The Erie Insurance Group also operates 23 field offices in 11 states. Seventeen of these offices provide both agency support and claims services and are referred to as branch offices, while the remaining six provide only claims services and are considered claims offices. Three field offices are owned by the Exchange and leased to us. One
We own three field offices. One field office is owned by EFL and leased to us. The net rent expense for the field office leased from EFL was $0.3 million in 2008.
Certain statements contained herein are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are not in the present or past tense and can generally be identified by the use of words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “likely,” “plan,” “project,” “seek,” “should,” “target,” “will,” and other expressions that indicate future trends and events. Forward-looking statements include, without limitation, statements and assumptions on which such statements are based that are related to our plans, strategies, objectives, expectations, intentions and adequacy of resources. Examples of such statements are discussions relating to management fee revenue, cost of management operations, underwriting, premium and investment income volumes, and agency appointments. Such statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Among the risks and uncertainties that could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements are the following: factors affecting the property/casualty and life insurance industries generally, including price competition, legislative and regulatory developments, government regulation of the insurance industry including approval of rate increases, the size, frequency and severity of claims, natural disasters, exposure to environmental claims, fluctuations in interest rates, inflation and general business conditions; the geographic concentration of our business as a result of being a regional company; the accuracy of our pricing and loss reserving methodologies; changes in driving habits; our ability to maintain our business operations including our information technology system; our dependence on the independent agency system; the quality and liquidity of our investment portfolio; our dependence on our relationship with Erie Insurance Exchange; and the other risks and uncertainties discussed or indicated in all documents filed by the Company with the Securities and Exchange Commission, including those described in Part I, “Item 1A. Risk Factors” and elsewhere in this report. A forward-looking statement speaks only as of the date on which it is made and reflects the Company’s analysis only as of that date. The Company undertakes 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.
management fee rate we charge. Periods of flattening premiums, generally result in lower margins from management operations. Our management fee revenue reflected minimal growth of 0.3% in 2008, as direct written premiums of the Property and Casualty Group increased only 0.4% compared to 2007. The Property and Casualty Group implemented price reductions of approximately $30 million in 2008, however we believe our pricing will stabilize in 2009 and anticipate approximately $36 million in direct written premium increases from rating actions taken in 2009. These increases could be offset by the effects on our business from the softening economy.
The upheaval in the financial markets in the third and fourth quarters of 2008 had a negative impact on our investment operations. What began in the second half of 2007 as a subprime mortgage crisis has grown to a global crisis in the financial markets. 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. Impairment charges were also affected by our proactive tax strategies which precluded us from asserting our intent to hold these investments to recovery. During 2008, we impaired $69.5 million of securities primarily for investments in the banking and finance industries. Included in the total impairment charge were $36.0 million in charges on fixed maturities and $33.5 million in charges on preferred stock. The Exchange also recognized substantial impairment charges in 2008 of $663.1 million with $204.2 million in bonds, $213.9 million in preferred stock and $245.0 million in common stock. Many of these securities are performing in line with anticipated or contractual cash flows.
The valuation of our entire investment portfolio was significantly affected by the 2008 upheaval in the financial markets. Net unrealized losses on fixed maturities at December 31, 2008 were $34.2 million compared with $0.9 million in net unrealized gains at December 31, 2007, with unrealized losses in the financial sector being the primary driver. There were also $4.7 million in net unrealized losses in equity securities at December 31, 2008 compared with $3.0 million at December 31, 2007. Our trading securities portfolio was similarly affected, with a net unrealized loss of $4.5 million at December 31, 2008 compared to a $17.2 million gain at December 31, 2007.
Finally, we generate revenues from our fixed maturity, equity and alternative investment portfolios. The portfolios are managed with a view toward maximizing after-tax yields and limiting credit risk, and we actively evaluate our portfolios for impairments. Due to the global liquidity crises surrounding the credit markets and more broadly the financial services industry in 2008, we recognized $69.5 million of impairment charges as a result of continued declines in fair value and credit deterioration on certain of our bonds and preferred stocks predominately in the banking and finance industry sectors. The majority of the impairments relate to securities that are artificially depressed due to current market conditions, but continue to meet interest and dividend obligations. We also had net losses on common stocks of $38.6 million and reduced valuation adjustments recorded by our real estate limited partnerships as a result of the general slow-down and recent economic downturn in the real estate markets. We have consistently generated high levels of cash flows from operations, which amounted to $150.8 million in 2008. Our net cash flows from operations have been used to pay shareholder dividends and to repurchase shares of our stock under our repurchase program.
In order to grow our management fee revenue, our key challenges in 2009 will be to continue to generate profitable property/casualty revenue growth while containing the growth of expenses in our management operations. Expense management is further challenged by our need to enhance technology and improve ease of doing business for our agents and policyholders.
We continued to pursue opportunities in our current territories through the appointment of 156 new agencies in 2008. During 2009, we plan to continue this momentum by appointing another 127 agencies. We continued to develop the personal lines pricing plan, by introducing additional variables that further segment risks and allow us to be price competitive for the best risks. The Property and Casualty Group continues to evaluate potential new product offerings and product extensions to meet consumer demands.
We plan to continue to control the growth in the cost of management operations by controlling salary and wage costs and other discretionary spending in 2009. However, we also intend to continue making targeted investments in technology to enhance customer service, ease of doing business with our agents and customers, and to improve our productivity. In 2009, we expect to incur additional expenses on our various technology initiatives aimed at improving our competitiveness. See “Future trends - costs of management operations” section for further details.
Gross margins from management operations decreased slightly to 17.6% in 2008 from 18.1% in 2007.
GAAP combined ratios of the insurance underwriting operations increased to 93.6 in 2008 from 88.1 in 2007 driven by slightly higher catastrophe losses and less favorable development of prior accident year loss reserves when compared to 2007 results.
Management fee revenue increased 0.3% and 0.4% in 2008 and 2007, respectively. The two determining factors of management fee revenue are: 1) the management fee rate we charge, and 2) the direct written premiums of the Property and Casualty Group. The management fee rate was 25% for both 2008 and 2007. Direct written premiums of the Property and Casualty Group were largely unchanged at $3.8 billion for 2008 and 2007.
