Erie Indemnity 10-Q 2023-03-31

Filed 2023-04-27. 7 sections, 173K characters. Original on sec.gov · Markdown · JSON

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2023

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period fromto

Commission file number 0-24000

ERIE INDEMNITY COMPANY
(Exact name of registrant as specified in its charter)
Pennsylvania25-0466020
(State or other jurisdiction of(IRS Employer
incorporation or organization)Identification No.)
100 Erie Insurance Place,Erie,Pennsylvania16530
(Address of principal executive offices)(Zip Code)
814870-2000
(Registrant’s telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

Class A common stock,stated value $0.0292 per shareERIENASDAQ Stock Market, LLC
(Title of each class)(Trading Symbol)(Name of each exchange on which registered)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer☒Accelerated filer☐Non-accelerated filer☐
Smaller reporting company☐Emerging growth company☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

The number of shares outstanding of the registrant’s Class A Common Stock as of the latest practicable date was 46,189,068 at April 21, 2023.

The number of shares outstanding of the registrant’s Class B Common Stock as of the latest practicable date was 2,542 at April 21, 2023.

PART I.FINANCIAL INFORMATION
Item 1.Financial Statements (Unaudited)
Statements of Operations – Three months ended March 31, 2023 and 2022
Statements of Comprehensive Income – Three months ended March 31, 2023 and 2022
Statements of Financial Position – March 31, 2023 and December 31, 2022
Statements of Shareholders' Equity – Three months ended March 31, 2023 and 2022
Statements of Cash Flows – Three months ended March 31, 2023 and 2022
Notes to Financial Statements – March 31, 2023
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.Quantitative and Qualitative Disclosures About Market Risk
Item 4.Controls and Procedures
PART II.OTHER INFORMATION
Item 1.Legal Proceedings
Item 1A.Risk Factors
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.Exhibits
SIGNATURES

PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

ERIE INDEMNITY COMPANY

STATEMENTS OF OPERATIONS (UNAUDITED)

(dollars in thousands, except per share data)

Three months ended
March 31,
20232022
Operating revenue
Management fee revenue - policy issuance and renewal services$558,090$487,992
Management fee revenue - administrative services15,18914,313
Administrative services reimbursement revenue172,827163,327
Service agreement revenue6,3596,478
Total operating revenue752,465672,110
Operating expenses
Cost of operations - policy issuance and renewal services469,095424,471
Cost of operations - administrative services172,827163,327
Total operating expenses641,922587,798
Operating income110,54384,312
Investment income
Net investment income2,18310,504
Net realized and unrealized investment losses(5,282)(7,279)
Net impairment losses recognized in earnings(1,633)(216)
Total investment (loss) income(4,732)3,009
Interest expense—999
Other income3,337473
Income before income taxes109,14886,795
Income tax expense22,90718,176
Net income$86,241$68,619
Net income per share
Class A common stock – basic$1.85$1.47
Class A common stock – diluted$1.65$1.31
Class B common stock – basic and diluted$278$221
Weighted average shares outstanding – Basic
Class A common stock46,188,81946,188,761
Class B common stock2,5422,542
Weighted average shares outstanding – Diluted
Class A common stock52,296,62152,300,501
Class B common stock2,5422,542
Dividends declared per share
Class A common stock$1.19$1.11
Class B common stock$178.50$166.50

See accompanying notes to Financial Statements. See Note 11, "Accumulated Other Comprehensive Income (Loss)", for amounts reclassified out of accumulated other comprehensive income (loss) into the Statements of Operations.

ERIE INDEMNITY COMPANY

STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(in thousands)

Three months ended
March 31,
20232022
Net income$86,241$68,619
Other comprehensive income (loss), net of tax
Change in unrealized holding gains (losses) on available-for-sale securities10,494(26,919)
Amortization of prior service costs and net actuarial (gain) loss on pension and other postretirement plans(2,742)1,730
Total other comprehensive income (loss), net of tax7,752(25,189)
Comprehensive income$93,993$43,430

See accompanying notes to Financial Statements. See Note 11, "Accumulated Other Comprehensive Income (Loss)", for amounts reclassified out of accumulated other comprehensive income (loss) into the Statements of Operations.

ERIE INDEMNITY COMPANY

STATEMENTS OF FINANCIAL POSITION

(dollars in thousands, except per share data)

March 31,December 31,
20232022
Assets(Unaudited)
Current assets:
Cash and cash equivalents$122,376$142,090
Available-for-sale securities57,47024,267
Receivables from Erie

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of financial condition and results of operations highlights significant factors influencing Erie Indemnity Company ("Indemnity", "we", "us", "our"). This discussion should be read in conjunction with the historical financial statements and the related notes thereto included in Part I, Item 1. "Financial Statements" of this Quarterly Report on Form 10-Q, and with Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" for the year ended December 31, 2022, as contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2023.

