania. The Company pays other members of the Erie Insurance Group an amount determined by an agreement for office space and for the use of facilities, equipment and services.
The Company’s profitability depends principally on the ability to price and manage risk on insurance products, the ability to attract and retain deposit funds and the ability to manage expenses. Specific drivers of the Company’s profitability include:
• Returns on investments, including maintaining interest rate spreads over the amounts credited to deposit funds.
The Company, EIC and the Exchange share common facilities and services. The costs of such common services are allocated to the Company based upon the Company’s usage. Additionally, EIC is the common paymaster for the Erie Insurance Group. The Company reimburses EIC for operating expenses, including salary and benefit costs. Operating expenses of the Company paid by EIC are reimbursed on a monthly basis. The amount of these reimbursements totaled $28.9 million, $26.1 million and $23.8 million for 2004, 2003 and 2002, respectively. No interest is charged or received on these intercompany balances due to the timely settlement terms and nature of the items.
The Erie Insurance Group affiliated property/casualty insurance companies periodically purchase annuities from the Company in connection with the structured settlement of claims. The reserves held for structured settlement annuities sold to the affiliated property/casualty insurance companies totaled $213.7 million and $201.9 million at December 31, 2004 and 2003, respectively.
The Erie Insurance Group Retirement Plan for employees purchases from the Company individual annuities for some terminated vested employees or beneficiaries receiving benefits. These are nonparticipating annuity contracts under which the Company has unconditionally contracted to provide specified benefits to beneficiaries in return for a fixed premium from the plan. Annuity deposit balances outstanding relating to pension annuities sold to the Erie Insurance Group Retirement Plan are $43.0 million and $45.0 million at December 31, 2004 and 2003, respectively.
The Company has $40 million due to EIC in the form of two surplus notes. Interest and principal payments are subject to prior approval by the Pennsylvania Insurance Commissioner. The first note amounting to $15 million bears an annual interest rate of 6.45%. Interest on the surplus note is scheduled to be paid semi-annually. The note is payable on demand on or after December 31, 2005. Interest paid on this note totaled $1.0 million in 2004, 2003, and 2002.
In 2003, the Company issued the second note for $25 million bearing an annual interest rate of 6.70%, scheduled to be paid semi-annually. The surplus note is payable on demand on or after December 31, 2018. Interest paid on this note totaled $1.7 million and $0.6 million in 2004 and 2003, respectively.
The Company makes estimates and assumptions that can have a significant effect on amounts and disclosures reported in the financial statements. The most significant estimates relate to valuation of investments, deferred policy acquisition costs and reserves for policy liabilities. While management believes its estimates are appropriate, the ultimate amounts may differ from the estimates provided. The methods for making these estimates are continually reviewed and any adjustments considered necessary are reflected in current earnings.
Management makes estimates concerning the valuation of all investments. Fixed maturity and preferred stock investments are recorded at fair value under generally accepted accounting principles. Fair values are estimated using quoted market prices where available. For securities not actively traded, fair values are obtained from independent pricing services, from broker dealers, or from models that take into consideration such factors, among others, as the credit rating of the issuer, duration of the security, yields on comparably rated publicly-traded securities and risk-free yield curves. Investment in limited partnerships include real estate and mezzanine debt securities. Investments in limited partnerships are valued using the equity method, which approximates the Company’s proportionate share of reported net equity. These valuations are determined by the general partner of the limited partnership and reviewed by the Company for reasonableness. Such investments are illiquid and market values are subjectively determined due to a lack of quoted market prices.
The DAC related to universal life products and deferred annuities is amortized in relation to the expected gross profits from projected investment, mortality and expense margins and surrender charges of the policies over a specified period of time. This period is 30 years for universal life and 20 years for deferred annuities. Both historical and anticipated investment returns, including realized gains and losses, are considered in determining the amortization of DAC. GAAP requires that changes in expected future gross profits on the annuity and universal life products cause the DAC amortization rate be revised retroactively, or “unlocked”, to the date of policy issuance. The cumulative change in DAC related to prior periods is recognized as a component of the current period’s DAC amortization, along with DAC amortization associated with the actual gross profits of the current period. Lower actual gross profits in a period would typically result in less DAC amortization in that period, whereas higher actual gross profits would result in more amortization in the period. However, if lower gross profits were expected to continue into the future, additional amortization of the existing DAC asset may occur. See the “Analysis of policy-related benefit and expenses” section that follows for a discussion on the 2004 retrospective adjustment.
