The companies comprising the Erie Insurance Group share a corporate home office complex in Erie, Pennsylvania, which comprises approximately 521,000 square feet.
a management fee of up to 25% of all property and casualty insurance premiums written or assumed by the Exchange, less the costs associated with the sales, underwriting, and issuance of these policies;
net investment income and results on investments that belong to Indemnity; and
Net income decreased in 2014 when compared to 2013 due to an underwriting loss experienced in the property and casualty insurance operations in 2014 compared to an underwriting gain in 2013 and lower levels of income from our investment operations. The underwriting results in the property and casualty insurance operations were negatively impacted by an increase in current accident year losses and catastrophe losses compared to 2013, offset somewhat by favorable development on prior accident year loss reserves. Our income from investment operations recorded lower levels of net realized gains on investments and earnings from limited partnerships in 2014 compared to 2013 offset somewhat by higher levels of net investment income.
The Exchange’s property and casualty insurance operations experienced a 8.6% and 9.6% increase in direct written premium in 2014 and 2013, respectively, driven by increases in policies in force and the average premium per policy, which also positively impacted Indemnity’s management fee revenue.
We disclose operating income, a non-GAAP financial measure, to enhance our investors’ understanding of our performance related to the Indemnity shareholder interest. Our method of calculating this measure may differ from those used by other companies, and therefore comparability may be limited.
Management operations generate internal management fee revenue, which accrues to the Indemnity shareholder interest, as Indemnity provides services relating to the sales, underwriting, and issuance of policies on behalf of the Exchange. Management fee revenue is based upon all premiums written or assumed by the Exchange and the management fee rate, which is not to exceed 25%. Our Board of Directors establishes the management fee rate at least annually, generally in December for the following year, and considers factors such as the relative financial strength of Indemnity and the Exchange and projected revenue streams. The management fee rate was set at 25% for 2014, 2013 and 2012. Our Board of Directors set the 2015 management fee rate again at 25%, its maximum level. Management fee revenue is eliminated upon consolidation.
The property and casualty insurance business is driven by premium growth, the combined ratio, and investment returns. The property and casualty insurance industry is cyclical, with periods of rising premium rates and shortages of underwriting capacity followed by periods of substantial price competition and excess capacity. The cyclical nature of the insurance industry has a direct impact on the direct written premium of the Property and Casualty Group.
Geographic expansion is also a component of the Property and Casualty Group's premium growth strategy. The Property and Casualty Group began writing private passenger automobile, home insurance, and personal excess liability insurance in Kentucky in the fourth quarter of 2014.
The key measure of underwriting profitability traditionally used in the property and casualty insurance industry is the combined ratio, which is expressed as a percentage. It is the sum of the ratio of losses and loss expenses to premiums earned (loss ratio) plus the ratio of policy acquisition and other underwriting expenses to premiums earned (expense ratio). When the combined ratio is less than 100%, underwriting results are generally considered profitable; when the combined ratio is greater than 100%, underwriting results are generally considered unprofitable.
EFL generates revenues through the sale of its individual and group life insurance policies and fixed annuities. These products provide our property and casualty agency force an opportunity to cross-sell both personal and commercial accounts. EFL’s profitability depends principally on the ability to develop, price, and distribute insurance products, attract and retain deposit funds, generate investment returns, and manage expenses. Other drivers include mortality and morbidity experience, persistency experience to enable the recovery of acquisition costs, maintenance of interest spreads over the amounts credited to deposit funds, and the maintenance of strong ratings from rating agencies. EFL began writing life insurance and annuity products in Kentucky in the fourth quarter of 2014.
We generate revenues from our fixed maturity, equity security, and limited partnership investment portfolios to support our underwriting business. The Indemnity and Exchange portfolios are managed with the objective of maximizing after-tax returns on a risk-adjusted basis, while the EFL portfolio is managed to be closely aligned to its liabilities and to maintain a sufficient yield to meet profitability targets. We actively evaluate the portfolios for impairments, and record impairment writedowns on investments in instances where the fair value of the investment is substantially below cost, and it is concluded that the decline in fair value is other-than-temporary, which includes consideration for intent to sell.
Unfavorable changes in economic conditions, including declining consumer confidence, inflation, high unemployment, and the threat of recession, among others, may lead the Property and Casualty Group’s customers to modify coverage, not renew policies, or even cancel policies, which could adversely affect the premium revenue of the Property and Casualty Group, and consequently Indemnity’s management fee. These conditions could also impair the ability of customers to pay premiums when due, and as a result, the Property and Casualty Group’s bad debt write-offs could increase. Further, unanticipated increased inflation costs including medical cost inflation, construction and auto repair cost inflation, and tort issues may impact the estimated loss reserves and future premium rates. Our key challenge is to generate profitable revenue growth in a highly competitive market that continues to experience the effects of uncertain economic conditions.
Our portfolio of fixed income, preferred and common stocks, and limited partnerships are subject to market volatility especially in periods of instability in the worldwide financial markets. Over time, net investment income could also be impacted by volatility and by the general level of interest rates, which impact reinvested cash flow from the portfolio and business operations. Depending upon market conditions, which are unpredictable and remain uncertain, considerable fluctuation could exist in the fair value of our investment portfolio and reported total investment income, which could have an adverse impact on our financial condition, results of operations, and cash flows.
The consolidated financial statements include amounts based upon estimates and assumptions that have a significant effect on reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period and related disclosures. We consider an accounting estimate to be critical if 1) it requires assumptions to be made that were uncertain at the time the estimate was made, and 2) different estimates that could have been used, or changes in the estimate that are likely to occur from period-to-period, could have a material impact on our Consolidated Statements of Operations or Financial Position.
Paid development - Paid loss development patterns are generated from historical data and applied to current paid losses to generate estimated ultimate losses. Paid development techniques do not use information about case reserves and therefore are not affected by changes in case reserving practices. These techniques are generally most useful for short-tailed segments since a high percentage of ultimate losses are paid in early periods of development.
Survival ratio - This method measures the ratio of the average loss and loss expense amount paid annually to the total reserve for the product line or product coverage. The survival ratio represents the number of years of payments that the current level of reserves will cover. The reserve is established so that a particular ratio, representing the time to closing of all claims, is achieved. This method is also used as a reasonability check of reserve adequacy.
Personal auto physical damage and homeowners - These lines are fast-developing and we rely more on the paid and incurred development techniques.
Future cost increase assumptions are derived from a review of historical cost increases and are assumed to persist into the future. Future medical cost increases and claimant mortality assumptions utilized in the reserve estimates for massive injury lifetime medical claims are obtained from industry studies adjusted for our own experience. Reserve levels are sensitive to these assumptions because these amounts represent projections over 30 to 40 years into the future.
Loss reserves are set at ultimate cost, except for workers compensation loss reserves, which are discounted on a nontabular basis using an interest rate of 2.5% and our historical workers compensation payout patterns. In our workers compensation discounting methodology, we segregate the workers compensation massive injury claims that have longer payout patterns from the non-massive injury workers compensation claims. The discount on workers compensation reserves was $89 million at December 31, 2014. A 100-basis point increase in the discount rate would result in an increase to the discount of $48 million at December 31, 2014.