INDEX

Page Number
Cautionary Statement Regarding Forward-Looking Information21
Operating Overview22
Results of Operations24
Financial Condition30
Liquidity and Capital Resources31
Critical Accounting Estimates33

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

"Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995:

Statements contained herein that are not historical fact are forward-looking statements and, as such, are subject to risks and uncertainties that could cause actual events and results to differ, perhaps materially, from those discussed herein. Forward-looking statements relate to future trends, events or results and 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 forward-looking statements are discussions relating to premium and investment income, expenses, operating results, and compliance with contractual and regulatory requirements. Forward-looking 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, in addition to those set forth in our filings with the Securities and Exchange Commission, that could cause actual results and future events to differ from those set forth or contemplated in the forward-looking statements include the following:

  • dependence upon our relationship with the Erie Insurance Exchange ("Exchange") and the management fee under the agreement with the subscribers at the Exchange;

  • dependence upon our relationship with the Exchange and the growth of the Exchange, including:

◦general business and economic conditions;

◦factors affecting insurance industry competition;

◦dependence upon the independent agency system; and

◦ability to maintain our reputation for customer service;

  • dependence upon our relationship with the Exchange and the financial condition of the Exchange, including:

◦the Exchange's ability to maintain acceptable financial strength ratings;

◦factors affecting the quality and liquidity of the Exchange's investment portfolio;

◦changes in government regulation of the insurance industry;

◦litigation and regulatory actions;

◦emergence of significant unexpected events, including pandemics and inflation;

◦emerging claims and coverage issues in the industry; and

◦severe weather conditions or other catastrophic losses, including terrorism;

  • costs of providing policy issuance and renewal services to the Exchange under the subscriber's agreement;

  • ability to attract and retain talented management and employees;

  • ability to ensure system availability and effectively manage technology initiatives;

  • difficulties with technology or data security breaches, including cyber attacks;

  • ability to maintain uninterrupted business operations;

  • outcome of pending and potential litigation;

  • factors affecting the quality and liquidity of our investment portfolio; and

  • our ability to meet liquidity needs and access capital.

A forward-looking statement speaks only as of the date on which it is made and reflects our analysis only as of that date. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changes in assumptions, or otherwise.

OPERATING OVERVIEW

Overview

We serve as the attorney-in-fact for the subscribers (policyholders) at the Exchange, a reciprocal insurer that writes property and casualty insurance. Our primary function as attorney-in-fact is to perform policy issuance and renewal services on behalf of the subscribers at the Exchange. We also act as attorney-in-fact on behalf of the Exchange, as well as the service provider for its insurance subsidiaries, with respect to all administrative services.

The Exchange is a reciprocal insurance exchange, which is an unincorporated association of individuals, partnerships and corporations that agree to insure one another. Each applicant for insurance to the Exchange signs a subscriber's agreement, which contains an appointment of Indemnity as their attorney-in-fact to transact the business of the Exchange on their behalf. Pursuant to the subscriber’s agreement for acting as attorney-in-fact in these two capacities, we earn a management fee calculated as a percentage of the direct and affiliated assumed premiums written by the Exchange.

Our earnings are primarily driven by the management fee revenue generated for the services we provide to the Exchange. The policy issuance and renewal services we provide to the Exchange are related to the sales, underwriting and issuance of policies. The sales related services we provide include agent compensation and certain sales and advertising support services. Agent compensation includes scheduled commissions to agents based upon premiums written as well as additional commissions and bonuses to agents, which are earned by achieving targeted measures. Agent compensation generally comprises approximately two-thirds of our policy issuance and renewal expenses. The underwriting services we provide include underwriting and policy processing. The remaining services we provide include customer service and administrative support. We also provide information technology services that support all the functions listed above. Included in these expenses are allocations of costs for departments that support these policy issuance and renewal functions.

By virtue of its legal structure as a reciprocal insurer, the Exchange does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services in accordance with the subscriber's agreement. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and Indemnity. Claims handling services include costs incurred in the claims process, including the adjustment, investigation, defense, recording and payment functions. Life insurance management services include costs incurred in the management and processing of life insurance business. Investment management services are related to investment trading activity, accounting and all other functions attributable to the investment of funds. In 2022, approximately 71% of the

administrative services expenses were entirely attributable to the respective administrative functions (claims handling, life

insurance management and investment management), while the remaining 29% of these expenses were allocations of costs for

departments that support these administrative functions. The expenses we incur and related reimbursements we receive for

administrative services are presented gross in our Statements of Operations. The subscriber's agreement and service agreements provide for reimbursement of amounts incurred for these services to Indemnity. Reimbursements are settled at cost on a monthly basis. State insurance regulations require that intercompany service agreements and any material amendments be approved in advance by the state insurance department.

Our results of operations are tied to the growth and financial condition of the Exchange as the Exchange is our sole customer, and our earnings are largely generated from management fees based on the direct and affiliated assumed premiums written by the Exchange. The Exchange generates revenue by insuring preferred and standard risks, with personal lines comprising 69% of the 2022 direct and affiliated assumed written premiums and commercial lines comprising the remaining 31%. The principal personal lines products are private passenger automobile and homeowners. The principal commercial lines products are commercial multi-peril, commercial automobile and workers compensation.

Risks and Uncertainties

Ongoing supply chain disruptions, geopolitical events and other macroeconomic factors have created an elevated inflationary environment and rising interest rates. These factors along with recent developments within the banking industry create significant economic uncertainty, which may impact our investment valuations and returns and liquidity. As these events continue to evolve, the ultimate impact and duration remain uncertain at this time.