In 2008, the direct written premiums of the Property and Casualty Group increased 0.4% compared to a 0.5% decline in 2007. New policy direct written premiums of the Property and Casualty Group increased 2.9% in 2008 compared to 9.0% in 2007, while renewal premiums increased 0.1% in 2008 compared to a decline of 1.5% in 2007. New business policies in force increased 3.1% in 2008 compared to 6.4% in 2007, and renewal business policies in force increased 2.9% in 2008 compared to 1.9% in 2007. Despite the growth in policies in force, rate reductions of $30.3 million led to minimal growth in 2008, and rate reductions of $85.9 million contributed to the decline in 2007.
• The cost of management operations increased 1.2%, or $10.0 million, to $809.5 million in 2008, primarily due to the increase in non-commission expenses:
Commissions-Total commission costs decreased 0.6%, or $3.4 million, to $554.0 million in 2008 driven by a decrease in agent bonuses as a result of a reduction in the profitability component of the award. Offsetting this reduction were increases in normal scheduled rate commissions, a private passenger auto bonus and other promotional incentives classified as commissions.
Total costs other than commissions-All other non-commission expense increased 5.5%, to $255.6 million in 2008, driven by personnel, sales and policy issuance costs and other operating costs. Personnel costs increased primarily due to higher average pay rates and higher staffing levels coupled with increases in executive severance costs and management incentive plan expense. Sales and policy issuance costs rose due to increased agent advertising program expense. Other operating costs increased due to various corporate technology initiatives that resulted in additional contract labor fees and software costs.
• Contributing to underwriting income of $13.3 million and a 93.6 GAAP combined ratio in 2008, compared to underwriting income of $24.7 million and an 88.1 GAAP combined ratio in 2007, were the following factors:
catastrophe losses totaling 3.4 points, or $7.0 million, in 2008 due to remnants of Hurricane Ike in Ohio, Pennsylvania and Indiana, compared to 1.7 points, or $3.6 million, in 2007; and
Net realized losses on investments totaled $113.0 million in 2008 compared to 2007 realized losses of $5.2 million primarily due to impairment charges on fixed maturities and preferred stock of $69.5 million and net realized losses on common stock of $38.6 million.
Equity in EFL losses was $14.6 million in 2008 compared to earnings of $3.1 million in 2007. EFL recognized impairment charges of $83.5 million in 2008 primarily related to fixed maturities and preferred stock investments in the financial services industry sector, of which our share was $18.0 million.
The following presents a discussion of those accounting policies surrounding estimates that we believe are the most critical to our reported amounts and require the most subjective and complex judgment. If actual events differ
We make estimates concerning the valuation of all investments. Valuation techniques used to derive fair value of our available-for-sale and trading securities are based on observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, such as prices obtained from nationally recognized pricing services for identical instruments in active markets. Observable inputs other than quoted prices would include prices obtained from third party pricing services that model prices based on observable inputs. Unobservable inputs reflect our own assumptions regarding exit market pricing for these securities. Fair value for these securities, that comprise only 4.0% of our total investment portfolio, are determined using comparable securities or valuations received from outside broker dealers.
our ability and intent to retain the investment for a period of time sufficient to allow for a recovery in value.
We perform various procedures in review of the general partners’ valuations, and while we rely on the general partners’ financial statements as the best available information to record our share of the partnership unrealized gains and losses resulting from valuation changes, we adjust our financial statements for impairments of the partnership investment where appropriate. As there is no ready market for these investments, they have the greatest potential for variability. We survey each of the general partners quarterly about expected significant changes (plus or minus 10% compared to previous quarter) to valuations prior to the release of the fund’s quarterly and annual financial statements. Based on that information from the general partner, we consider whether recording of a valuation adjustment or additional disclosure is warranted.
Reserves for property/casualty insurance unpaid losses and loss adjustment expenses reflect our best estimate of future amounts needed to pay losses and related expenses with respect to insured events. These reserves include estimates for both claims that have been reported and those that have been incurred but not reported. They also include estimates of all future payments associated with processing and settling these claims. Reported losses represent cumulative loss and loss adjustment expenses paid plus case reserves for outstanding reported claims. Case reserves are established by a claims handler on each individual claim and are adjusted as new information becomes known during the course of handling the claims. Incurred but not reported reserves represent the difference between the actual reported loss and loss adjustment expenses and the estimated ultimate cost of all claims.
The process of estimating the liability for property/casualty unpaid loss and loss adjustment expense reserves is complex and involves a variety of actuarial techniques. This estimation process is based largely on the assumption that past development trends are an appropriate indicator of future events. Reserve estimates are based on our assessment of known facts and circumstances, review of historical settlement patterns, estimates of trends in claims frequency and severity, legal theories of liability and other factors. Variables in the reserve estimation process can be affected by 1) internal factors, including changes in claims handling procedures and changes in the quality of risk selection in the underwriting process, and 2) external events, such as economic inflation, regulatory and legislative changes. Due to the inherent complexity of the assumptions used, final loss settlements may vary significantly from the current estimates, particularly when those settlements may not occur until well into the future.
We also perform analyses to evaluate the adequacy of past reserve levels. Using subsequent information, we perform retrospective reserve analyses to test whether previously established estimates for reserves were reasonable. Our 2008 retrospective reserve analysis indicated the Property and Casualty Group’s December 31, 2007 direct reserves, excluding salvage and subrogation recoveries, had an estimated redundancy of approximately $122 million, which was 3.5% of reserves.
The Property and Casualty Group’s coverage with the greatest potential for variation are the catastrophic injury liability reserves. The automobile no-fault law in Pennsylvania before 1986 and workers compensation policies provide for 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. Workers compensation catastrophic injury claims have been segregated from the total population of workers compensation claims. Because the coverage related to the automobile no-fault and workers compensation claims is unique and the number of claims is about 120, the previously discussed methods are not used; rather ultimate losses are estimated on a claim-by-claim basis. An annual payment assumption is made for each of these claimants who sustained catastrophic injuries and then projected into the future based upon a particular assumption of the future inflation rate, including medical inflation and life expectancy of the claimant. The most significant variable in estimating this liability is medical cost inflation. Our medical inflation rate assumption in setting this reserve for 2008 is for a 9% annual increase grading down 1% after the first year, then grading down 0.5% per year to an ultimate rate of 5%. Our medical inflation rate assumption in setting this reserve for 2007 was a 10% annual increase grading down 1% per year to an ultimate rate of 5%. The life expectancy assumption (mortality) underlying this reserve estimate reflects experience to date. Our mortality rate assumption gives 75% weight to our own mortality experience and 25% weight to a disabled pensioner mortality table. Our actual mortality experience for disabled lives of catastrophically injured people is based on a relatively small number of lives. We believe weighting the mortality assumption to incorporate the disabled pensioner mortality table, which has longer life expectancies than our experience, is reasonable in estimating our ultimate liability for these claims. Actual experience, different than that assumed, could have a significant impact on the reserve estimate.