Workers compensation (massive injury lifetime medical claims) - The workers compensation massive injury reserve carried by the Property and Casualty Group totaled $82 million at December 31, 2014, compared to $94 million at December 31, 2013, net of discounting. The decrease in the workers compensation massive injury reserves in 2014, compared to 2013, was primarily due to the settlement of two claims, offset somewhat by the addition of two new claims. A 100-basis point increase in the medical cost inflation assumption would result in an increase in the Property and Casualty Group’s December 31, 2014 gross reserve of $20 million. This increase in the medical cost inflation assumption would also increase the related reinsurance recoverable and the workers compensation discount by $16 million, resulting in a $4 million increase in the net reserve.
$2 million, or 0.1% higher than the reserve amount we had established at December 31, 2012. At December 31, 2012, our estimate of direct loss reserves, including salvage and subrogation recoveries for accident years 2011 and prior was
$92 million, or 2.6% lower than the reserve amount we had established at December 31, 2011. See an additional discussion of our reserve development in the “Prior year loss reserve development” section.
Reserves for income-paying annuity future policy benefits are computed as the present value of future expected benefits. Principal assumptions used in the establishment of policy reserves are mortality and investment yields. Interest rates used to discount future expected benefits are set at the policy level and range from 1.50% to 9.0%. The equivalent aggregate interest rate is 5.7%. If the aggregate interest rate was reduced by 100 basis points, the present value of future expected benefits would increase by $16 million at December 31, 2014.
Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
marketplace. Fair value estimates for securities valued using unobservable inputs require significant judgment due to the illiquid nature of the market for these securities and represent the best estimate of the fair value that would occur in an orderly transaction between willing market participants at the measurement date under current market conditions. Fair value for these securities are generally determined using comparable securities or non-binding broker quotes received from outside broker dealers based upon security type and market conditions. Remaining securities, where a price is not available, are valued using an estimate of fair value based upon indicative market prices that include significant unobservable inputs not based upon, nor corroborated by, market information, including the utilization of discounted cash flow analyses which have been risk-adjusted to take into account illiquidity and other market factors. This category primarily consists of corporate bonds priced using non-binding broker quotes as well as certain private securities.
The primary basis for the valuation of limited partnership interests is 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 market conditions experienced in the fourth quarter of 2014.
While we perform various procedures in review of the general partners’ valuations, 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. Due to the limited market for these investments, there is 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 upon that information from the general partner, we consider whether additional disclosure is warranted. We analyze limited partnerships measured at fair value based upon NAV to determine if the most recently available NAV reflects fair value at the balance sheet date, with an adjustment being made where appropriate (change of plus or minus 5% compared to most recent NAV.)
Acquisition costs that vary with and relate to the production of life insurance and investment-type contracts are deferred. Deferred acquisition costs (“DAC”) are incremental direct costs of contract acquisition. These costs are limited to the successful acquisition of new and renewal contracts. Such costs consist principally of commissions and policy issuance expenses.
Indemnity had a net deferred tax asset of $37 million and $2 million at December 31, 2014 and 2013, respectively. There was no valuation allowance recorded on Indemnity at December 31, 2014 or 2013. The Exchange had a net deferred tax liability of $490 million and $450 million at December 31, 2014 and 2013, respectively.
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. Although Indemnity is the sponsor of these postretirement plans and records the funded status of these plans, the Exchange and EFL reimburse Indemnity for approximately 56% of the annual benefit expense of these plans, which represents pension benefits for Indemnity employees performing claims and EFL functions.
discount rates to projected benefit cash flows. A single discount rate is then developed to produce the same present value. The cash flows from the yield curve were matched against our projected benefit payments in the pension plan, which have a duration of about 20 years. This yield curve supported the selection of a 4.17% discount rate for the projected benefit obligation at December 31, 2014 and for the 2015 pension expense. The same methodology was used to develop the 5.11% and 4.19% discount rates used to determine the projected benefit obligation for 2013 and 2012, respectively, and the pension expense for 2014 and 2013, respectively. A 25 basis point decrease in the discount rate assumption, with other assumptions held constant, would increase pension cost in the following year by $4 million and would increase the pension benefit obligation by $34 million.
Indemnity earns management fee revenue from providing services relating to the sales, underwriting, and issuance of policies on behalf of the Exchange as a result of its attorney-in-fact relationship, which is eliminated upon consolidation. A summary of the results of our management operations is as follows:
Service agreement revenue includes service charges Indemnity collects from policyholders for providing extended payment terms on policies written by the Property and Casualty Group and late payment and policy reinstatement fees. The service
charges are fixed dollar amounts per billed installment. Service agreement revenue totaled $31 million in 2014, 2013 and 2012. The consistency in the service agreement revenue compared to the growth in policies in force reflects the continued shift in policies to the monthly direct debit payment plan, which does not incur service charges, and the no-fee single payment plan, which offers a premium discount. The shift to these plans is driven by the consumers’ desire to avoid paying service charges and to take advantage of the discount in pricing offered for paid-in-full policies.
Non-commission expense - Non-commission expense increased $23 million in 2014 compared to 2013. Information technology costs increased $13 million, which included $6 million of professional fees, $4 million of personnel costs, and
$3 million of hardware and software costs. Underwriting and policy processing costs increased $7 million due to the increased cost of underwriting reports, postage, and printing costs related to increased volume. Customer service costs increased
$4 million due to an increase of $2 million in credit card processing fees and $2 million in personnel costs. All other operating costs decreased $1 million.
In 2013, compared to 2012, non-commission expense increased $30 million. Sales and advertising costs increased $4 million due to personnel costs. Underwriting and policy processing costs increased $9 million due to increased personnel costs and the increased cost of underwriting reports and postage and printing costs. Information technology costs increased $5 million, which included $6 million of personnel costs, offset by a decrease of $1 million in software, hardware, and maintenance costs. Customer service costs increased $3 million due to an increase of $2 million in credit card processing fees and $1 million in personnel costs. Administrative and other costs increased $9 million driven by increases in professional fees and personnel costs of $5 million and $4 million, respectively. Personnel costs in all expense categories were impacted by higher staffing levels, increased pension and medical costs, and increased estimates for incentive plan compensation costs related to growth and underwriting performance.
The gross margin in 2014 was 15.8%, compared to 16.1% in 2013 and 17.3% in 2012. Excluding the adjustment in 2012 that reduced commission expense by $6 million (described above), the gross margin would have been 16.8% in 2012.
We measure profit or loss from our property and casualty insurance segment based upon its underwriting results, which are represented by net premiums earned less losses and loss expenses and policy acquisition and other underwriting expenses on a pre-tax basis. The loss and loss expense ratio and combined ratio are key performance indicators that we use to assess business trends and to make comparisons to industry results. The investment results related to our property and casualty insurance operations are included in our investment operations segment discussion.
Direct written premium - Direct written premium of the Property and Casualty Group increased 8.6% to $5.5 billion in 2014, from $5.1 billion in 2013, driven by an increase in policies in force and increases in average premium per policy. Year-over-year policies in force for all lines of business increased by 4.3% in 2014 as the result of continuing strong policyholder retention and an increase in new policies written, compared to 4.8% in 2013. The year-over-year average premium per policy for all lines of business increased 4.2% at December 31, 2014, compared to 4.5% at December 31, 2013.
Premiums generated from renewal business increased 9.0% to $4.8 billion in 2014, compared to 8.8%, or $4.4 billion, in 2013. Underlying the trend in renewal business premiums were increases in average premium per policy and steady policy retention ratios. The renewal business year-over-year average premium per policy increased 4.3% at December 31, 2014, compared to
New business premiums written on personal lines increased 6.0% in 2014, compared to 21.1% in 2013, driven by increases in new business policies written in the private passenger auto and other personal lines of business and average premium per policy. Personal lines new business policies written increased 3.0% in 2014, compared to 15.7% in 2013, while the year-over-year average premium per policy on personal lines new business increased 2.9% at December 31, 2014, compared to 4.7% at December 31, 2013.