Financial Overview

Three months ended March 31,
(dollars in thousands, except per share data)20232022% Change
(Unaudited)
Operating income$110,543$84,31231.1%
Total investment (loss) income(4,732)3,009NM
Interest expense—999(100.0)
Other income3,337473NM
Income before income taxes109,14886,79525.8
Income tax expense22,90718,17626.0
Net income$86,241$68,61925.7%
Net income per share – diluted$1.65$1.3125.7%

NM = not meaningful

Operating income increased in the first quarter of 2023, compared to the same period in 2022, as growth in operating revenue outpaced the growth in operating expenses. Management fee revenue for policy issuance and renewal services increased 14.4% to $558.1 million in the first quarter of 2023. Management fee revenue is based upon the management fee rate we charge and the direct and affiliated assumed premiums written by the Exchange. The management fee rate was 25% for both 2023 and 2022. The direct and affiliated assumed premiums written by the Exchange increased 14.6% to $2.3 billion in the first quarter of 2023, compared to the same period in 2022.

Cost of operations for policy issuance and renewal services increased 10.5% to $469.1 million in the first quarter of 2023, compared to the same period in 2022, primarily due to higher scheduled commissions driven by direct and affiliated assumed written premium growth, as well as increased compensation, professional fees, and technology investments, partially offset by decreased agent incentive compensation driven by higher claims severity and related loss costs experienced by the Exchange.

Management fee revenue for administrative services increased 6.1% to $15.2 million in the first quarter of 2023, compared to the same period in 2022. The administrative services reimbursement revenue and corresponding cost of operations increased both total operating revenue and total operating expenses by $172.8 million in the first quarter of 2023, but had no net impact on operating income.

Total investment income decreased $7.7 million in the first quarter of 2023 compared to the same period in 2022, primarily due to a decrease in net investment income partially offset by lower net realized and unrealized investment losses in 2023 compared to 2022.

General Conditions and Trends Affecting Our Business

Economic conditions

Unfavorable changes in economic conditions, including declining consumer confidence, inflation, high unemployment, and the threat of recession, among others, may lead the Exchange’s customers to modify coverage, not renew policies, or even cancel policies, which could adversely affect the premium revenue of the Exchange, and consequently our management fee. Current economic conditions have contributed to an elevated inflationary environment, which could impact the Exchange's operations and our management fee. In particular, unanticipated increased inflation costs including medical cost inflation, building material cost inflation, auto repair and replacement cost inflation, and tort issues may impact adequacy of estimated loss reserves and future premium rates of the Exchange. The extent and duration of the impacts to economic conditions remain uncertain. If any of these items impacted the financial condition or operations of the Exchange, it could have an impact on our financial results. See Financial Condition and Liquidity and Capital Resources contained within this report, as well as Part I. Item 1A. "Risk Factors" included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 as filed with the Securities and Exchange Commission on March 1, 2023 for a discussion of the potential impacts to our operations or those of the Exchange.

Financial market volatility

Our portfolio of fixed maturity and equity security investments is 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 occur 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. Various ongoing geopolitical events, the high inflationary environment and recent developments in the banking sector have had a significant impact on the global financial markets. The value of our invested assets could be adversely impacted and there is potential for future losses and/or impairments on our investment portfolio resulting from continued supply chain disruptions, instability and volatility within the banking sector, further inflationary pressures and rising interest rates.

RESULTS OF OPERATIONS

Management fee revenue

We have two performance obligations in the subscriber’s agreement, providing policy issuance and renewal services and acting as attorney-in-fact for the Exchange, as well as the service provider for its insurance subsidiaries with respect to all administrative services. We earn management fees for acting as the attorney-in-fact for the subscribers at the Exchange in these two capacities, and allocate our revenues between our performance obligations.

The management fee is calculated by multiplying all direct and affiliated assumed premiums written by the Exchange by the management fee rate, which is determined by our Board of Directors at least annually. The management fee rate was set at 25%, the maximum rate, for both 2023 and 2022. Changes in the management fee rate can affect our revenue and net income significantly. The transaction price, including management fee revenue and administrative services reimbursement revenue, includes variable consideration and is allocated based on the estimated standalone selling prices developed using industry information and other available information for similar services. We update the transaction price and the related allocation at least annually based upon the most recent information available or more frequently if there have been significant changes in any components considered in the transaction price.

The following table presents the allocation and disaggregation of revenue for our two performance obligations for the three months ended March 31:

(dollars in thousands)20232022% Change
(Unaudited)
Policy issuance and renewal services
Direct and affiliated assumed premiums written by the Exchange$2,303,868$2,010,19714.6%
Management fee rate24.30%24.30%
Management fee revenue559,840488,47814.6
Change in estimate for management fee returned on cancelled policies (1)(1,750)(486)NM
Management fee revenue - policy issuance and renewal services$558,090$487,99214.4%
Administrative services
Direct and affiliated assumed premiums written by the Exchange$2,303,868$2,010,19714.6%
Management fee rate0.70%0.70%
Management fee revenue16,12714,07114.6
Change in contract liability (2)(933)238NM
Change in estimate for management fee returned on cancelled policies (1)(5)4NM
Management fee revenue - administrative services15,18914,3136.1
Administrative services reimbursement revenue172,827163,3275.8
Total revenue from administrative services$188,016$177,6405.8%

NM = not meaningful

*(1)*A constraining estimate of variable consideration exists related to the potential for management fees to be returned if a policy were to be cancelled mid-term. Management fees are returned to the Exchange when policies are cancelled mid-term and unearned premiums are refunded.

*(2)*Management fee revenue - administrative services is recognized over time as the services are provided. See Part I, Item 1. "Financial Statements - Note 3, Revenue, of Notes to Financial Statements" contained within this report.