Total individual policies in force grew 4.1% to 302,115 at December 31, 2004, from 290,290 at December 31, 2003. Net premiums collected on traditional life insurance policies increased to $38.6 million in 2004, from $37.8 million in 2003. Renewal premiums accounted for the increase in direct premiums in 2004 as the Company’s independent agents focused more heavily on property and casualty underwriting profitability as opposed to new business production. Net renewal premiums collected increased 5.6% to $1.8 million in 2004. Policies in force on traditional products increased 5.3% to 212,102 in 2004, from 201,492 in 2003. Direct life insurance in force continues to grow, totaling $30.1 billion at December 31, 2004, an increase of $3.0 billion, or 11.1%, over 2003. Life insurance in force after consideration of reinsurance ceded increased 1.8% to $17.6 billion at December 31, 2004.
The Company’s new generation of products are heavily reinsured, which allows the Company to price the products more competitively and reduces underwriting volatility. Under the reinsurance treaty for the ERIE
Target Term product, the reinsurer assumes 90% of mortality risk up to $3.0 million (the Company’s retention limit is $300,000) and assumes all mortality risk above that amount. The reinsurance treaty for the ERIE Flagship Term2 product provides that the reinsurer assumes 50% of mortality risk up to $600,000 (the Company’s retention limit is $300,000) and assumes all mortality risk above that amount.
Ceded reinsurance premiums increased in 2004 due in part to the continued growth in sales of the Erie Target Term and Erie Flagship Term2 products. The reinsurance premiums ceded on the Flagship and Target Term life insurance products alone amounted to $18.1 million, $12.8 million and $8.7 million in 2004, 2003 and 2002, respectively. During 2004, the Company recorded corrections to its ceded reinsurance and reinsurance allowance accounts as a result of reinsurance administration and accounting errors. Some of the corrections pertained to years prior to 2004. The total net amount of the correction was a charge of $0.5 million, and approximately $0.3 million, or $0.02 per share after taxes, pertained to prior periods.
Total annuity and universal life deposits, which do not appear as revenue on the Statements of Operations, were $90.9 million, $157.5 million and $187.7 million in 2004, 2003 and 2002, respectively. First-year and single premium annuity deposits, excluding deposits for structured settlements and deposits for the Erie Insurance Group Retirement Plan, decreased $68.9 million to $31.8 million in 2004, from $100.7 million in 2003. The Company’s ability to attract deposits depends in large part on the relative attractiveness of its products compared to other investment alternatives. Annuity deposits have declined over the past 18 months due to lower credited interest rates and an improved equity market.
The Company recognized net realized gains on investments of $9.4 million and $13.2 million in 2004 and 2003, respectively, and net realized losses of $9.6 million in 2002. The Company recorded no impairments on fixed maturity and equity security investments in 2004 and $3.4 million and $25.8 million in 2003 and 2002, respectively.
Interest expense incurred on deposits increased $2.5 million, or 5.1% in 2004 and $2.2 million, or 4.6%, in 2003. This increase can be attributed to the growth of annuities on deposit. At December 31, 2004, the balance of annuity deposits totaled $984.9 million, compared to $932.6 million at December 31, 2003, an increase of 5.6%. Interest was credited on annuity and universal life deposits in 2004 and 2003 at the following rates:
The Company’s investment strategies provide that portfolios are structured to match the features of the life insurance and annuity products sold by the Company. Annuities and life insurance policies are long-term products; therefore, the Company’s investment strategy takes a long-term perspective emphasizing investment quality, diversification and superior investment returns. The Company’s investments are managed on a total return approach that focuses on current income and capital appreciation.
The Company’s fixed maturities at December 31, 2004, consist of investments in bonds, redeemable preferred stock and notes. It is the Company’s objective that the fixed maturity portfolio be of very high quality and well-diversified within each market sector. The Company only purchases investment-grade securities. Non-investment grade issues held by the Company are the result of downgrades of securities previously rated investment grade. The portfolio is managed with the goal of achieving reasonable returns while limiting exposure to risk.