Homeowners new business premiums written increased 2.9% in 2014, compared to 18.4% in 2013. New business policies written for homeowners decreased 0.5% in 2014, compared to an increase of 11.7% in 2013. The new business year-over-year average premium per policy for homeowners increased 3.5% at December 31, 2014, compared to 6.0% at December 31, 2013.
Renewal premiums written on personal lines increased 8.2% in 2014, compared to 7.3% in 2013, driven by increases in average premium per policy and steady policy retention ratios. The year-over-year average premium per policy on personal lines renewal business increased 3.6% at December 31, 2014, compared to 3.8% at December 31, 2013. The personal lines year-over-year policy retention ratio was 90.9% at December 31, 2014, 91.2% at December 31, 2013, and 91.6% at December 31, 2012.
Private passenger auto renewal premiums written increased 6.3% in 2014, compared to 4.5% in 2013. The year-over-year average premium per policy on private passenger auto renewal business increased 2.0% at December 31, 2014, compared to 1.5% at December 31, 2013. The private passenger auto year-over-year policy retention ratio was 91.7% at December 31, 2014, and 92.1% at December 31, 2013 and 2012.
Renewal premiums for commercial lines increased 11.3% in 2014, compared to 12.9% in 2013, driven by increases in average premium per policy and steady policy retention ratios. The combined impact of these increases was seen primarily in the
Changes in premium levels attributable to the growth in policies in force directly affect the profitability of the Property and Casualty Group and have a direct bearing on Indemnity’s management fee. Our continued focus on underwriting discipline and the maturing of our pricing sophistication models has contributed to the Property and Casualty Group’s growth in new policies in force, steady policy retention ratios, and increased average premium per policy. The continued growth of our policy base is dependent upon the Property and Casualty Group’s ability to retain existing policyholders and attract new policyholders. A lack of new policy growth or the inability to retain existing customers could have an adverse effect on the Property and Casualty Group’s premium level growth, and consequently Indemnity’s management fee.
Changes in premium levels attributable to rate changes also directly affect the profitability of the Property and Casualty Group and have a direct bearing on Indemnity’s management fee. Pricing actions contemplated or taken by the Property and Casualty Group are subject to various regulatory requirements of the states in which our insurers operate. The pricing actions already implemented, or to be implemented, have an effect on the market competitiveness of our insurance products. Such pricing actions, and those of competitors, could affect the ability of our agents to retain and attract new business. We expect the Property and Casualty Group’s pricing actions to result in a net increase in direct written premium in 2015, however, exposure reductions and/or changes in our mix of business as a result of economic conditions could impact the average premium written by the Property and Casualty Group, as customers may reduce coverages.
Current accident year, excluding catastrophe losses - The current accident year loss and loss expense ratio for all lines of business, excluding catastrophe losses, was 68.1% in 2014, compared to 66.8% in 2013 and 68.1% in 2012. The personal lines loss and loss expense ratio related to the current accident year, excluding catastrophe losses, was 67.9% in 2014, compared to 67.3% in 2013 and 68.5% in 2012. The commercial lines loss and loss expense ratio related to the current accident year, excluding catastrophe losses, was 68.6% in 2014, compared to 65.7% in 2013 and 67.1% in 2012. The higher ratios for 2014 were driven primarily by a higher volume of non-catastrophe weather related claims resulting from more severe winter weather experienced in the first quarter and a few large commercial property claims, compared to 2013.
Favorable development of $78 million related to better than expected severity trends in personal auto, commercial multi-peril, and workers compensation lines of business. Additionally, $42 million of favorable development was due to changes on individual claims, primarily workers compensation massive injury lifetime medical claims, personal auto massive injury lifetime medical claims, and the settlement of one commercial multi-peril individual large claim.
The 2013 direct business adverse development, including reserves for catastrophe losses and salvage and subrogation recoveries, totaled $2 million, contributing only 0.1 points to the combined ratio, and represented 0.1% of the net loss reserves at December 31, 2012. The most significant factors contributing to the 2013 adverse development were:
Adverse development of $29 million related to the personal auto and workers compensation massive injury lifetime medical claims due to increased annual claims cost expectations. This was offset somewhat by favorable development of $10 million due to the settlement of three massive injury lifetime medical claims. These primarily impacted accident years 2003 and prior.
Favorable development of $22 million related to the personal auto line of business resulting from better than expected severity trends, offset somewhat by minor changes across all other lines of business, which impacted the
The 2012 direct business favorable development, including reserves for catastrophe losses and salvage and subrogation recoveries, totaled $92 million, improved the combined ratio by 2.1 points, and represented 2.6% of the net loss reserves at December 31, 2011. The most significant factors contributing to the 2012 favorable development were:
Favorable development of $11 million related to the commercial auto line of business primarily resulting from better than expected severity trends, which impacted the 2007 through 2011 accident years.
Adverse development of $15 million related to the workers compensation line of business primarily resulting from increased severity trends, which impacted accident years 2000 through 2008.
$13 million in 2013 and $14 million in 2012. The adverse development in 2014 was primarily from the personal auto and workers compensation lines of business somewhat offset by favorable development in commercial auto. The favorable development in 2013 and 2012 was due to less than anticipated growth in involuntary reinsurance.
Ceded reinsurance - The Property and Casualty Group's ceded reinsurance reserve recoveries remained flat during 2014, compared to an increase of $8 million in 2013 and an increase of $9 million in 2012. An increase in ceded recoveries is reflected as favorable loss development as it represents an increase in recoveries resulting from adverse development on our direct loss reserves, while a decrease in ceded recoveries is reflected as adverse loss development as it represents a decrease in recoveries resulting from favorable development on our direct loss reserves. Ceded reinsurance reserves primarily relate to the pre-1986 automobile massive injury claims. In 2013, the increase in ceded recoveries was primarily due to adverse development related to the pre-1986 automobile massive injury claims and the commercial multi-peril and business catastrophe liability lines of business, offset somewhat by favorable development in the workers compensation line of business. In 2012, the increase in ceded recoveries was primarily the result of adverse development related to the pre-1986 automobile massive injury claims.
The Exchange retains 100% of the income from the life insurance operations.
EFL’s investment revenue decreased in 2014 due to a decrease in net realized gains on investments from the sale of bonds. Offsetting this decrease was a slight increase in net investment income from higher bond earnings primarily due to increased holdings. EFL’s investment revenue increased in 2013 due to an increase in net realized gains on investments from the sale of bonds and a slight increase in equity in earnings of limited partnerships. Offsetting these increases was a slight decrease in net investment income due to lower investment yields and a slight increase in impairment losses recognized in earnings due to bond impairments. See the discussion of investments in the “Investment Operations” segment that follows for further information.
In 2014, total benefits and expenses were impacted by a decrease in benefits and other changes in policy reserves, as a result of a decrease in interest on annuity deposits partially offset by a slight increase in death benefits. Amortization of deferred policy acquisition costs also decreased compared to 2013 as a result of the annual unlocking. In 2013, total benefits and expenses were primarily impacted by increases in benefits and other changes in policy reserves, as a result of increases in death benefits and future policy benefits, and the amortization of deferred policy acquisition costs, as a result of the annual unlocking, compared to 2012.