Direct and affiliated assumed premiums written by the Exchange

Direct and affiliated assumed premiums include premiums written directly by the Exchange and premiums assumed from its wholly owned property and casualty subsidiaries. Direct and affiliated assumed premiums written by the Exchange increased 14.6% to $2.3 billion in the first quarter of 2023 compared to the first quarter of 2022, primarily driven by increased personal lines and commercial multi-peril premiums written. Year-over-year policies in force for all lines of business increased 4.4% in the first quarter of 2023 compared to 3.1% in the first quarter of 2022. The year-over-year average premium per policy for all lines of business increased 6.4% at March 31, 2023 compared to 1.5% at March 31, 2022.

Premiums generated from new business increased 36.3% to $339 million in the first quarter of 2023 compared to the same period in 2022, primarily driven by increased premiums written in the personal auto, homeowners and commercial multi-peril lines. Contributing to this change was a 25.9% increase in new business policies written and a 10.3% increase in year-over-year average premium per policy on new business at March 31, 2023. Premiums generated from new business increased 4.0% to $249 million in the first quarter of 2022 compared to the same period in 2021, primarily driven by increased premium written in the commercial multi-peril lines. In the first quarter of 2022, year-over-year average premium per policy on new business increased 6.3%, partially offset by a 4.7% decrease in new business policies written.

Premiums generated from renewal business increased 11.5% to $2.0 billion in the first quarter of 2023 compared to the first quarter of 2022 and increased 7.5% to $1.8 billion in the first quarter of 2022 compared to the first quarter of 2021. Underlying the trend in renewal business premiums in both periods was a 5.8% increase in year-over-year average premium per policy at March 31, 2023, and 0.9% at March 31, 2022, as well as an increase in year-over-year policies in force of 3.5% and 3.1% in the first quarters of 2023 and 2022, respectively, driven by a slight increase in the policy retention ratios.

Personal lines – Total personal lines premiums written increased 15.8% to $1.5 billion in the first quarter of 2023, compared to 5.6% in the first quarter of 2022, driven by a 5.8% increase in total personal lines year-over-year average premium per policy and a 4.8% increase in total personal lines policies in force.

Commercial lines – Total commercial lines premiums written increased 12.2% to $756 million in the first quarter of 2023, compared to 10.0% in the first quarter of 2022, driven by a 9.5% increase in total commercial lines year-over-year average premium per policy and a 2.1% increase in total commercial lines policies in force.

Future trends-premium revenue – Through a careful agency selection process, the Exchange plans to continue its effort to expand the size of its agency force to increase market penetration in existing operating territories to contribute to future growth.

Changes in premium levels attributable to the growth in policies in force and rate changes directly affect the profitability of the Exchange and have a direct bearing on our management fee. Future premiums could be impacted by potential regulatory changes and continued inflationary trends, among others. Inflation-driven severity increases continued to impact underwriting results in the first quarter of 2023, and will continue to impact future rate decisions. See also Part I. Item 1A. "Risk Factors" included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 as filed with the Securities and Exchange Commission on March 1, 2023.

Policy issuance and renewal services

Three months ended March 31,
(dollars in thousands)20232022% Change
(Unaudited)
Management fee revenue - policy issuance and renewal services$558,090$487,99214.4%
Service agreement revenue6,3596,478(1.8)
564,449494,47014.2
Cost of policy issuance and renewal services469,095424,47110.5
Operating income - policy issuance and renewal services$95,354$69,99936.2%

Policy issuance and renewal services

The management fee revenue allocated for providing policy issuance and renewal services was 24.30% of the direct and affiliated assumed premiums written by the Exchange for both three month periods ended March 31, 2023 and 2022. This portion of the management fee is recognized as revenue when the policy is issued or renewed because it is at that time that the services we provide are substantially complete and the executed insurance policy is transferred to the customer. The increase in management fee revenue for policy issuance and renewal services was driven by the increase in the direct and affiliated assumed premiums written by the Exchange discussed previously.

Service agreement revenue

Service agreement revenue primarily consists of service charges we collect from subscribers/policyholders for providing multiple payment plans on policies written by the Exchange and its property and casualty subsidiaries and also includes late payment and policy reinstatement fees. The service charges are fixed dollar amounts per billed installment. The decrease in service agreement revenue for the three month period ended March 31, 2023 compared to the same period in 2022 is primarily due to the continued shift to payment plans that do not incur service charges or offer a premium discount for certain payment methods.

Cost of policy issuance and renewal services

Three months ended March 31,
(dollars in thousands)20232022% Change
(Unaudited)
Commissions:
Total commissions$308,808$281,1359.8%
Non-commission expense:
Underwriting and policy processing$43,723$41,0546.5%
Information technology57,19545,66625.2
Sales and advertising12,88712,7251.3
Customer service8,0858,347(3.1)
Administrative and other38,39735,5448.0
Total non-commission expense160,287143,33611.8
Total cost of policy issuance and renewal services$469,095$424,47110.5%

Commissions – Commissions increased $27.7 million in the first quarter of 2023 compared to the same period in 2022, primarily driven by the growth in direct and affiliated assumed written premium, partially offset by a decrease in agent incentive compensation. The estimated agent incentive payouts at March 31, 2023 are based on actual underwriting results for the two prior years and current year-to-date actual results and forecasted results for the remainder of 2023. The profitability component of agent incentive compensation decreased due to higher claims severity and related loss costs in the three-year period ending 2023 compared to the three-year period ended 2022.