Major cash outflows from operations are for benefits to policyholders, commissions to agents and salaries, wages and operating expenses. The net positive cash flow from operations is used to fund Company commitments and to build the investment portfolio, thereby increasing future investment returns. Net cash provided by operating activities in 2004 was $17.1 million compared to $11.4 million in 2003 and $22.8 million in 2002.
The Company’s liquidity position remains strong as investments and cash and cash equivalents increased by $24.5 million during 2004 to $1.5 billion at December 31, 2004. As an added measure of liquidity, the Company has arranged for a $10 million line of credit with a commercial bank. The Company may use extensions of credit from the bank to fund working capital needs of the Company and for other general corporate purposes. There were no borrowings under this credit line in 2004, 2003 or 2002. Management believes its cash flow from operations and its liquid assets and marketable securities will enable the Company to meet foreseeable cash requirements. The continued adequacy of the liquidity depends upon factors including future securities’ market conditions, changes in interest rate levels and policyholder perceptions of the Company’s strength, which could lead to reduced cash inflows or increased cash outflows.
The Commonwealth of Pennsylvania follows the statutory accounting practices related to minimum Risk-Based Capital (RBC) requirements for domestic insurance companies that were developed by the NAIC. The NAIC standard set for measuring RBC is a method of calculating the minimum amount of capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The RBC formula is used by the state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. At December 31, 2004, the Company substantially exceeded the minimum RBC levels that require regulatory action.
Annuity contracts issued between February 25, 2003 and July 9, 2003 have a guaranteed interest rate of 3.0%. Contract forms issued before February 2003 have a stepped-down guaranteed interest rate structure.
The guaranteed interest rates and approximate current deposit liabilities for deferred annuity products with credited interest rates subject to change by the Company are as follows:
• Universal life products provide for planned premium amounts. Additional unplanned premium payments may be made at any time during the insured’s lifetime and before the end of the payment period. The amounts of such payments must be acceptable to the Company and be within IRS guidelines. Policies in force at December 31, 2004 have an annualized planned premium of $30.5 million.
• Flexible premium deferred annuity (FPDA) contracts allow the Company to limit deposits to a maximum of $25,000 per year. The Company began limiting deposits to the contractual maximum effective July 10, 2003 on products with interest rate guarantees exceeding 3.0% to insure that overall product interest spreads are maintained. Currently, there are 24,016 FPDA contracts in force, of which 19,763 have guarantees in excess of 3.0%. No additional payments are permitted on single premium deferred annuity contracts.
The Company’s rating from A.M. Best is A (Excellent). The A (Excellent) rating continues to affirm the Company’s strong financial position indicating that the Company has an excellent ability to meet its ongoing obligations to policyholders. The Company is also rated by Standard & Poor’s, but this rating is based solely on public information. Standard & Poor’s rates the Company’s Api, “strong.” The Company also has a rating of B (Good) from Weiss Ratings, Inc. According to Weiss Ratings, the B rating indicates that the Company offers good financial security and has the resources necessary to deal with a variety of adverse conditions.
In October 2004, the New York Attorney General filed various lawsuits against Marsh and McLennan as a result of an investigation of insurance brokers and producer compensation practices. The investigation and subsequent lawsuits, contained allegations of “bid rigging” and other inappropriate solicitation practices by such insurance brokers and others who were sued by the New York Attorney General. After the New York lawsuits were filed, several states commenced general inquiries or investigations on the subject of producer compensation. Some member companies of the Erie Insurance Group, including the Company, received inquiries from the North Carolina Department of Insurance and the Pennsylvania Insurance Department as did most or all other insurance companies.
Pennsylvania - In November 2004, the Company, Exchange, Erie Insurance Company and Erie Insurance Property and Casualty Company each received an Inquiry Letter concerning “Inappropriate Solicitation Practices” from the Insurance Commissioner of the Commonwealth of Pennsylvania. The Inquiry Letters were sent to all insurers domiciled in Pennsylvania and requested a detailed explanation of the types of compensation arrangements existing between the members of the Erie Insurance Group and its independent insurance agents. The Inquiry Letters also demanded information concerning the existence or knowledge of any Inappropriate Solicitation Practices, as that term is defined in the Inquiry Letters. The Erie Insurance Group filed a response indicating that it has no knowledge of, or reason to believe, that any of its agents or employees have engaged in Inappropriate Solicitation Practices. The Erie Insurance Group also advised the Pennsylvania Insurance Department that it has not received any complaints from policyholders, potential customers or regulators alleging Inappropriate Solicitation Practices by any Erie Insurance Group agent or employee.