The Exchange’s investment results include net investment revenues from EFL’s operations of $105 million in 2014, $111 million in 2013, and
Indemnity's net investment income increased by $1 million in 2014, compared to 2013, and decreased by $1 million in 2013, compared to 2012, while net investment income for the Exchange increased by $27 million and decreased by $14 million during the same respective periods. The increase in net investment income for Indemnity in 2014 was due to higher invested balances and higher investment yields, while the decrease in 2013 was primarily due to lower average invested balances. The increase in net investment income for the Exchange in 2014 was due to an increase in invested balances partially offset by lower investment yields, while the decrease in 2013 was due to lower yields partially offset by an increase in invested balances.
Net impairment losses recognized in earnings for Indemnity were $0.1 million in 2014, compared to $0.4 million in 2013, and $0.1 million in 2012. Impairment losses for the Exchange totaled $4 million in 2014, compared to $13 million in 2013, and $0.1 million in 2012. The impairments for the Exchange in 2014 and 2013 were related to several securities in unrealized loss positions that we intended to sell prior to an expected recovery to our cost basis.
The Exchange’s results include net realized gains from EFL’s operations of $9 million in 2014, $17 million in 2013, and $9 million in 2012.
(1) The Exchange’s results include equity in earnings of limited partnerships from EFL’s operations of $1 million in 2014 and 2013, and $0.1 million in 2012.
Limited partnership earnings tend to be cyclical based upon market conditions, the age of the partnership, and the nature of the investments. Generally, limited partnership earnings are recorded on a quarter lag from financial statements we receive from our general partners. As a consequence, earnings from limited partnerships reported at December 31, 2014 reflect investment valuation changes resulting from the financial markets and the economy for the twelve month period ending September 30, 2014.
Indemnity's equity in earnings of limited partnerships decreased by $11 million in 2014, compared to 2013, and increased by
Fixed maturities classified as available-for-sale are carried at fair value with unrealized gains and losses, net of deferred taxes, included in shareholders’ equity. Indemnity’s net unrealized gains on fixed maturities, net of deferred taxes, amounted to
$6 million at December 31, 2014, compared to $5 million at December 31, 2013. At December 31, 2014, the Exchange had net unrealized gains on fixed maturities of $303 million, compared to $234 million at December 31, 2013.
(1) Includes certain exchange traded funds with underlying holdings of fixed maturity securities totaling $13 million for Indemnity and $140 million for the Exchange at December 31, 2014, and $25 million for Indemnity and $198 million for the Exchange at December 31, 2013. These securities meet the criteria of a common stock under U.S. GAAP, and are included on the balance sheet as available-for-sale equity securities. Remaining common stock investments are classified as trading securities.
Equity securities classified as available-for-sale include preferred and certain common stock securities, and are carried at fair value on the Consolidated Statements of Financial Position with all changes in unrealized gains and losses reflected in other comprehensive income. The unrealized gain on equity securities classified as available-for-sale, net of deferred taxes, for Indemnity was $0.6 million at December 31, 2014, compared to an unrealized loss of less than $0.1 million at December 31, 2013. The net unrealized gain on equity securities classified as available-for-sale, net of deferred taxes, for the Exchange was $40 million at December 31, 2014, compared to an unrealized gain of $26 million at December 31, 2013.
Our common stocks classified as trading securities are measured at fair value with all increases or decreases in fair value reflected in the Consolidated Statements of Operations.
The factors which may potentially cause the greatest variation between current reserve estimates and the actual future paid amounts include unforeseen changes in statutory or case law altering the amounts to be paid on existing claim obligations, new medical procedures and/or drugs with costs significantly different from those seen in the past, inflation, and claims patterns on current business that differ significantly from historical claims patterns.
(1) Loss reserves are set at estimated ultimate costs, except for workers compensation loss reserves which have been discounted using an interest rate of 2.5%. This discounting reduced unpaid losses and loss expenses by $89 million and $85 million at December 31, 2014 and 2013, respectively.
EFL’s primary commitment is its obligation to pay future policy benefits under the terms of its life insurance and annuity contracts. To meet these future obligations, EFL establishes life insurance reserves based upon the type of policy, the age, gender, and risk class of the insured, and the number of years the policy has been in force. EFL also establishes annuity and universal life reserves primarily based upon the amount of policyholder deposits (less applicable insurance and expense charges) plus interest earned on those deposits. Life insurance and annuity reserves are supported primarily by EFL’s long-term, fixed income investments as the underlying policy reserves are generally also of a long-term nature.
$65 million represents the current period actuarial loss. The 2014 actuarial loss was primarily due to the change in the discount rate assumption used to measure the future benefit obligations to 4.17% in 2014, from 5.11% in 2013. At December 31, 2013, shareholders’ equity increased by $81 million, net of tax, of which $10 million represents amortization of the prior service cost and net actuarial loss and $71 million represents the current period actuarial gain. The 2013 actuarial gain was primarily due to the change in the discount rate assumption used to measure the future benefit obligations to 5.11% in 2013, from 4.19% in 2012. Although Indemnity is the sponsor of these postretirement plans and records the funded status of these plans, the Exchange and EFL reimburse Indemnity for approximately 56% of the annual benefit expense of these plans, which represents pension benefits for Indemnity employees performing claims and EFL functions.
At December 31, 2014, we recorded a net deferred tax asset of $37 million related to Indemnity and a net deferred tax liability of $490 million related to the Exchange. There was no deferred tax valuation allowance recorded at December 31, 2014. During calendar years 2014, 2013, and 2012, we received cash refunds of federal income taxes paid in prior tax periods of
Net cash used in investing activities totaled $596 million in 2014, $759 million in 2013, and $85 million in 2012. Changes in investing activities in 2014 primarily included a decrease in certain fixed maturity purchases and increased cash generated from the sale of preferred stocks, offset somewhat by an increase in other preferred stock purchases combined with decreased cash generated from the sale, call and maturity of fixed income securities, compared to 2013. At December 31, 2014, we had contractual commitments to invest up to $483 million related to our limited partnership investments to be funded as required by the partnerships’ agreements. Of this amount, the total remaining commitment to fund limited partnerships that invest in private equity securities was $151 million, mezzanine debt securities was $165 million, and real estate activities was
At December 31, 2014, Indemnity recorded a net deferred tax asset of $37 million. There was no deferred tax valuation allowance recorded at December 31, 2014. During calendar year 2014, Indemnity received cash refunds of federal income taxes paid in prior tax periods of $1 million.
Net cash used in Indemnity’s financing activities totaled $139 million in 2014, $116 million in 2013, and $299 million in 2012. The increase in cash used in financing activities for 2014 was driven by an increase in the cash outlay for dividends paid to shareholders, somewhat offset by a decrease in the cash outlay for share repurchases. Decreased cash used in financing activities in 2013 was driven by a decrease in dividends paid to shareholders, due to the accelerated payment of the regular first quarter 2013 dividend into the fourth quarter of 2012 and a special one-time cash dividend, and a decrease in the cash outlay for share repurchases. Dividends paid to shareholders totaled $119 million, $84 million, and $229 million in 2014, 2013 and 2012, respectively. Indemnity increased both its Class A and Class B shareholder regular quarterly dividends for 2014 and 2013. In 2012, in addition to the regular quarterly dividend declared in November, the Board also declared a special one-time cash dividend of $2.00 on each Class A share and $300.00 on each Class B share, totaling $95 million. The payment of both the regular and special dividend was accelerated and paid in December 2012 due to the potential significant increases in tax rates on 2013 dividend income pending at the time of declaration. In 2013, the regular quarterly dividend was declared by the Board at its December meeting and paid in January of the following year. There are no regulatory restrictions on the payment of dividends to Indemnity’s shareholders. Dividends have been approved at a 7.2% increase for 2015.