automobile catastrophic injury liability reserve is $14.6 million at December 31, 2008. Each 100-basis point change in the medical cost inflation assumption would result in a change in net liability for us of $2.2 million. At December 31, 2008, the reserve carried by the Property and Casualty Group for workers compensation catastrophic injury reserves, which is our best estimate of this liability at this time, was $249.4 million, which is net of $13.6 million of anticipated reinsurance recoverables. Our property/casualty insurance subsidiaries’ share of the workers compensation catastrophic injury reserves is $13.7 million at December 31, 2008. Each 100-basis point change in the medical cost inflation assumption would result in a change in net liability for us of $1.6 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 component of the actuarial loss generated during 2008 that related to the actual investment return being different from assumed during the prior year was $106.1 million. Recognition of this loss will be deferred over a four year period, consistent with the market-related asset value methodology. Once factored into the market-related asset value, these experience losses will be amortized over a period of 15 years, which is the remaining service period of the employee group.
Policies in force increased 2.9% to 4,002,209 in 2008 from 3,888,333 in 2007.
Premium rate changes resulted in a $30.3 million decrease in 2008 written premiums.
Estimates for agent bonuses decreased $14.6 million offset by a $6.8 million increase in normal and accelerated rate commissions and a $5.1 million increase in the private passenger auto bonus and other promotional incentives.
Sales and policy issuance costs increased 27.1%, or $6.1 million due to increased spending on agent marketing and advertising programs.
Personal lines - The Property and Casualty Group’s personal lines new business premiums written increased 2.5% to $266.9 million in 2008 from $260.4 million in 2007 and $247.1 million in 2006. Personal lines new business policies in force rose 3.3% to 391,316 in 2008, from 378,994 in 2007, which was 4.9% higher than 361,147 in 2006. The year-over-year average premium per policy on personal lines new business decreased 0.7% to $682 from $687 in 2007, which was 0.4% more than the 2006 average of $684. Total personal lines policies in force increased 2.9% in 2008 to 3,485,276.
Private passenger auto new business premiums written increased 5.3% to $170.3 million in 2008 from $161.7 million in 2007, driven by an increase in new business policies in force of 7.3% to 168,709 in 2008 compared to 157,297 in 2007. A private passenger auto incentive program has been in place since July 2006 to stimulate policy growth and has contributed to the increase in new business policies in force. Under the program, eligible agents receive a bonus based on the number of new private passenger auto policies issued. This program was revised effective June 1, 2008. See “Private Passenger Auto Bonus” section for further details of the change. The year-over-year average premium per policy for private passenger auto decreased 1.8% to $1,009 in 2008 from $1,028 in 2007. Certain private passenger auto rate actions that became effective in 2008 reduced rates in Pennsylvania, New York and Ohio. In 2007, the private passenger auto new premiums increased 7.6% to $161.7 million, compared to $150.3 million in 2006, as new policies in force increased 7.3% and the average premium per policy rose 0.3%.
which was 3.0% more than $1,575 in 2006. Commercial lines new business policies in force increased to 88,632 at December 31, 2008, up 2.6% from 86,403 at December 31, 2007, which was up 13.0% from 76,478 at December 31, 2006. Factors contributing to the increase in new commercial lines premiums written in 2008 include more proactive communications between us and our commercial agents, continued refinement and enhancements to our quote processing systems and our use of more refined pricing based on predictive modeling which were initiated in 2007. The 2007 increase in the average premium per policy on commercial lines new business resulted from certain workers compensation pricing actions that increased rates in Illinois, Maryland and Virginia. Total commercial lines policies in force increased 3.0% in 2008 to 516,933.
Industry commercial rate levels have been weakening since 2005 as exposure growth that drives commercial premiums has slowed. These trends are expected to continue in 2009. Rate actions approved for 2009 are primarily for decreases in workers compensation in Pennsylvania offset by increases in commercial-multi peril in Pennsylvania and Ohio.
a decrease in the estimate for agent bonuses of $14.6 million,
All other operating costs increased $1.8 million primarily due to $5.2 million of increased consulting fees, primarily contract labor costs related to various technology initiatives, and $2.8 million of additional hardware and software costs. Offsetting this increase was a 2007 charge of $4.3 million for a judgment against us.
Scheduled and accelerated rate commissions - Scheduled rate commissions were impacted by a 0.4% increase in the direct written premiums of the Property and Casualty Group in 2008. Also, effective July 1, 2008, commission rates were increased for certain commercial lines new business premiums which added $1.5 million to 2008 scheduled rate commissions. An increase in workers compensation commission rates, which became effective in the latter half of 2007 in certain states, added $2.8 million of commission expense in 2008. In 2007, scheduled rate commissions were flat compared to 2006, due to the 0.5% decrease in direct written premiums of the Property and Casualty Group offset by the increase in workers compensation commission rates that added $1.2 million of commission expense.
Accelerated rate commissions are offered under specific circumstances to certain newly-recruited agencies for their initial three years of operation. Accelerated rate commissions are increasing as expected given the additional new agency appointments in recent years. We appointed 156 new agencies in 2008, 214 in 2007 and 139 in 2006. There were 263 agencies receiving accelerated rate commissions in 2008 compared to 216 and 118 in 2007 and 2006, respectively. Accelerated commissions are expected to continue to increase in the future as a result of these recent new agency appointments and those expected in 2009.
Personnel costs, the second largest component in the cost of management operations, increased 3.8%, or $5.3 million, in 2008. Salaries and wages increased $4.7 million in 2008 due to higher average pay rates. Executive severance costs and the recognition of certain compensation expense for our new chief executive officer contributed an additional $2.9 million in 2008. Expense for management incentive plans increased $2.7 million due to additional levels of management being included in the plans in 2008. Management performance under the plan improved relative to plan targets, resulting in higher bonuses under the plans. Employee benefit costs, which are included in personnel costs, decreased $2.7 million in 2008 primarily due to investment losses on compensation plan balances of participating executives. The 2007 personnel costs included $3.3 million of additional severance for our former president and chief executive officer.