The Sarbanes-Oxley Act of 2002 established numerous compliance requirements for public companies which include an annual evaluation of internal controls (Section 404). The Company is considered a non-accelerated filer by definition, and is not subject to the Section 404 reporting requirements until 2005. The Company is expected to incur between $0.5 million and $1.0 million in external costs to comply with Section 404 in 2005.
“Safe Harbor” Statement Under the Private Securities Litigation Reform Act of 1995: Certain forward-looking statements contained herein involve risks and uncertainties. These statements include certain discussions relating to underwriting, premium and investment income volume, business strategies, profitability and business relationships and the Company’s other business activities during 2004 and beyond. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential” and similar expressions. These forward-looking statements reflect the Company’s current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties that may cause results to differ materially from those anticipated in those statements. Many of the factors that will determine future events or achievements are beyond our ability to control or predict.
The Audit Committee of the Board of Directors, composed of outside directors, meets periodically with the Company’s management, internal auditors and independent registered public accounting firm to review the work of each and to inquire as to their assessment of the performance of Company financial personnel. The independent registered public accounting firm and internal auditors have full and free access to the Audit Committee, without the presence of management, to discuss results of work performed and communicate other appropriate matters.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Erie Family Life Insurance Company at December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. Also, in our opinion the 2004 and 2003 related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Erie Family Life Insurance Company (the Company), a Pennsylvania-domiciled life insurer, is engaged in the business of underwriting and selling nonparticipating individual and group life insurance policies, annuities and disability income products. The Company markets its products through independent agents in 10 states and the District of Columbia and is subject to supervision and regulations of the states in which it operates. A majority of the Company’s business is written in Pennsylvania, Ohio, Maryland and Virginia. See also Note 15.
Certain amounts previously reported in the 2003 financial statements have been reclassified to conform to the current period’s presentation. Such reclassifications did not impact earnings or total shareholders’ equity.
Fixed maturities and marketable equity securities are classified as available-for-sale. Equity securities consist of nonredeemable preferred stock while fixed maturities consist of bonds, notes and redeemable preferred stock. Available-for-sale securities are stated at fair value, with the unrealized gains and losses, net of deferred tax, reflected in shareholders’ equity in accumulated other comprehensive income. Realized gains and losses on sales of investments are recognized in income on the specific identification method. There are no securities classified as trading securities or held-to-maturity securities.
Mortgage loans on commercial real estate are recorded at unpaid balances, adjusted for amortization of premium or discount. Valuation allowances, if needed, are provided for impairment in net realizable value based on periodic valuations.
Interest and dividend income is recorded as earned. Bond premiums and discounts are amortized and accreted. These adjustments are included in investment income.
The Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board released Issue 03-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” in 2003 with disclosure requirements ratified the same year. In March 2004, the remaining guidance was ratified to be effective for annual periods ending after June 15, 2004. In October 2004, the effective date of certain application paragraphs was delayed pending further discussion by the Task Force. EITF 03-1 provides guidance to determine when an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss. The guidance also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The Company meets the disclosure requirements of EITF 03-1. The impact of the application guidance of EITF 03-1 on the Company’s operations and financial position will not be known until the final issue is adopted.
In accordance with FAS 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments, the DAC related to universal life products and deferred annuities is amortized in relation to the expected gross profits from projected investment, mortality and expense margins and surrender charges of the policies over a specified period. This specified period is 30 years for universal life and 20 years for deferred annuities. Both historical and anticipated investment returns, including realized gains and losses, from the investment of policyholder funds are considered in determining the amortization of deferred policy acquisition costs. GAAP requires that changes in expected future gross profits on the annuity and universal life products cause the DAC amortization rate to be revised retroactively, or “unlocked”, to the date of policy issuance. The cumulative change in DAC related to prior periods is recognized as a component of the current period’s DAC amortization, along with DAC amortization associated with the actual gross profits of the current period. Lower actual gross profits in a period would typically result in less DAC amortization in that period, whereas higher actual gross profits would result in more amortization in the period. However, if lower gross profits were expected to continue into the future, additional amortization of the existing DAC asset may occur. See Note 5 for a discussion on the retrospective adjustment made in 2004 to the DAC amortization.