Indemnity repurchased 276,390 shares of its Class A nonvoting common stock in conjunction with its stock repurchase program at a total cost of $19.5 million in 2014, based upon settlement date. In 2013, shares repurchased under this program totaled 441,024 at a total cost of $31.9 million, compared to 986,439 shares at a total cost of $70.2 million in 2012. In October 2011, our Board of Directors approved a continuation of the current stock repurchase program for a total of
In 2014, we repurchased 64,398 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $4.9 million for the vesting of stock-based awards for executive management and an outside director, and for awards under our long-term incentive plan. These shares were delivered in January, May and June 2014, respectively. In 2013, we repurchased 3,477 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $255,454 to settle payments due to a retired executive under our long-term incentive plan. These shares were delivered to the plan participant in January 2013 and July 2013. In 2012, we also repurchased 1,803 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $129,849 to settle payments due to two retired senior vice presidents under our long-term incentive plan. These shares were delivered to the plan participants in January 2012 and June 2012, respectively.
Outside of the Exchange’s normal operating and investing cash activities, future funding requirements could be met through:
$328 million were pledged as collateral on the line at December 31, 2014. These securities have no trading restrictions and are reported as available-for-sale fixed maturities in the Consolidated Statements of Financial Position. The bank requires compliance with certain covenants, which include statutory surplus and risk based capital ratios. The Exchange was in compliance with its bank covenants at December 31, 2014.
Limited partnership commitments will be funded as required for capital contributions at any time prior to the agreement expiration date. The commitment amounts are presented using the expiration date as the factor by which to age when the amounts are due. At December 31, 2014, Indemnity’s total commitment to fund limited partnerships that invest in private equity securities was $10 million, mezzanine debt was $9 million, and real estate activities was $5 million. At December 31, 2014, the Exchange’s total commitment to fund limited partnerships that invest in private equity securities was $141 million, mezzanine debt was $156 million, and real estate activities was $162 million.
Operating leases - real estate are for 18 of our 25 field offices that are operated in the states in which the Property and Casualty Group does business and two operating leases are for office space and a warehouse facility leased from unaffiliated parties.
The outlook for all ratings is stable. According to A.M. Best, a “Superior” rating (A+), the second highest financial strength rating category, is assigned to those companies that, in A.M. Best’s opinion, have achieved superior overall performance when compared to the standards established by A.M. Best and have a superior ability to meet obligations to policyholders over the long term. Only 9.7% of insurance groups are rated A+ or higher, and we are included in that group. By virtue of its affiliation with the Property and Casualty Group, EFL is typically rated one level lower, or an “Excellent” rating (A), than our property and casualty insurance companies by A.M. Best Company. Financial strength ratings continue to be an important factor in evaluating the competitive position of insurance companies.
The Exchange is operated for the interest of its subscribers (policyholders) and any distributions it might declare would only be payable to them. The Exchange did not make any distributions to its subscribers (policyholders) in 2014, 2013, or 2012.
As an insurance company, we are in the business of taking risks from our policyholders, managing these risks in a cost-effective manner and ensuring long term stability for policyholders as well as shareholders. Since risk is integral to our business, we strive to manage the multitude of risks we face in an optimal manner. Some risks can occur simultaneously or be correlated with other risks. Therefore an event or a series of events has the potential to impact multiple areas of our business and materially affect our operations, financial position or liquidity. As such, our ERM program takes a holistic view of risk and ensures implementation of risk responses to mitigate potential impacts across our entire group of companies.
Our Board of Directors has a broad oversight responsibility over our intercompany relationships within and among the Property and Casualty Group. As a consequence, our Board of Directors may be required to make decisions or take actions that may not be solely in the interest of our shareholders, such as setting the management fee rate paid by the Exchange to Indemnity and ratifying any other significant intercompany activity.
Indemnity makes certain payments on behalf of the Erie Insurance Group’s related entities. These amounts are reimbursed to Indemnity on a cost basis in accordance with service agreements between Indemnity and the individual entities within the Erie Insurance Group. These reimbursements are settled on a monthly basis.
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, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, 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.
Postretirement plans, net of tax (benefit) expense of $(31), $44 and $(17), respectively
Cash and cash equivalents (Exchange portion of $422 and $403, respectively)
Class A common stock, stated value $0.0292 per share; 74,996,930 shares authorized; 68,299,200 shares issued; 46,189,068 and 46,461,125 shares outstanding, respectively
Dividends declared - Class B ($387.90, $361.875 and $637.50 per share, respectively)
All property and casualty and life insurance operations are owned by the Exchange and Indemnity functions solely as the management company.
Rights of shareholders of Indemnity and subscribers (policyholders) of the Exchange - The shareholders of Indemnity, through the management fee, have a controlling financial interest in the Exchange; however, they have no other rights to or obligations arising from assets and liabilities of the Exchange. The shareholders of Indemnity own its equity but have no rights or interest in the Exchange’s (noncontrolling interest) income or equity. The noncontrolling interest equity represents the Exchange’s equity held for the interest of its subscribers (policyholders), who have no rights or interest in the Indemnity shareholder interest income or equity.
In February 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. ASU 2013-02 requires entities to present in either a single note or parenthetically on the face of the financial statements the effect of significant amounts reclassified from each component of accumulated other comprehensive income based on its source and the income statement line affected by the reclassification. ASU 2013-02 was effective for reporting periods beginning after December 15, 2012. We adopted the guidance effective January 1, 2013 and disclose reclassifications from accumulated other comprehensive income and the impact on our consolidated financial statements in Note 18, "Indemnity Accumulated Other Comprehensive Loss".
In February 2015, the FASB issued ASU 2015-02, “Consolidation”, which changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. ASU 2015-02 modifies the evaluation of whether limited partnerships are variable interest entities and the consolidation analysis of reporting entities that are involved in variable interest entities, particularly those that have fee arrangements and related party relationships. All legal entities are subject to reevaluation under this revised consolidation model. ASU 2015-02 is effective for interim and annual periods beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. We are currently evaluating this new guidance and have not yet determined the impact that the adoption of this new consolidation model will have on our consolidated financial statements.
principles for recognizing revenue and provides a common revenue standard for GAAP. The core principle of the guidance is
consideration to which the entity expects to be entitled in exchange for those goods or services. Insurance contracts are not
within the scope of this guidance. ASU 2014-09 is effective for interim and annual periods beginning after December 15, 2016. Early application is not permitted. We do not expect the adoption of ASU 2014-09 related to the management fee and service agreement revenue to have a material impact on our consolidated financial statements.
Available-for-sale securities - Fixed maturity, preferred stock, and common stock securities classified as available-for-sale are reported at fair value. Unrealized holding gains and losses, net of related tax effects, on available-for-sale securities are recorded directly to shareholders’ equity as accumulated other comprehensive income (loss).
Fixed income and redeemable preferred stock (debt securities) are evaluated monthly for other-than-temporary impairment loss. For debt securities that have experienced a decline in fair value and that we intend to sell, or for which it is more likely than not we will be required to sell the security before recovery of its amortized cost, an other-than-temporary impairment is deemed to have occurred, and is recognized in earnings.