Non-commission expense – Non-commission expense increased $17.0 million in the first quarter of 2023 compared to the first quarter of 2022. Underwriting and policy processing expense increased $2.7 million primarily due to increased personnel and underwriting report costs. Information technology costs increased $11.5 million primarily due to increased professional fees, hardware and software costs, and personnel costs. Administrative and other costs increased $2.9 million primarily due to an increase in personnel costs related to compensation and building occupancy costs, partially offset by a decrease in professional fees. Personnel costs in all expense categories were also impacted by lower pension costs due to an increase in the discount rate compared to 2022.

Administrative services

Three months ended March 31,
(dollars in thousands)20232022% Change
(Unaudited)
Management fee revenue - administrative services$15,189$14,3136.1%
Administrative services reimbursement revenue172,827163,3275.8
Total revenue allocated to administrative services188,016177,6405.8
Administrative services expenses
Claims handling services148,200142,4964.0
Investment management services8,7459,891(11.6)
Life management services15,88210,94045.2
Operating income - administrative services$15,189$14,3136.1%

Administrative services

The management fee revenue allocated to administrative services was 0.70% of the direct and affiliated assumed premiums written by the Exchange for both three month periods ended March 31, 2023 and 2022. This portion of the management fee is recognized as revenue over a four-year period representing the time over which the services are provided. We also report reimbursed costs as revenues, which are recognized monthly as services are provided. The administrative services expenses we incur and the related reimbursements we receive are recorded gross in the Statements of Operations.

Cost of administrative services

By virtue of its legal structure as a reciprocal insurer, the Exchange does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services in accordance with the subscriber's agreement. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and Indemnity. The subscriber's agreement and service agreements provide for reimbursement of amounts incurred for these services to Indemnity. Reimbursements due from the Exchange and its insurance subsidiaries are recorded as a receivable and settled at cost.

Total investment (loss) income

A summary of the results of our investment operations is as follows for the three months ended March 31:

(dollars in thousands)20232022% Change
(Unaudited)
Net investment income$2,183$10,504(79.2)%
Net realized and unrealized investment losses(5,282)(7,279)27.4
Net impairment losses recognized in earnings(1,633)(216)NM
Total investment (loss) income$(4,732)$3,009NM

NM = not meaningful

Net investment income

Net investment income includes interest and dividends on our fixed maturity and equity security portfolios and the results of our limited partnership investments, net of investment expenses. Net investment income decreased $8.3 million in the first quarter of 2023 primarily due to lower equity in earnings of limited partnerships, partially offset by an increase in bond income due to higher yields and cash and cash equivalent income driven by an increase in rates. Included in net investment income is $10.8 million of limited partnership losses in the first quarter of 2023 compared to earnings of $2.8 million for the same period in 2022.

Net realized and unrealized investment losses

A breakdown of our net realized and unrealized investment (losses) gains is as follows for the three months ended March 31:

(in thousands)20232022
Securities sold:(Unaudited)
Available-for-sale securities$(1,619)$(2,080)
Equity securities(2,504)(280)
Equity securities change in fair value(1,159)(4,921)
Miscellaneous02
Net realized and unrealized investment losses$(5,282)$(7,279)

Net realized and unrealized losses during the first quarter of 2023 were primarily due to disposals of equity securities impacted by the recent banking industry events as well as disposals of available-for-sale securities and market value adjustments on equity securities. Net realized and unrealized losses during the first quarter of 2022 were primarily due to market value adjustments on equity securities and disposal of available-for-sale securities.

Net impairment losses recognized in earnings

Net impairment losses of $1.6 million in the first quarter of 2023 were related to available-for-sale securities and include $1.4 million of securities in an unrealized loss position where we had the intent to sell prior to recovery of our amortized cost basis and $0.2 million of credit impairment losses. Net impairment losses of $0.2 million in the first quarter of 2022 also included both credit and intent to sell related impairments on available-for-sale securities.

Financial condition of Erie Insurance Exchange

Serving in the capacity of attorney-in-fact for the Exchange, we are dependent on the growth and financial condition of the Exchange, who is our sole customer. The strength of the Exchange and its wholly owned subsidiaries is rated annually by A.M. Best Company through assessing its financial stability and ability to pay claims. The ratings are generally based upon factors relevant to policyholders and are not directed toward return to investors. The Exchange and each of its property and casualty subsidiaries are rated A+ "Superior", the second highest financial strength rating, which is assigned to companies that 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. On August 9, 2022, the outlook for the financial strength rating was affirmed as stable. As of December 31, 2022, only approximately 12% of insurance groups, in which the Exchange is included, are rated A+ or higher.

The financial statements of the Exchange are prepared in accordance with statutory accounting principles prescribed by the Commonwealth of Pennsylvania. Financial statements prepared under statutory accounting principles focus on the solvency of the insurer and generally provide a more conservative approach than under U.S. generally accepted accounting principles. Statutory direct written premiums of the Exchange and its wholly owned property and casualty subsidiaries grew 14.6% to $2.3 billion in the first three months of 2023 compared to the first three months of 2022. These premiums, along with investment income, are the major sources of cash that support the operations of the Exchange. Policyholders’ surplus determined under statutory accounting principles was $9.9 billion at March 31, 2023 and $10.1 billion at December 31, 2022. The Exchange and its wholly owned property and casualty subsidiaries' year-over-year policy retention ratio continues to be high at 90.6% at March 31, 2023 and 90.5% at December 31, 2022.