Liabilities for life insurance and income-paying annuity future policy benefits are computed primarily by the net level premium method with assumptions as to anticipated mortality, withdrawals, lapses and investment yields. Disability income reserves are calculated as two-year preliminary term mid-terminal reserves plus unearned premium reserves plus claim reserves. Deferred annuity future policy benefit liabilities are established at accumulated values without reduction for surrender charges. Reserves for universal life plans are based on the contract account balance. Variations are inherent in such calculations due to the estimates and assumptions necessary in the calculations. Interest rate assumptions for noninterest-sensitive life insurance range from 3.50% to 4.00% on policies issued in 1980 and prior years and 5.00% to 7.25% on policies issued in 1981 and subsequent years. Mortality and withdrawal assumptions are based on tables typically used in the industry, modified to reflect actual experience where appropriate.
Universal life and annuity deposits are credited with varying interest rates determined at the discretion of the Company subject to certain minimums. Interest rates credited on deposits during the year were as follows:
The Company may be required, under the solvency or guaranty laws of the various states in which it is licensed, to pay assessments up to prescribed limits to fund policyholder losses or liabilities of insolvent life insurance companies. Certain states permit these assessments, or a portion thereof, to be recovered as an offset to future premium taxes.
Assessments are recognized as incurred when an event obligating the Company has occurred and the amount can be reasonably estimated. The Company commonly becomes aware of insolvencies prior to obtaining specific assessment amounts from state guaranty associations to estimate its share of the liability. The Company estimates its liability based on information received from the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA). The information provided by NOLHGA is obtained from a variety of sources and is only an estimate. When the assessment is subject to credit against future premium taxes, and such credits are likely to be recoverable, an asset is established. The asset is reduced when the credits are realized under applicable state law.
Premiums on traditional life insurance products are recognized as earned when due. Reserves for future policy benefits are established as premiums are earned. Premiums received for annuity and universal life products are not reported as revenue, but as deposits, and included in liabilities for annuity and universal life deposits in accordance with FAS 97. For universal life products, revenue is recognized as amounts are assessed against the policyholder’s account for mortality coverage and contract expenses. The primary source of revenue on annuity deposits is derived from the interest earned by the Company, which is reflected in net investment income and interest on annuity deposits. Disability income premiums are recognized as revenue pro rata over the terms of the contracts.
Expense reimbursements received in connection with reinsurance ceded have been accounted for as a reduction of the related policy acquisition costs. Amounts recoverable from reinsurers for future policy
Software development costs have been capitalized and included in other assets. Total software development costs are being amortized on a straight-line basis over the expected useful life of the asset. The carrying value of this asset at December 31, 2004 and 2003, was $1.2 million and $1.4 million, respectively.
No investments in an unrealized loss position at December 31, 2004, had experienced a decline in market value that was considered by management to be significant and other-than-temporary, based on Company policy. There were no market conditions, industry characteristics or fundamental operating results of a specific issuer that suggested other-than-temporary impairment of any of the investments held at December 31, 2004.
At December 31, 2004, net unrealized gains on investments of $39.2 million consisted of $79.6 million in gross unrealized gains, less $3.5 million in gross unrealized losses, less $15.8 million in other related offsets and deferred taxes of $21.1 million.
Bonds having a fair value of $2.1 million at December 31, 2004, were on deposit with various regulatory authorities as required by law. Bonds having a fair value of $15.4 million are pledged as collateral on a $10 million line of credit with a bank. There were no borrowings on the line during 2004 and 2003.
Cash and cash equivalents: The carrying amounts approximate their fair value.
Fixed maturities and equity securities: For equity securities, fair values were based on quoted market prices. For fixed maturities, fair values were obtained from independent pricing services. For the few securities where an independent service provides no price, broker-dealer quotations are used.
Annuity deposits: Included in this category are deferred annuity contracts. The Company retains the right to change interest rates subject to a one-year guaranteed interest rate and a minimum interest rate provided in the contract. To the extent that current market rates are below the guaranteed minimum interest rate, the fair value of these contracts may exceed the carrying value. To the extent that surrender charges apply to account balances, the fair value of these contracts may be below the carrying value. The carrying value of these contracts totaled $688.5 million and $648.8 million as of December 31, 2004 and 2003, respectively, while the estimated fair value of these contracts totaled $698.0 million and $677.7 million, respectively.