Costs that vary with and directly relate to the successful acquisition of new and renewal insurance and investment-type contracts are deferred. These costs are principally commissions, premium taxes and policy issuance expenses.
Property and casualty insurance - DAC is amortized as premiums are earned over the applicable policy term. Investment income is considered in determining the recoverability of DAC. If a premium deficiency exists, it would first be recognized by charging any unamortized acquisition costs to expense. If the premium deficiency were greater than unamortized acquisition costs, a liability would be accrued for the excess deficiency. There was no reduction in costs deferred in any periods presented. Profitability is analyzed annually to ensure recoverability.
Life insurance - DAC related to traditional life insurance products is amortized in proportion to premium revenues over the premium-paying period of related policies using assumptions about mortality, morbidity, lapse rates, expenses, and future yield on related investments established when the policy was issued. Amortization is adjusted each period to reflect policy lapse or termination rates as compared to anticipated experience. DAC related to universal life products and deferred annuities is amortized over the estimated lives of the contracts in proportion to actual and expected future gross profits, investment, mortality, expense margins, and surrender charges. Historical and anticipated investment returns, including realized gains and losses, are considered in determining the amortization of DAC.
The liability for future benefits of life insurance contracts is the present value of such benefits less the present value of future net premiums. Life insurance and income-paying annuity future policy benefit reserves are computed primarily by the net level premium method with assumptions as to mortality, withdrawal, lapses, and investment yields. Traditional life insurance products are subject to loss recognition testing. The adequacy of the related reserves is verified as part of loss recognition testing. Loss recognition is necessary when the sum of the reserve and the present value of projected policy cash flows is less than unamortized DAC.
Property and casualty insurance - Insurance premiums written are earned over the terms of the policies on a pro-rata basis. Premiums receivable from policyholders represent premiums written but not yet collected. Premiums receivable are reported net of an allowance for uncollectible premiums. Unearned premiums represent that portion of premiums written which is applicable to the unexpired terms of policies in force. Losses and loss expenses are recorded as incurred.
Life insurance - Premiums on traditional life insurance products are recognized as revenue when due. Reserves for future policy benefits are established when premiums are earned. Premiums received for annuity and universal life products are reported as deposits and included in liabilities. For universal life products, revenue is recognized when 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 EFL, which is reflected in net investment income.
Life insurance - Reinsurance premiums, commissions, and expense reimbursements on reinsurance ceded on life insurance policies are accounted for on a basis consistent with those used in accounting for the underlying reinsured policies. Expense reimbursements received in connection with new reinsurance ceded have been accounted for as a reduction of the related policy acquisition costs. Amounts recoverable from reinsurers for future policy benefits are estimated in a manner consistent with the assumptions used for the underlying policy benefits. Amounts recoverable for incurred claims, future policy benefits, and expense reimbursements are recorded as assets. Reinsurance contracts do not relieve EFL from its obligations to policyholders.
Indemnity earns management fees from the Exchange for providing sales, underwriting, and policy issuance services. Pursuant to the subscriber’s agreements with the policyholders at the Exchange, Indemnity may retain up to 25% of all premiums written or assumed by the Exchange. Management fee revenue is calculated by multiplying the management fee rate by the direct premiums written by the Exchange and the other members of the Property and Casualty Group, which are assumed by the Exchange under an intercompany pooling arrangement. The Property and Casualty Group issues policies with annual terms
All property and casualty and life insurance operations are owned by the Exchange, and Indemnity functions solely as the management company.
Our reportable segments include management operations, property and casualty insurance operations, life insurance operations, and investment operations. Accounting policies for segments are the same as those described in the summary of significant accounting policies (see Note 2, “Significant Accounting Policies”). 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.
The year ended December 31, 2012 includes an adjustment that reduced commission expense by $6 million. This amount represents the reimbursement by the North Carolina Reinsurance Facility (NCRF) for commissions Indemnity paid to agents on the surcharges collected on behalf of the NCRF which was incorrectly recorded as a benefit to the Exchange in prior periods.
Our property and casualty insurance operations segment includes personal and commercial lines. Personal lines consist primarily of personal auto and homeowners and are marketed to individuals. Commercial lines consist primarily of commercial multi-peril, commercial auto, and workers compensation and are marketed to small- and medium-sized businesses. Our property and casualty policies are sold by independent agents. Our property and casualty insurance underwriting operations are conducted through the Exchange and its subsidiaries and include assumed involuntary and ceded reinsurance business and run-off activity of the previously assumed voluntary reinsurance business. We evaluate profitability of the property and casualty insurance operations principally based upon net underwriting results represented by the combined ratio.
Our life insurance operations segment includes traditional and universal life insurance products and fixed annuities marketed to individuals using the same independent agency force utilized by our property and casualty insurance operations. We evaluate profitability of the life insurance segment principally based upon segment net income, including investments, which for segment purposes are reflected in the investment operations segment. At the same time, we recognize that investment-related income is integral to the evaluation of the life insurance segment because of the long duration of life products. In 2014, investment activities on life insurance-related assets generated revenues of $105 million, resulting in EFL reporting income before income taxes of $49 million, before intercompany eliminations. In 2013, investment activities on life insurance-related assets generated revenues of $111 million, resulting in EFL reporting income before income taxes of $48 million, before intercompany eliminations. In 2012, investment activities on life insurance-related assets generated revenues of $104 million, resulting in EFL reporting income before income taxes of $46 million, before intercompany eliminations.
The investment operations segment includes returns from our fixed maturity, equity security and limited partnership investment portfolios to support our underwriting business. The Indemnity and Exchange portfolios are managed with the objective of maximizing after-tax returns on a risk-adjusted basis, while the EFL portfolio is managed to be closely aligned to its liabilities and to maintain a sufficient yield to meet profitability targets. We actively evaluate the portfolios for impairments and record impairment writedowns on investments in instances where the fair value of the investment is substantially below cost, and it is concluded that the decline in fair value is other-than-temporary. Investment-related income for the life operations is included in the investment segment results.
(1) Other investments measured at fair value represent four real estate funds included on the balance sheet as limited partnership investments that are reported under the fair value option. These investments can never be redeemed with the funds. Instead, distributions are received when liquidation of the underlying assets of the funds occur. It is estimated that the underlying assets will generally be liquidated between 5 and 10 years from the inception of the funds. The fair value of these investments is based on the net asset value (NAV) information provided by the general partner. Fair value is based on our proportionate share of the NAV based on the most recent partners' capital statements received from the general partners, which is generally one quarter prior to our balance sheet date. These values are then analyzed to determine if the NAV represents fair value at our balance sheet date, with adjustment being made where appropriate. We consider observable market data and perform a review validating the appropriateness of the NAV at each balance sheet date. It is likely that all of the investments will be redeemed at a future date for an amount different than the NAV of our ownership interest in partners' capital as of December 31, 2014. During the year ended December 31, 2014, Indemnity made no contributions and received distributions totaling $12.9 million, and the Exchange made no contributions and received distributions totaling $41.5 million for these investments. As of December 31, 2014, the amount of unfunded commitments related to the investments was $0.6 million for Indemnity and $1.7 million for the Exchange.