We have prepared our financial statements considering the financial strength of the Exchange based on its A.M. Best rating and strong level of surplus. While policyholders' surplus declined by $0.2 billion from December 31, 2022, driven by higher loss costs and unrealized investment losses resulting from continued inflationary pressures, market volatility, and rising interest rates, we continue to monitor these conditions and believe that the Exchange falls within established risk tolerances. However, see Part I. Item 1A. "Risk Factors" included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 as filed with the Securities and Exchange Commission on March 1, 2023 for possible outcomes that could impact that determination.

FINANCIAL CONDITION

Investments

Our investment portfolio is managed with the objective of maximizing after-tax returns on a risk-adjusted basis. The following table presents the carrying value of our investments as of:

(dollars in thousands)March 31, 2023% to totalDecember 31, 2022% to total
(Unaudited)
Fixed maturities$915,66685%$894,66184%
Equity securities72,963772,5607
Agent loans (1)68,054669,4767
Other investments17,952230,5112
Total investments$1,074,635100%$1,067,208100%

*(1)*The current portion of agent loans is included in the line item "Prepaid expenses and other current assets" in the Statements of Financial Position.

Fixed maturities

Under our investment strategy, we maintain a fixed maturity portfolio that is of high quality and well diversified within each market sector. This investment strategy also achieves a balanced maturity schedule. Our fixed maturity portfolio is managed with the goal of achieving reasonable returns while limiting exposure to risk.

Fixed maturities are carried at fair value with unrealized gains and losses, net of deferred taxes, included in shareholders’ equity. Net unrealized losses on fixed maturities, net of deferred taxes, totaled $42.0 million at March 31, 2023, compared to $52.5 million at December 31, 2022.

The following table presents a breakdown of the fair value of our fixed maturity portfolio by industry sector and rating as of:

(in thousands)March 31, 2023 (1)
AAAAAABBBNon- investment gradeFair value
(Unaudited)
Basic materials$0$0$0$4,474$6,168$10,642
Communications02,88112,85312,68814,94943,371
Consumer04,92713,87374,54534,434127,779
Diversified0000447447
Energy003,84317,7056,07627,624
Financial02,07998,180119,85512,783232,897
Industrial0010,18816,50721,51048,205
Structured securities (2)134,552179,83419,02412,7330346,143
Technology1,90205,34420,27112,99140,508
Utilities002,40331,8333,81438,050
Total$136,454$189,721$165,708$310,611$113,172$915,666

*(1)*Ratings are supplied by S&P, Moody’s, and Fitch. The table is based upon the lowest rating for each security.

*(2)*Structured securities include residential and commercial mortgage-backed securities, collateralized debt obligations, and asset-backed securities.

Equity securities

Equity securities primarily include nonredeemable preferred stocks and are carried at fair value in the Statements of Financial Position with all changes in unrealized gains and losses reflected in the Statements of Operations.

The following table presents an analysis of the fair value of our equity securities by sector as of:

(in thousands)March 31, 2023December 31, 2022
(Unaudited)
Financial services$59,484$61,084
Utilities6,2615,708
Energy4,0683,576
Consumer2,2351,854
Technology5000
Communications267338
Industrial1480
Total$72,963$72,560

LIQUIDITY AND CAPITAL RESOURCES

We continue to monitor the sufficiency of our liquidity and capital resources given the potential impact of current economic conditions, including volatility within the banking sector, inflationary pressures, and rising interest rates. We maintain relationships and cash balances at diversified and well-capitalized financial institutions and have established processes to monitor them. While we did not see a significant impact on our sources or uses of cash in the first three months of 2023, future disruptions in the markets could occur, which may affect our liquidity position. If our normal operating and investing cash activities were to become insufficient to meet future funding requirements, we believe we have sufficient access to liquidity through our cash position, diverse liquid marketable securities and our $100 million bank revolving line of credit that does not expire until October 2026. See broader discussions of potential risks to our operations in the Operating Overview contained within this report and Part I. Item 1A. "Risk Factors" included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 as filed with the Securities and Exchange Commission on March 1, 2023.

Sources and Uses of Cash

Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet the short- and long-term cash requirements of its business operations and growth needs. Our liquidity requirements have been met primarily by funds generated from management fee revenue and income from investments. Cash provided from these sources is used primarily to fund the costs of our management operations including commissions, salaries and wages, pension plans, share repurchases, dividends to shareholders, the purchase and development of information technology, and other capital expenditures. See Part I, Item 1. "Financial Statements - Note 8, Postretirement Benefits, of Notes to Financial Statements" contained within this report for our defined benefit pension plan funding policy and expected pension contribution in 2023. We expect that our operating cash needs will be met by funds generated from operations. Cash in excess of our operating needs is primarily invested in investment grade fixed maturities. As part of our liquidity review, we regularly evaluate our capital needs based on current and projected results and consider the potential impacts to our liquidity, borrowing capacity, financial covenants and capital availability.

Volatility in the financial markets presents challenges to us as we do occasionally access our investment portfolio as a source of cash. Some of our fixed income investments, despite being publicly traded, may be illiquid. Volatility in these markets could impair our ability to sell certain fixed income securities or cause such securities to sell at deep discounts. We believe we have sufficient liquidity to meet our needs from sources other than the liquidation of securities.