During 2008, investments were made to support our efforts to increase sales and improve our operating performance. As noted previously, increased expenses related to commission and incentive changes as well as investments in new information technology are being incurred. In 2008, we incurred $9.7 million of additional costs including contract labor costs, capitalized software and software license and maintenance expense in conjunction with the planning and design for the development of a new policy administration platform. See also “Factors That May Affect Future Results.”
Catastrophe losses, a majority of which related to Hurricane Ike in 2008, contributed 3.4 points to the GAAP combined ratio, compared to 1.7 points in 2007.
The underlying non-catastrophe accident year combined ratio increased to 93.4 in 2008, compared to 91.7 in 2007, as a result of slightly decreasing average premiums and increased loss costs.
Catastrophes are an inherent risk of the property/casualty insurance business and can have a material impact on our insurance underwriting results. In addressing this risk, we employ what we believe are reasonable underwriting standards and monitor our exposure by geographic region. The Property and Casualty Group also maintains property catastrophe reinsurance coverage from unaffiliated insurers. The Property and Casualty Group maintains sufficient property catastrophe reinsurance coverage from unaffiliated reinsurers and no longer participates in the voluntary assumed reinsurance business, which lowers the variability of the underwriting results of the Property and Casualty Group.
Net investment income decreased $8.7 million in 2008 as yields were down and we continued to repurchase shares of our common stock. Funds used to repurchase treasury shares amounted to $102.0 million in 2008, compared to $236.7 million in 2007.
Investment income includes primarily interest and dividends on our fixed maturity and equity security portfolios. The decline in net investment income in 2008 and 2007 is primarily due to continued repurchases of our common stock under our stock repurchase program. Investments were liquidated in the current year to help fund stock repurchases thus limiting the funds available for investment operations. The current stock repurchase program runs through June 30, 2009.
Impairment charges of $69.5 million included $36.0 million on fixed maturities and $33.5 million on preferred stock were recorded for the year ended December 31, 2008. Impairment charges during the year increased significantly due to the disruption in financial markets during the third and fourth quarters of 2008. Impairment charges were also influenced by our proactive tax planning strategy related to capital loss carrybacks. This strategy assists us in monetizing our deferred tax assets before they expire, but affects our impairment analysis as we do not have the intent to hold investments to recovery. Securities in an unrealized loss position are stratified below based on time in a loss position and magnitude of the loss as a percentage of book value of the security at December 31, 2008.
The percentage columns in the table above represent the severity of the decline at December 31,2008 and are not indicative of the severity for the entire duration during which the securities were in an unrealized loss position of greater than 10%.
See Item 8. “Financial Statements and Supplementary Data - Note 6 of Notes to Consolidated Financial Statements” contained within this report for additional disclosures regarding net realized (losses) gains on investments.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial position of Erie Indemnity Company as of December 31, 2008 and 2007, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008 of Erie Indemnity Company and our report dated February 20, 2009, expressed an unqualified opinion thereon.
We have audited the accompanying consolidated statements of financial position of Erie Indemnity Company as of December 31, 2008 and 2007, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the financial statement schedules listed in the Index at Item 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.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Erie Indemnity Company at December 31, 2008 and 2007, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the 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.
As discussed in Note 5 to the consolidated financial statements, in 2008 the Company changed its method of accounting for its common stock portfolio in connection with the adoption of Statement of Financial Accounting Standards No. 159. As discussed in Note 10 to the consolidated financial statements, in 2006 the Company changed its method of accounting for post retirement benefit plans in connection with the adoption of Statement of Financial Accounting Standards No. 158.
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, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 20, 2009, expressed an unqualified opinion thereon.
In December 2008, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) No. FAS140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities.” This FSP requires public entities that have a variable interest in a variable interest entity to provide additional disclosures about their involvement with variable interest entities. This FSP is effective for the first reporting period ending after December 15, 2008. We have provided the required disclosures concerning variable interest entities in Note 17.
In 2007, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159) which we adopted on January 1, 2008. SFAS 159 gave us the irrevocable option to report selected financial assets and liabilities at fair value. SFAS 159 also established presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement bases for similar types of assets and liabilities. We adopted the fair value option for our common stock portfolio as of January 1, 2008 because it better reflects the way we manage our common stock portfolio under a total return approach. These assets were formerly accounted for as available-for-sale under SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” with changes in fair value recorded in other comprehensive income. Beginning January 1, 2008 all changes in fair value of our common stock are recognized in earnings as they occur. The adoption of SFAS 159 required the unrealized gains and losses on these securities at January 1, 2008 to be included in a cumulative effect adjustment to beginning retained earnings. The net impact of the cumulative effect adjustment for our common stock portfolio on January 1, 2008 increased retained earnings and reduced other comprehensive income by $11.2 million, net of tax. See also Note 5.
In 2006, SFAS 157, “Fair Value Measurements,” was issued and provides guidance for using fair value to measure assets and liabilities as well as enhances disclosures about fair value measurements which became effective for us on January 1, 2008. The standard applies whenever other standards require, or permit, assets or liabilities to be measured at fair value. The standard did not expand the use of fair value in any new circumstances and thus, did not have an impact on our financial position, results of operations or cash flows. The statement established a fair value hierarchy that prioritizes the observable and unobservable inputs to valuation techniques used to measure fair value into three levels. Quantitative and qualitative disclosures focus on the inputs used to measure fair value for these measurements and the effects of these measurements in the financial statements. We implemented this standard during the first quarter of 2008 and have provided the required disclosures concerning inputs used to measure fair value in Note 5.