The following table presents our consolidated fair value measurements on a recurring basis by asset class and level of input at December 31, 2013:
(1) Other investments measured at fair value represent four real estate funds included on the balance sheet as limited partnership investments that are reported under the fair value option. These investments can never be redeemed with the funds. Instead, distributions are received when liquidation of the underlying assets of the funds occur. It is estimated that the underlying assets will generally be liquidated between 5 and 10 years from the inception of the funds. The fair value of these investments is based on the net asset value (NAV) information provided by the general partner. Fair value is based on our proportionate share of the NAV based on the most recent partners' capital statements received from the general partners, which is generally one quarter prior to our balance sheet date. These values are then analyzed to determine if the NAV represents fair value at our balance sheet date, with adjustment being made where appropriate. We consider observable market data and perform a review validating the appropriateness of the NAV at each balance sheet date. It is likely that all of the investments will be redeemed at a future date for an amount different than the NAV of our ownership interest in partners' capital as of December 31, 2013. During the year ended December 31, 2013, Indemnity made no contributions and received distributions totaling $2.4 million, and the Exchange made no contributions and received distributions totaling $21.7 million for these investments. As of December 31, 2013, the amount of unfunded commitments related to the investments was $1.5 million for Indemnity and $4.5 million for the Exchange.
For Indemnity, there were no Level 1 to Level 2 transfers for the year ended December 31, 2013. Level 2 to Level 1 transfers totaled $1 million due to trading activity levels related to one preferred stock holding, and there where no transfers between Level 2 and Level 3.
Other investments represent certain limited partnerships that are recorded at fair value based upon net asset value (NAV) provided by the general partner. Due to the nature of these investments, the NAV was classified within Level 3. The unobservable inputs are not reasonably available to us and therefore have not been included in the tables below. These investments totaled $8 million for Indemnity and $71 million for the Exchange at December 31, 2014, and $18 million for Indemnity and $98 million for the Exchange at December 31, 2013.
Common stock investments and Corporate debt securities - The unobservable inputs used in the fair value measurement of direct private equity common stock investments and certain corporate debt securities are comparable private transaction earnings before interest, taxes, depreciation, and amortization (“EBITDA”) multiples, the average EBITDA multiple for comparable publicly traded companies and the amount of discount applied to the price due to the illiquidity of the securities being valued. Significant changes in any of those inputs in isolation could result in a significantly higher or lower fair value measurement.
Nonredeemable preferred stock - represents a private security where cost was determined to be the best estimate of fair value.
The following table presents our consolidated fair value measurements on a recurring basis by pricing source at December 31, 2014:
There were no assets measured at fair value on a nonrecurring basis during the year ended December 31, 2014.
Available-for-sale securities in a gross unrealized loss position at December 31, 2014 are as follows. Data is provided by length of time for securities in a gross unrealized loss position.
Realized gains and losses on sales of securities are recognized in income based upon the specific identification method. Realized gains (losses) on investments were as follows:
The fair value on our common stock portfolio is based upon exchange traded prices provided by a nationally recognized pricing service.
In considering if fixed maturity securities were credit-impaired, some of the factors considered include: potential for the default of interest and/or principal, level of subordination, collateral of the issue, compliance with financial covenants, credit ratings, and industry conditions. We have the intent to sell all credit-impaired fixed maturity securities, therefore the entire amount of the impairment charges were included in earnings and no non-credit impairments were recognized in other comprehensive income. See also Note 2, “Significant Accounting Policies.”
We have provided summarized financial information in the following tables for the years ended December 31, 2014 and 2013. Amounts provided in the tables are presented using the latest available financial statements received from the partnerships for the respective periods. Limited partnership financial information has been presented based upon the investment percentage in the partnerships for the Erie Insurance Group consistent with how we evaluate these investments.
As these investments are generally reported on a one-quarter lag, our limited partnership results through December 31, 2014 include partnership financial results for the fourth quarter of 2013 and the first three quarters of 2014.
Per the limited partnership financial statements, total partnership assets were $45 billion and total partnership liabilities were
$5 billion at December 31, 2013 (as recorded in the September 30, 2013 limited partnership financial statements). For the twelve month period comparable to that presented in the preceding table (fourth quarter of 2012 and first three quarters of 2013), total partnership valuation adjustment gains were $2 billion and total partnership net income was $7 billion.
We capitalize computer software costs developed or obtained for internal use. Capitalized costs include internal and external labor and overhead. Capitalization ceases and amortization begins no later than the point at which a computer software project is complete and ready for its intended use. Capitalized software costs are amortized over the estimated useful life of the software.
The following table outlines the estimated future amortization expense related to capitalized software development costs as of December 31, 2014:
$328 million were pledged as collateral on the line at December 31, 2014.
The following table provides a reconciliation of our property and casualty beginning and ending loss and loss expense reserve balances for the years ended December 31:
The reinsurance credit related to life policy and deposit contract reserves was $146 million, $134 million and $122 million at December 31, 2014, 2013 and 2012 respectively, and is presented in other assets in the Consolidated Statements of Financial Position.
Reinsurance contracts do not relieve the Property and Casualty Group or EFL from the 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 maintains several property catastrophe reinsurance treaties with nonaffiliated reinsurers to mitigate future potential catastrophe loss exposures. During 2014, a first treaty provided coverage of up to 30% of a loss of $100 million in excess of the Property and Casualty Group’s loss retention of $300 million per occurrence, a second treaty provided coverage of up to 90% of a loss of $500 million in excess of $400 million, a third treaty provided coverage of up to 85% of a loss of $200 million in excess of $900 million, and a fourth treaty provided coverage of up to 100% of a loss of
In addition to the property catastrophe treaties, the Property and Casualty Group also cedes certain individual lines of business to unaffiliated reinsurers and cedes certain individual risks on a facultative basis. The Property and Casualty Group maintains several 100% quota share agreements with A.M. Best A++ rated Hartford Steam Boiler Inspection and Insurance Company. These agreements cede 100% of the covered insurance risk relating to the reinsured portions of the equipment breakdown, employment practices liability, and identity recovery lines of business. During 2014, the Property and Casualty Group ceded a total of $24 million in premium to Hartford Steam Boiler. The cessions for 2013 and 2012 were $21 million and $17 million respectively.
EFL maintains several reinsurance treaties with nonaffiliated life reinsurance companies in order to reduce claims volatility. EFL had direct life insurance in force totaling $47 billion and $45 billion at December 31, 2014 and 2013, respectively. Of these amounts, EFL ceded $21 billion of life insurance in force at December 31, 2014 and 2013. The largest amount of in force life insurance ceded to one reinsurer totaled $10 billion at December 31, 2014 and 2013.
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 each provide benefits through a final average earnings formula.
The rate of compensation increase for the employee plan is age-graded. An equivalent single compensation increase rate of 3.32% in 2014 and 4.15% in 2013 and 2012 would produce similar results.
Projected benefit obligations increased $180 million at December 31, 2014 compared to December 31, 2013. The largest factor driving the increase was the change in the discount rate. Also contributing to this increase was the adoption of the newly issued mortality tables, which was partially offset by the decrease related to other plan assumptions that were updated to reflect our most recent actual experience.
Funded status at end of year, included in Indemnity Other Liabilities
Both the defined benefit pension plan and the SERP had accumulated benefit obligations in excess of plan assets at December 31, 2014. The SERP had an accumulated benefit obligation in excess of plan assets at December 31, 2013.
The charges recognized as amendments were the result of factoring in the prior service cost for four new plan participants in 2014.
U.S. equity securities - 22% seek to achieve excess returns relative to the Russell 2000 Index, while 30% seek to achieve excess returns relative to the S&P 500. The remaining 48% of the allocation to U.S. equity securities are comprised of equity index funds that track the S&P 500.