Universal life deposits: The Company retains the right to change interest rates on its universal life deposits subject to minimum interest rates provided in the policy. The Company also retains the right to change the expense and cost of insurance charges that are deducted from universal life deposits, subject to maximum amounts provided in the policy. As a result, the carrying value of these policies approximates their fair value.
Comprehensive income is comprised of net income and other comprehensive (loss) income, which includes unrealized (depreciation) appreciation of investments, net of tax and deferred acquisition costs.
Activity in the liability for unpaid policy and contract claims is as follows:
The provision for federal income taxes consists of the following for the years ended December 31:
The Company recorded an adjustment to deferred income taxes during the fourth quarter of 2003. Deferred tax liabilities established in previous years to reflect potential income tax exposures were determined to be unnecessary and the amounts provided were reversed during the fourth quarter. The one-time non-cash reduction in deferred taxes of $1.3 million, increased fourth quarter earnings by $0.14 per share.
Temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to deferred income tax assets and liabilities for the years ended December 31 are as follows:
The employees of the Company participate in the pension and other employee benefit plans of EIC. The pension benefits are based on years of service and salary. Pension costs are funded by EIC in amounts
sufficient to at least meet ERISA minimum funding requirements. The Company, through EIC, also participates in certain deferred compensation and supplemental pension plans for certain executive and senior officers. The amounts recorded by the Company for the deferred compensation and supplemental pension plan totaled $1.1 million, $1.1 million and $0.7 million at December 31, 2004, 2003 and 2002, respectively, which are settled in cash to EIC as payments are made under these plans. The pension and related benefit costs allocated to the Company from EIC equaled $0.6 million, $0.2 million and $0 in 2004, 2003 and 2002, respectively.
The Company owns certain real estate it leases to EIC. The real estate is recorded net of accumulated depreciation of $1.8 million and $1.7 million at December 31, 2004 and 2003, respectively. Rentals paid by EIC to the Company totaled $0.3 million each year in 2004, 2003 and 2002, respectively.
The Erie Insurance Group 401(k) plan for employees includes an investment option in a Company annuity. Annuity deposits in 2004, 2003 and 2002 included $2.3 million, $2.6 million and $2.2 million, respectively, of deposits on annuity contracts purchased by Erie Insurance Group employees through the 401(k) plan. Annuity deposit balances outstanding relating to 401(k) annuities sold to employees are $30.2 million and $28.0 million at December 31, 2004 and 2003, respectively.
The Company’s most popular insurance products, ERIE Flagship Term2 and ERIE Target Term are reinsured 50% and 90%, respectively, with nonaffiliated reinsurers. Sales of ERIE Flagship Term, ERIE Flagship Term2 and the ERIE Target Term continue to result in increased ceded reinsurance balances. Total direct life insurance in force on these products was $17.4 billion, $13.9 billion, and $9.5 billion in 2004, 2003, and 2002, respectively. Reinsurance ceded on these products totaled $11.6 billion, $8.9 billion, and $6.1 billion in 2004, 2003, and 2002, respectively.
The effect of ceded reinsurance in the Statements of Operations is as follows:
A reconciliation of shareholders’ equity as filed with regulatory authorities to shareholders’ equity reported in the accompanying financial statements as of December 31 follows:
The minimum statutory capital and surplus requirements under Pennsylvania law for stock life insurance companies (Section 386 of the PA Insurance Code) amounts to $1.6 million. The Company’s total statutory capital and surplus well exceeded these minimum requirements.
2004: During the second quarter, the Company unlocked certain assumptions related to determination of DAC for its universal life and fixed annuities. As a result of unlocking these assumptions, amortization of DAC was decreased by $6.5 million in the second quarter. See Note 12 for a discussion on the charge against income during the fourth quarter of 2004 relating to the PEGLI pool.
2003: The Company recorded an adjustment to deferred income taxes during the fourth quarter of 2003. Deferred tax liabilities established in previous years to reflect potential income tax exposures were determined to be unnecessary and the amounts provided were reversed during the fourth quarter. The one-time non-cash reduction in deferred taxes increased fourth quarter earnings by $0.14 per share.