In September 2008, the FASB issued an Exposure Draft (ED), “Amendments to FIN 46(R) - Consolidation of Variable Interest Entities.” This proposed statement would amend the guidance for determining whether an enterprise is the primary beneficiary of a variable interest entity (VIE) by requiring a qualitative analysis to determine if an enterprise’s variable interest gives it a controlling financial interest. A primary beneficiary would be expected to be identified through the qualitative analysis, which looks at the power to direct activities of the VIE, including its economic performance and the right to receive benefits from the VIE that are significant. Under the current quantitative analysis required by FIN 46(R), although we hold a variable interest in it, we are not deemed to be the primary beneficiary of the Exchange (see Note 17), and the Exchange’s results are not consolidated with ours. If the ED to amend FIN 46(R) is adopted in its current form, we believe we would be deemed to have a controlling financial interest in the Exchange, by virtue of our attorney-in-fact relationship with the Exchange, and consolidation would be required. This would require that the Exchange’s financial statements, which are currently only prepared in accordance with statutory accounting principles, be prepared in accordance with generally accepted accounting principles. The Exchange would then also be subject to the Sarbanes-Oxley section 404 internal control reporting requirements. Given the materiality of the Exchange’s operations, consolidating the Exchange’s financial statements with the Company’s would significantly change our current reporting entity, related footnote disclosures and the overall presentation of management’s discussion and analysis. The Exchange’s equity, which is owned by its subscriber policyholders, would be shown as a noncontrolling interest in such consolidated statements and the net earnings and equity of the Company would be unchanged by this presentation. FIN 46(R) is to be effective for fiscal years that begin after November 15, 2009.
The accompanying consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (GAAP) that differ from statutory accounting practices prescribed or permitted for insurance companies by regulatory authorities. See also Note 19.
Certain amounts previously reported in the 2007 financial statements have been reclassified to conform to the current period’s presentation. Such reclassifications only affected the Consolidated Statements of Cash Flows.
short and long-term prospects of the issuer and its industry based on analysts’ recommendations;
An investment that is deemed other than temporarily impaired is written down to its estimated fair value. Impairment charges are included in net realized (losses) gains in the Consolidated Statements of Operations.
We regularly review the adequacy of our estimated loss and loss adjustment expense reserves by line of business. Adjustments to previously established reserves are reflected in the operating results of the period in which the adjustment is determined to be necessary. Such adjustments could possibly be significant, reflecting any variety of new and adverse or favorable trends.
Loss reserves are set at full expected cost, except for workers compensation loss reserves, which have been discounted using an interest rate of 2.5%. Unpaid losses and loss adjustment expenses in the Consolidated Statements of Financial Position were reduced by $5.4 million and $5.5 million at December 31, 2008 and 2007, respectively, due to discounting.
The reserves for losses and loss adjustment expenses are reported net of receivables for salvage and subrogation of $6.7 million and $6.8 million at December 31, 2008 and 2007, respectively.
Although we are not required to do so under the subscriber’s agreement with the Exchange, we return the management fee charged the Exchange when mid-term policy cancellations occur for the unearned premium on the policy. We estimate mid-term policy cancellations and record a related allowance which is adjusted quarterly. The effect of recording changes in this estimated allowance decreased our management fee revenue by $0.2 million for the year ended December 31, 2008 while increasing management fee revenue by $0.8 million and $1.5 million for the years ended December 31, 2007 and 2006, respectively.
Insurance premiums written are earned over the terms of the policies on a pro-rata basis. Unearned premiums represent that portion of premiums written which is applicable to the unexpired terms of policies in force. Losses and loss adjustment expenses are recorded as incurred. Premiums earned and losses and loss adjustment expenses incurred are reflected net of amounts ceded to the Exchange on the Consolidated Statements of Operations. See also Note 18.
Provisions for income taxes include deferred taxes resulting from changes in cumulative temporary differences between the tax basis and financial statement basis of assets and liabilities. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Basic earnings per share are calculated under the two-class method, which allocates earnings to each class of stock based on its dividend rights. See Note 13. Class B shares are convertible into Class A shares at a conversion ratio of 2,400 to 1. The computation of Class A diluted earnings per share reflects the potentially dilutive effect of outstanding employee stock-based awards under the long-term incentive plan and awards not yet vested related to the outside directors’ stock compensation plan. See Note 11.
On October 10, 2008, the FASB issued Financial Staff Position (FSP) SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for that Asset Is Not Active.” This FSP provides clarification regarding the application of SFAS 157 in a market that is not active and provides illustrations to consider in determining prices in such an environment. This FSP was effective upon issuance. We have considered the guidance provided in this FSP for securities held at December 31, 2008 that were not actively traded. The adoption of FSP SFAS 157-3 during the third quarter did not have a material effect on our results of operations, financial position or liquidity.
Valuation techniques used to derive fair value of our available-for-sale and trading securities are based on observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources. Unobservable inputs reflect our own assumptions regarding exit market pricing 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 in the current market conditions. Certain securities were downgraded to Level 3 as a result. These techniques provide the inputs for the following fair value hierarchy:
One or more of the inputs used to determine the value of the security are unobservable. Fair values for these securities are determined using comparable securities or valuations received from outside brokers or dealers. Examples of Level 3 fixed maturities may include certain private preferred stock and bond securities, collateralized debt and loan obligations, and credit linked notes.
The following table represents the fair value measurements on a recurring basis for our invested assets by major category and level of input as required by SFAS 157:
The following tables provide a reconciliation of assets measured at fair value on a recurring basis for securities using Level 3 inputs for the twelve months ended December 31, 2008:
We have no assets that were measured at fair value on a nonrecurring basis during the year ended December 31, 2008.
Following are the components of net realized gains (losses) on investments as reported in the Consolidated Statements of Operations. The 2008 fixed maturity and preferred stock impairment charges primarily related to securities in the finance industry.
We perform various procedures in review of the general partners’ valuations. While we generally rely on the general partners’ financial statements as the best available information to record our share of the partnership unrealized gains and losses resulting from valuation changes, we adjust our financial statements for impairments at the fund level where appropriate. As there is no active market for these investments, they have the greatest potential for market price variability. Unrealized gains and losses for these investments are reflected in the equity in earnings on limited partnerships in our Consolidated Statements of Operations under equity method accounting. For the years ended December 31, 2008, 2007 and 2006, equity in earnings from our limited partnerships as reported in the Consolidated Statements of Operations accounted for 4.7%, 19.3% and 14.0%, respectively, of our pre-tax income. We do not exert significant influence over any of these partnerships, consequently, they are accounted for under the equity method of accounting. We have provided summarized financial information in the following table for the years ended December 31, 2008 and 2007. Amounts provided in the table are presented using the latest available financial statements received from the partnerships.
Our investments in the limited partnerships held at December 31, 2008 and 2007 have aggregate assets, liabilities, valuation adjustments and net income (loss) from the most recently available financial statements received from the partnerships, which in almost all cases are unaudited financial statements as of September 30, 2008.