Cash flow activities

The following table provides condensed cash flow information as follows for the three months ended March 31:

(in thousands)20232022
(Unaudited)
Net cash provided by operating activities$48,031$23,553
Net cash used in investing activities(12,326)(13,732)
Net cash used in financing activities(55,419)(52,218)
Net decrease in cash and cash equivalents$(19,714)$(42,397)

Net cash provided by operating activities was $48.0 million in the first three months of 2023, compared to $23.6 million for the same period in 2022. Increased cash provided by operating activities was primarily due to an increase in management fees received of $67.5 million driven by growth in direct and affiliated assumed premiums written by the Exchange and a decrease in agent bonuses paid of $23.2 million. Partially offsetting this increase in cash provided by operating activities was an increase in cash paid for agent commissions of $31.0 million due to higher scheduled commissions driven by premium growth, and an increase in general operating expenses paid of $23.3 million.

Net cash used in investing activities was $12.3 million in the first three months of 2023, compared to $13.7 million for the same period in 2022. Decreased cash used in investing activities was primarily due to a decrease in loans made to agents of $4.3 million, partially offset by an increase in fixed asset purchases of $3.7 million. Proceeds from sales and maturities/calls of investments were mostly offset by purchases of investments in both periods.

Net cash used in financing activities was $55.4 million in the first three months of 2023, compared to $52.2 million for the same period in 2022, primarily due to increased dividends paid to shareholders of $3.7 million. We increased both our Class A and Class B shareholder regular quarterly dividends by 7.2% for 2023, compared to 2022. There are no regulatory restrictions on the payment of dividends to our shareholders.

Capital Outlook

We regularly prepare forecasts evaluating the current and future cash requirements for both normal and extreme risk events, including under current inflationary conditions, rising interest rates, and recent banking industry events. Should an extreme risk event result in a cash requirement exceeding normal cash flows, we have the ability to meet our future funding requirements through various alternatives available to us.

Outside of our normal operating and investing cash activities, future funding requirements could be met through: 1) unpledged cash and cash equivalents, which total approximately $108.8 million at March 31, 2023, 2) $100 million bank revolving line of credit, and 3) liquidation of unpledged assets held in our investment portfolio, including preferred stock and investment grade bonds, which totaled approximately $757.8 million at March 31, 2023. Volatility in the financial markets could impair our ability to sell certain fixed income securities or cause such securities to sell at deep discounts. Additionally, we have the ability to curtail or modify discretionary cash outlays such as those related to shareholder dividends and share repurchase activities.

As of March 31, 2023, we have access to a $100 million bank revolving line of credit with a $25 million letter of credit sublimit that expires on October 29, 2026. As of March 31, 2023, a total of $99.1 million remains available under the facility due to $0.9 million outstanding letters of credit, which reduce the availability for letters of credit to $24.1 million. We had no borrowings outstanding on our line of credit as of March 31, 2023. Investments with a fair value of $115.6 million were pledged as collateral on the line of credit at March 31, 2023. These investments have no trading restrictions and are reported as available-for-sale securities and cash and cash equivalents in the Statement of Financial Position. The bank requires compliance with certain covenants, which include leverage ratios and debt restrictions. We were in compliance with all covenants at March 31, 2023.

CRITICAL ACCOUNTING ESTIMATES

We make estimates and assumptions that have a significant effect on the amounts and disclosures reported in the financial statements. The most significant estimates relate to investment valuation and retirement benefit plans for employees. While management believes its estimates are appropriate, the ultimate amounts may differ from estimates provided. Our most critical accounting estimates are described in Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" for the year ended December 31, 2022 of our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 1, 2023. See Part I, Item 1. "Financial Statements - Note 5, Fair Value, of Notes to Financial Statements" contained within this report for additional information on our valuation of investments.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk is primarily related to fluctuations in interest rates and prices. Quantitative and qualitative disclosures about market risk resulting from changes in interest rates, prices, and other risk exposures for the year ended December 31, 2022 are included in Item 7A. "Quantitative and Qualitative Disclosures About Market Risk" of our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 1, 2023.

The current inflationary environment, rising interest rates and recent banking industry events may create future volatility; however, there have been no material changes that impacted our portfolio or reshaped our periodic investment reviews of asset allocations during the three months ended March 31, 2023. We continue to closely monitor events in the banking industry and take appropriate measures, when necessary, to minimize potential risk exposure to our cash and investment balances. For a recent discussion of conditions surrounding our investment portfolio, see the "Operating Overview", "Results of Operations", and "Financial Condition" discussions contained in Part I, Item 2. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" contained within this report.

Item 4. CONTROLS AND PROCEDURES

We carried out an evaluation, with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.

Our management evaluated, with the participation of the Chief Executive Officer and Chief Financial Officer, any change in our internal control over financial reporting and determined there has been no change in our internal control over financial reporting during the three months ended March 31, 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Erie Indemnity Company ("Indemnity") was named as a defendant in a complaint filed on August 24, 2021, by alleged subscribers of the Erie Insurance Exchange (the "Exchange") in the Court of Common Pleas Civil Division of Allegheny County, Pennsylvania captioned TROY STEPHENSON, CHRISTINA STEPHENSON, SUSAN RUBEL, and STEVEN BARNETT, individually and on behalf of all others similarly situated (Plaintiffs) v. Erie Indemnity Company (Defendant).

The complaint seeks relief for alleged breaches of fiduciary duty by Indemnity in connection with the setting of the management fee it receives, pursuant to the terms of the Subscribers Agreement executed between Indemnity and all policyholders of the Exchange, as compensation for acting as the attorney-in-fact in the management of the Exchange. The relief sought is for the period beginning two years prior to the date of the filing of the complaint and continuing through 2021.