All full-time and regular part-time employees are eligible to participate in a traditional qualified 401(k) or a Roth 401(k) savings plan. We match 100% of the participant contributions up to 3% of compensation and 50% of participant contributions over 3% and up to 5% of compensation. Matching contributions paid to the plan were $11 million in 2014,
$10 million in 2013, and $9 million in 2012. Employees are permitted to invest the employer-matching contributions in our Class A common stock. Employees, other than executive and senior officers, may sell the shares at any time without restriction; sales by executive and senior officers are subject to restrictions imposed by our insider trading policies and the federal securities laws. The plan acquires shares in the open market necessary to meet the obligations of the plan. Plan participants held 0.2 million shares of our Class A common stock at December 31, 2014 and 2013.
250,000 shares or the equivalent of $5 million during any one performance period. We repurchase our Class A common stock on the open market to settle plan awards. We do not issue new shares of common stock to settle plan awards. LTIP awards are considered vested at the end of each applicable performance period.
The LTIP provides the recipient the right to earn performance shares or units based on the level of achievement of performance goals as defined by us. Performance measures and a peer group of property and casualty companies to be used for comparison are determined by the ECDC. The performance measures for the 2014, 2013 and 2012 awards were the reported combined ratio, growth in direct written premiums and return on invested assets over a three-year performance period as compared to the results of the peer group over the same period. Because the award is based upon a comparison to results of a peer group over a three-year period, the award accrual is based upon estimates of probable 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.
$4 million was paid in June 2014. At December 31, 2012, the awards for the 2010-2012 performance period were fully vested and the related cash award of $5 million was paid in May 2013.
Effective April 17, 2013, our Board of Directors approved an equity compensation plan (“ECP”) designed to reward key employees, as determined by the ECDC or the chief executive officer, who can have a significant impact on our long-term performance and to further align the interests of such employees with those of our shareholders. The ECP permits grants of restricted shares, restricted share units and other share based awards, to be satisfied with shares of our Class A common stock or cash. The ECDC determines the form of the award to be granted at the beginning of each performance period. The number of shares of Indemnity’s Class A common stock authorized for grant under the ECP is 100,000 shares, with no one person able to
Restricted share awards may be entitled to receive dividends payable during the performance period, or, if subject to performance goals, to receive dividend equivalents payable upon vesting. Dividend equivalents may provide for the crediting of interest or hypothetical reinvestment experience payable after expiration of the performance period.
We have two classes of common stock: Class A which has a dividend preference and Class B which has voting power and a conversion right. 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. Holders of Class B shares may, at their option, convert their shares into Class A shares at the rate of 2,400 Class A shares per Class B share. There were no shares of Class B common stock converted into Class A common stock in 2014 and 2013. In 2012, four shares of Class B common stock were converted into Class A common stock. There is no provision for conversion of Class A shares to Class B shares, and, Class B shares surrendered for conversion cannot be reissued.
A stock repurchase program was authorized for our outstanding Class A nonvoting common stock beginning January 1, 2004. Treasury shares are recorded in the Consolidated Statements of Financial Position at total cost based upon trade date. Shares repurchased under this program, based upon trade date, totaled 272,057 at a total cost of $19.2 million during 2014, and 431,556 shares at a total cost of $31.2 million during 2013. In October 2011, our Board of Directors approved a continuation of the current stock repurchase program for a total of $150 million, with no time limitation. We had approximately $18 million of repurchase authority remaining under this program at December 31, 2014, based upon trade date.
In 2014, we repurchased 64,398 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $4.9 million. Of this amount, we repurchased 2,800 shares of our outstanding Class A nonvoting common stock at a total cost of $201,411, or $71.93 per share, for the vesting of stock-based awards for executive management. These shares were delivered to executive management in January 2014. In May 2014, we repurchased
7,227 shares of our outstanding Class A nonvoting common stock at a total cost of $552,503, or $76.45 per share, for the vesting of stock-based awards for a former outside director. These shares were delivered in May 2014. In May and June 2014, we repurchased 54,371 shares of our outstanding Class A nonvoting common stock at a total cost of $4,143,544, or $76.21 per share, for the vesting of stock-based awards in conjunction with our long-term incentive plan. These shares were delivered to plan participants in June 2014.
Changes in Indemnity's accumulated other comprehensive loss by component attributable to the Indemnity shareholder interest is presented as follows for the year ended December 31:
Amounts reclassified out of accumulated other comprehensive income (loss) and the related affected line item in the Consolidated Statements of Operations where net income is presented are as follows for the year ended December 31:
Components of accumulated other comprehensive income (loss) related to postretirement plan items are included in the computation of pension plan cost. See Note 15, "Postretirement Benefits," for additional details.
The minimum statutory capital and surplus requirements under Pennsylvania and New York law for the Exchange’s property and casualty insurance subsidiaries amounts to $12 million. The Exchange’s property and casualty insurance subsidiaries’ total statutory capital and surplus significantly exceed these minimum requirements, totaling $364 million at December 31, 2014. The risk-based capital levels of all members of the Property and Casualty Group and EFL significantly exceed the minimum requirements. Cash and securities with a carrying value of $15 million were deposited by the property and casualty and life entities with regulatory authorities under statutory requirements at December 31, 2014.
As prescribed by the Insurance Department of the Commonwealth of Pennsylvania, the Exchange records unearned subscriber fees (fees to the attorney-in-fact) as deductions from unearned premium reserve and charges current operations on a pro-rata basis over the periods covered by the policies. The Pennsylvania-domiciled members of the Property and Casualty Group discount workers compensation loss reserves on a non-tabular basis as prescribed by the Insurance Department of the Commonwealth of Pennsylvania. The Exchange’s NAIC prepared statutory surplus, excluding the impact of the Pennsylvania prescribed practices, would have been $6.2 billion at December 31, 2014. EIC’s NAIC prepared statutory surplus, excluding the impact of the Pennsylvania prescribed practices, would have been $307 million at December 31, 2014. EPC and Flagship record the discounting of workers compensation loss reserves on a direct basis, however, after application of the intercompany pooling arrangement, there is no impact on these financial statements.
Receivables from the Exchange and EFL and concentrations of credit risk - Financial instruments could potentially expose Indemnity to concentrations of credit risk, including unsecured receivables from the Exchange. A majority of Indemnity’s revenue and receivables are from the Exchange and affiliates. See also Note 4, “Variable Interest Entity.”
Expense allocations - All claims handling services for the Exchange are performed by Indemnity employees who are entirely dedicated to claims related activities. All costs associated with these employees are reimbursed to Indemnity from the Exchange’s revenues in accordance with the subscriber’s agreement. Indemnity is reimbursed by EFL from its revenues for all costs associated with employees who perform life insurance related operating activities for EFL in accordance with its service agreement with Indemnity. Common overhead expenses included in the expenses paid by Indemnity are allocated based upon appropriate utilization statistics (employee count, square footage, vehicle count, project hours, etc.) specifically measured to accomplish proportional allocations. Executive compensation is allocated based upon each executive’s primary responsibilities (management services, property and casualty claims operations, EFL operations, and investment operations). We believe the methods used to allocate common overhead expenses among the affiliated entities are reasonable.
Office leases - Indemnity leases certain office space from the Exchange, including the home office and three field office facilities. Rent expenses for the facilities totaled $8 million in 2014 and $6 million in 2013 and 2012. Indemnity also has a lease commitment with EFL for a branch office until 2018. Annual rentals paid to EFL under this lease totaled $0.4 million in 2014, 2013 and 2012.