See also Note 21 for investment commitments related to limited partnerships.
We participate in a program whereby marketable securities from our investment portfolio are lent to independent brokers or dealers based on, among other things, their creditworthiness, in exchange for collateral initially equal to 102% of the value of the securities on loan and are thereafter maintained at a minimum of 100% of the fair value of the securities loaned. The fair value of the securities on loan to each borrower is monitored daily by the third-party custodian and the borrower is required to deliver additional collateral if the fair value of the collateral falls below 100% of the fair value of the securities on loan. The collateral is invested primarily in short-term, investment grade asset-backed securities and floating rate notes. The program is in the process of being terminated and we anticipate it to be completed during 2010.
Cash equivalents are principally comprised of investments in bank money market funds and approximate fair value.
with a fair value of $132.0 million are pledged as collateral on the loan at December 31, 2008. These securities have no restrictions and are reported as available-for-sale fixed maturities in the Consolidated Statement of Financial Position as of December 31, 2008. The bank requires compliance with certain covenants which include minimum net worth and leverage ratios. We are in compliance with all bank covenants at December 31, 2008.
The components of accumulated other comprehensive (loss) income, net of tax, as of December 31 are as follows:
EFL recognized pre-tax investment impairment charges of $83.5 million and $11.1 million in 2008 and 2007, respectively. The 2008 impairments were primarily related to its bonds and preferred stock in the financial services industry sector. A deferred tax asset valuation allowance of $32.8 million was recorded in the Statements of Operations for 2008 related to these impairments where the related deferred tax asset is not expected to be realized. A deferred tax valuation allowance of $6.8 million was recorded in accumulated other comprehensive income for remaining unrealized losses on securities where the related deferred tax asset is not expected to be realized. The comprehensive loss for 2008 includes $70.2 million, net of deferred taxes, in unrealized depreciation on investments. For 2007, the unrealized depreciation, net of tax, was $5.7 million.
Our share of EFL’s unrealized depreciation of investments, net of tax, reflected in EFL’s shareholders’ equity, is $15.5 million and $0.3 million at December 31, 2008 and 2007, respectively. EFL’s Board of Directors voted to discontinue the payment of dividends effective with the second quarter of 2006 as all shares are now owned by affiliated entities. However, the Board of Directors could decide to declare shareholder dividends in the future. Dividends paid to us totaled $0.9 million for the year ended December 31, 2006. See Note 17 regarding the tender offer transaction made by the Erie Insurance Exchange for EFL’s shares during the second quarter of 2006.
Our pension plans consist of a noncontributory defined benefit pension plan covering substantially all employees and an unfunded supplemental employee retirement plan (SERP) for certain members of executive and senior management of the Erie Insurance Group. The pension plans provide benefits to covered individuals satisfying certain age and service requirements. The defined benefit pension plan and SERP provide benefits through a final average earnings formula and a percent of average monthly compensation formula, respectively.
We previously provided retiree health benefits in the form of medical and pharmacy health plans for eligible retired employees and eligible dependents. In May 2006, the retiree health benefit plan was curtailed by an amendment that restricted eligibility to those who attained age 60 and 15 years of service on or before July 1, 2010. As a result, a one-time curtailment benefit was recognized during 2006.
The two economic assumptions that have the most impact on the pension and other retiree benefit expense are the discount rate and the long-term rate of return on plan assets. In determining the discount rate assumption, we utilized a bond-matching study that compared projected pension plan benefit flows to the cash flows from a comparable portfolio of fixed maturity instruments rated AA- or better with duration similar to plan liabilities. Based on all available information, it was determined that 6.06% was the appropriate discount rate as of December 31, 2008 to calculate our benefit liability. Accordingly, 6.06% will be used to determine our 2009 pension and other retiree benefit cost. The employee pension plan’s expected long-term rate of return on assets is based on historical long-term returns for the asset classes included in the employee pension plan’s target asset allocation.
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 benefit cost. 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 following tables set forth change in benefit obligation, plan assets and funded status of the pension plans as well as the net periodic benefit cost.
Rate of compensation increase is age-graded. An equivalent single compensation increase rate of 4.25% in 2008, 2007 and 2006 would produce similar results.
The 2008 actuarial loss was primarily due to a significant difference in the plan’s actual investment returns in 2008 from the expected returns assumed and the decrease in the discount rate assumption used to estimate the future benefit obligations to 6.06% in 2008 from 6.62% in 2007. The loss on plan assets in 2008 was $82 million compared to a gain of $22 million in 2007. The component of the $144.6 million actuarial loss produced in 2008 that related to the difference between actual and expected investment returns was $106.1 million. Recognition of this loss will be deferred over a four year period consistent with the market-related asset value methodology. Once factored into the market-related asset value, these experience losses will be amortized over a period of 15 years, which is the average remaining service period of the employee group in the plan.
The employee pension plan utilizes a return enhancing asset and liability allocation strategy. This investment strategy is based on an understanding that 1) equity investments are expected to outperform debt investments over the long-term, 2) the potential volatility of short-term returns from equities is acceptable in exchange for the larger expected long-term returns and 3) a portfolio structured across investment disciplines and markets (both domestic and foreign) reduces volatility. As a result, the employee pension plan’s asset allocation will include a broadly diversified allocation among equity, debt and other investments. The policy asset allocation targets allow for assets to be invested between 40% to 65% in equity securities, 35% to 60% in debt securities and 0% to 5% in other investments. The portfolio is composed of mutual funds that are used exclusively as investment vehicles for employee benefit plans. The target asset allocation for the portfolio is:
Our policy, beginning in 2007, is to fund the employee pension plan for an amount equal to the normal cost for the plan but at least equal to the IRS minimum required contribution in accordance with the Pension Protection Act of 2006. For 2009, the expected contribution amount is $15.0 million.
Until eligibility for the benefit fully terminates in 2010, the annual reduction to our expense as a result of our 2006 plan curtailment is expected to be approximately $1.3 million net of allocation to affiliates.
The retiree health benefit plan’s actuarial gains in 2008, 2007 and 2006 resulted from changes in the discount rate assumption.