The complaint seeks (i) a finding that Indemnity has breached its fiduciary duties; (ii) an award of damages in an amount to be determined at trial; and (iii) such other relief, including disgorgement of profits or other injunctive relief, that the Court deems just and proper.

Service of the complaint was effectuated on September 20, 2021. A Notice of Removal to the United States District Court for the Western District of Pennsylvania was filed on October 20, 2021. On November 2, 2021, Plaintiffs filed a Notice of Voluntary Dismissal. As a result, the action was dismissed without prejudice.

On December 6, 2021, another Complaint was filed in the Court of Common Pleas of Allegheny County, Pennsylvania captioned ERIE INSURANCE EXCHANGE, an unincorporated association, by TROY STEPHENSON, CHRISTINA STEPHENSON, and STEVEN BARNETT, trustees ad litem, and alternatively, ERIE INSURANCE EXCHANGE, by TROY STEPHENSON, CHRISTINA STEPHENSON, and STEVEN BARNETT, (Plaintiff), v. ERIE INDEMNITY COMPANY, (Defendant).

This most recent complaint has the same allegation of breach of fiduciary duty by Indemnity in connection with the setting of the management fee it receives, pursuant to the terms of the Subscribers Agreement executed between Indemnity and all policyholders of the Exchange, as compensation for acting as the attorney-in-fact in the management of the Exchange.

This most recent complaint seeks the same relief, specifically, (i) a finding that Indemnity has breached its fiduciary duties; (ii) an award of damages in an amount to be determined at trial; and (iii) such other relief, including disgorgement of profits or other injunctive relief, that the Court deems just and proper.

A Notice of Removal to the United States District Court for the Western District of Pennsylvania was filed on January 27, 2022. Indemnity intends to vigorously defend against all of the allegations and requests for relief in the complaint.

By Memorandum Opinion and Order dated September 28, 2022, the Court granted the Motion for Remand and directed the case be remanded to the Court of Common Pleas of Allegheny County, Pennsylvania. On September 30, 2022, Indemnity filed a Motion to Stay the Remand Order pending an appeal to the United States Court of Appeals for the Third Circuit. On October 3, 2022, the Court granted the Stay. On October 11, 2022, Indemnity filed a Petition for Permission to Appeal the Remand Order with the Third Circuit. By Order dated November 7, 2022, a three judge panel of the Court denied the Petition to Appeal.

On November 21, 2022, Indemnity filed a Petition for Rehearing requesting that the Third Circuit permit the appeal. By Order dated January 9, 2023, the Court granted the petition for rehearing and vacated the prior Order of October 7, 2022, denying permission to appeal. The appeal is being heard by a three-judge panel of the Third Circuit. The matter is fully briefed, and argument is scheduled for April 20, 2023.

Indemnity intends to vigorously defend against all of the allegations and requests for relief in the complaint.

Separately, Indemnity filed a Complaint in Federal Court to invoke certain provisions of the “All Writs Act” and the “Anti-Injunction Act.” By filing this complaint, Indemnity seeks to protect the federal court’s prior binding, final judgments in favor of Indemnity and thereby foreclose further litigation of the claims and issues pertaining to the compensation practices that were the subject of the prior judgments.

For additional information on contingencies, see Part I, Item 1. "Financial Statements - Note 13, Commitment and Contingencies, of Notes to Financial Statements".

Item 1A. RISK FACTORS

There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 as filed with the Securities and Exchange Commission on March 1, 2023.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Issuer Purchases of Equity Securities

In 2011, our Board of Directors approved a continuation of the current stock repurchase program, authorizing repurchases for a total of $150 million with no time limitation. This repurchase authority included, and was not in addition to, any unspent amounts remaining under the prior authorization.

The following table presents the number and average price of our outstanding Class A nonvoting common stock shares purchased during the quarter ending March 31, 2023:

(dollars in thousands, except per share data)
PeriodTotal number of shares purchasedAverage price paid per shareTotal number of shares purchased as part of publicly announced programDollar value of shares that may yet be purchased under the program
January 1-31, 2023 (1)1,610$252.32—$17,754
February 1-28, 2023———17,754
March 1-31, 2023 (2)2,894235.01—17,754
Total4,504241.20—

*(1)*Represents shares purchased on the open market for stock-based awards in conjunction with our equity compensation plan.

*(2)*Represents shares purchased on the open market to fund the rabbi trust for both the outside director deferred stock compensation plan (1,581 shares at an average price of $237.68 per share) and the incentive compensation deferral plan (1,313 shares at an average price of $231.79 per share).

Item 6. EXHIBITS

Exhibit
NumberDescription of Exhibit
31.1+Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2+Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32++Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS+Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH+Inline XBRL Taxonomy Extension Schema Document.
101.CAL+Inline XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF+Inline XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB+Inline XBRL Taxonomy Extension Label Linkbase Document.
101.PRE+Inline XBRL Taxonomy Extension Presentation Linkbase Document.
104+Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).

+ Filed herewith.

++ Furnished herewith.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Erie Indemnity Company
(Registrant)
Date:April 27, 2023By:/s/ Timothy G. NeCastro
Timothy G. NeCastro, President & CEO
By:/s/ Gregory J. Gutting
Gregory J. Gutting, Executive Vice President & CFO