The December 31, 2008, accumulated retiree health benefit obligation was based on an 8.0% increase for 2009 over the cost of covered health care benefits during 2008. A 100-basis point change in assumed health care cost trend rates would have the following effects:
Amounts recognized in other comprehensive income for the years ended December 31 for the retiree health benefit plan were as follows:
2004 LTIP - Beginning in 2004, the LTIP award is based on the level of achievement of objective measures of performance over a three-year period as compared to a peer group of property/casualty companies that write predominately personal lines insurance. The 2008 awards are based on the reported combined ratio, growth in direct written premiums and total return on invested assets as defined by the Erie Insurance Group. The 2007 and 2006 awards were based on the adjusted combined ratio, growth in direct written premiums and total return on invested assets as defined by the Erie Insurance Group. These internal measures are compared to the same performance measures of a peer group of companies. Because the award is based on a comparison to results of a peer group over a three-year period, the award accrual is based on estimates of results for the remaining performance period. This estimate is subject to variability if our results or the results of the peer group are substantially different than the results we project.
Earned amounts are allocated to related entities and settled in cash once the payout is made. The after-tax compensation cost charged to operations for these restricted stock awards was $1.7 million, $1.3 million and $2.4 million for the years ending December 31, 2008, 2007 and 2006, respectively, after allocation to affiliates.
The 2008 deferred income tax benefit was primarily driven by impairments and unrealized losses on common stock and limited partnerships. The decrease in 2007 deferred income taxes compared to 2006 resulted primarily from adjustments to the basis of certain limited partnership investments.
We are the attorney-in-fact for Erie Insurance Exchange, a reciprocal insurance company. In that capacity we provide the Exchange with all services and facilities necessary for it to conduct its insurance business. Consequently, we are not subject to state corporate income or franchise taxes in most jurisdictions in which we do business because the one insurance business that we conduct with the Exchange pays taxes based on gross premiums in lieu of taxes based on income or capital.
There is no provision for conversion of Class A shares to Class B shares and Class B shares surrendered for conversion cannot be reissued. Each share of Class A common stock outstanding at the time of the declaration of any dividend upon shares of Class B common stock shall be entitled to a dividend payable at the same time, at the same record date, and in an amount at least equal to 2/3 of 1.0% of any dividend declared on each share of Class B common stock. We may declare and pay a dividend in respect to Class A common stock without any requirement that any dividend be declared and paid in respect to Class B common stock. Sole shareholder voting power is vested in Class B common stock except insofar as any applicable law shall permit Class A common shareholders to vote as a class in regards to any changes in the rights, preferences and privileges attaching to Class A common stock.
A stock repurchase program was authorized for our outstanding Class A common stock beginning January 1, 2004. In April 2008, our Board of Directors approved a continuation of the stock repurchase program for an additional $100 million authorizing repurchases through June 30, 2009. Treasury shares are recorded in the Consolidated Statements of Financial Position at cost. Shares repurchased under this plan totaled 2.1 million at a total cost of $102.0 million during 2008. Cumulative shares repurchased under this plan through 2008 totaled 11.7 million at a total cost of $610.1 million.
Driving the favorable development in 2008, 2007 and 2006 on prior year accident reserves were improved frequency and severity trends for automobile bodily injury and uninsured/underinsured motorist bodily injury claims.
A management fee is charged to the Exchange for services we provide under subscriber’s agreements with policyholders of the Exchange. The fee is a percentage of direct written premium of the Property and Casualty Group. This percentage rate is adjusted periodically by our Board of Directors but cannot exceed 25%. The effective management fee rate charged the Exchange was 25% in 2008 and 2007 and 24.75% in 2006. The Board of Directors elected to maintain the fee at 25% beginning January 1, 2009.
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 90 days advance written notice.
Through 2005, EIC and EINY had in effect an all-lines aggregate excess-of-loss reinsurance agreement with the Exchange that limited EIC’s and EINY’s retained share of ultimate net losses in any applicable accident year. The excess-of-loss reinsurance agreement was not renewed for the 2008, 2007 or 2006 accident years. Included in 2006 are net charges under the agreement of $1.0 million related to the commutation of the 2001 accident year. The unpaid loss recoverable related to the 2001 accident year of $7.8 million was settled in 2006. The present value of the estimated losses from the 2001 accident year, or $6.8 million, resulted in a charge of $1.0 million to our property/casualty insurance subsidiaries. The cash was paid for the settlement of the 2001 accident year in January 2007. There are two years remaining under the agreement, 2004 and 2005, neither of which have triggered recognition of recoverable amounts through December 31, 2008.
The claims handling services of the Exchange are performed by personnel who are entirely dedicated to and paid for by the Exchange from its own policyholder revenues. The Exchange’s claims function and its management and administration are exclusively the responsibility of the Exchange and not a part of the service we provide under the subscriber’s agreement. Likewise, personnel who perform activities within the life insurance operations of EFL are paid for by EFL from its revenues. However, we are the legal entity that employs personnel on behalf of the Exchange and EFL and we function as a common paymaster for all employees. Common overhead expenses included in the expenses paid by us are allocated based on appropriate utilization statistics (employee count, square footage, vehicle count, project hours, etc.) specifically measured to accomplish proportional allocations. Executive compensation is allocated based on each executive’s primary responsibilities (management services, property/casualty claims operations, EFL operations and investment operations). We believe the methods used to allocate common overhead expenses among the affiliated entities are reasonable.
In the determination as to whether we are the primary beneficiary we consider the variability in the management fee as well as the variability in underwriting results which would accrue to us under the pooling arrangement in determining the residual returns from the Exchange. The variability is modeled using our stochastic modeling software assigning probabilities to the possible outcomes and determining a probability in the weighted result. The outcomes are calculated using discounted cash flows assuming a discount rate of 5%. Gross cash flows modeled assume a run-off of existing insurance policies and investments. To evaluate circumstances as of the determination date, no new insurance policies are assumed to be written after the evaluation date. We do not include new investments from cash inflows from underwriting profits or investment income, which is conservative, as inclusion of these would only lessen our beneficial interest.
We calculate the amount of variability absorbed by us and compare it to the total variability absorbed by all variable interest holders of the Exchange. In the modeled result we absorb approximately 2% of the total variability of the Exchange at December 31, 2008 which is well below the majority and supports the conclusion that the Company is not the primary beneficiary of the Exchange.
Our management fee revenues made up 84% of our 2008 total revenues. This proportion was greater than the historical percentage which has approximated 72% as our investment operations generated significant losses as a result of the volatile market conditions experienced in the third and fourth quarters of 2008. Excluding impairment charges, management fee revenues accounted for 79% of our 2008 total revenues. These management fee revenues are based on the direct written premiums of the Exchange and the other members of the Property and Casualty Group.
We participate in the underwriting results of the Exchange through the pooling arrangement in which our insurance subsidiaries have a 5.5% participation. If the Exchange were to default, our insurance subsidiaries would be liable for the policies that they wrote directly. Our property/casualty insurance subsidiaries wrote approximately 17% of the direct written premiums of the Property and Casualty Group in 2008.
A concentration of credit risk exists, and our exposure is limited to, the unsecured receivables due from the Exchange for our management fee, costs and reimbursements that are reflected on our Consolidated Statements of Financial Position. See Note 16.
As with our investments, the Exchange’s investment portfolio was impacted by declines in the value of securities that resulted from the recent significant disruption in the securities markets. Driving the Exchange’s 2008 investment losses were impairment charges of $197.9 million on fixed maturities, $245.0 million on common stock and $220.2 million on preferred securities. Impairment charges for 2007 were $103.7 million. Under statutory accounting, deferred tax assets on realized capital losses from impairments of investments are reflected as a change in surplus rather than in deferred income taxes on the statement of operations. Deferred taxes on impairment charges incurred in 2008 totaled $232.1 million.
Reinsurance contracts do not relieve the Property and Casualty Group from its primary obligations to policyholders. A contingent liability exists with respect to reinsurance recoverables in the event reinsurers are unable to meet their obligations under the reinsurance agreements.
The Property and Casualty Group maintained an umbrella excess-of-loss reinsurance treaty with nonaffiliated reinsurers covering commercial and personal catastrophe liability risks. In 2008, this treaty provided coverage of 85% of a specified loss amount in excess of the loss retention of $1 million per occurrence. The specified maximum loss amount for the commercial and personal catastrophe liability was $9 million and $4 million, respectively. The Property and Casualty Group entered into an additional umbrella excess-of-loss reinsurance treaty, effective January 1, 2008, with nonaffiliated reinsurers covering commercial catastrophe liability risks in excess of the loss retention of $10 million per occurrence. The specified maximum loss amount for the commercial catastrophe liability was $10 million. Neither of these treaties were renewed for 2009 due to the proposed pricing for the coverage as well as the loss profile of the Property and Casualty Group.
The Property and Casualty Group maintains a property catastrophe treaty with nonaffiliated reinsurers to mitigate future potential catastrophe loss exposure. During 2008, this reinsurance treaty provided coverage of up to 95% of a loss of $400 million in excess of the Property and Casualty Group’s loss retention of $450 million per occurrence. This treaty was renewed for 2009 under the same terms. There have been no losses subject to this treaty.
The following tables summarize insurance and reinsurance activities of our property/casualty insurance subsidiaries. See also Note 15 for a discussion of the intercompany reinsurance pooling agreement with the Exchange.
Combined shareholders’ equity including amounts reported by our property/casualty insurance subsidiaries on the statutory basis was $798.3 million and $1.0 billion at December 31, 2008 and 2007, respectively. Combined net income, including amounts reported by our property/casualty insurance subsidiaries on a statutory basis, was $58.4 million, $210.6 million and $205.8 million for 2008, 2007 and 2006, respectively.
Cash and securities with carrying values of $6.6 million and $6.3 million were deposited by our property/casualty insurance subsidiaries with regulatory authorities under statutory requirements as of December 31, 2008 and 2007, respectively.
We operate our business as three reportable segments-management operations, insurance underwriting operations and investment operations. Accounting policies for segments are the same as those described in the summary of significant accounting policies, with the exception of the management fee revenues received from the property/casualty insurance subsidiaries. These revenues are not eliminated in the segment detail below, as we base our decisions on the segment presentation. See also Note 3. Assets are not allocated to the segments but rather are reviewed in total for purposes of decision-making. No single customer or agent provides 10% or more of revenues for the Property and Casualty Group.
Our principal operations consist of serving as attorney-in-fact for the Exchange, which constitutes our management operations. We operate in this capacity solely for the Exchange. Our insurance underwriting operations arise through direct business of our property/casualty insurance subsidiaries and by virtue of the pooling agreement between our subsidiaries and the Exchange, which includes assumed reinsurance from nonaffiliated domestic and foreign sources. The Exchange exited the assumed reinsurance business effective December 31, 2003, and therefore unaffiliated reinsurance includes only run-off activity of the assumed reinsurance business. Insurance provided in the insurance underwriting operations consists of personal and commercial lines and is sold by independent agents. Personal lines consist primarily of private passenger auto and are marketed to individuals, and commercial lines are marketed to small- and medium-sized businesses. The performance of the personal lines and commercial lines is evaluated by our management based upon the underwriting results as determined under SAP for the total pooled business of the Property and Casualty Group.
The third and fourth quarter investment (loss) income - unaffiliated was impacted by the significant disruption in the financial markets. We recorded impairment charges of $37.4 million and $7.7 million in the third and fourth quarters of 2008, respectively. Included in the total impairments in the third quarter were $21.7 million related to our preferred stock portfolio and $15.7 million related to our fixed maturities. Included in the total impairments in the fourth quarter were $1.4 million and $6.3 million related to our preferred stock and fixed maturities, respectively. Fourth quarter was also impacted by $18.4 million of realized losses on common stock and $17.4 million related to market value adjustments on limited partnerships.
During December 2007 a correction was made to allocate additional information technology costs to affiliates as they were not allocated appropriately throughout the year. The total amount of 2007 costs allocated to the Exchange and EFL in December of 2007 related to the prior three quarters was $4.3 million, or $0.05 per share. If these costs would have been appropriately allocated in the first three quarters of 2007, earnings per share in each quarter would have increased between $0.01 and $0.02 per share.
The primary basis for the valuation of limited partnership interests are financial statements prepared by the general partner. Because of the timing of the preparation and delivery of these financial statements, the use of the most recently available financial statements provided by the general partners generally result in a quarter delay in the inclusion of the limited partnership results in our Consolidated Statements of Operations. Due to this delay, these financial statements do not reflect the volatility in market conditions experienced in the fourth quarter 2008. We expect additional deterioration to be reflected in the general partners’ year end financial statements, which we will receive in 2009, and such declines could be significant.