Erie Indemnity Co.
ERIE INDEMNITY CO (Form: 8-K, Received: 05/06/2010 16:34:15)
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of Earliest Event Reported): May 6, 2010
Erie Indemnity Company
(Exact name of registrant as specified in its charter)
         
Pennsylvania   0-24000   25-0466020
         
(State or other jurisdiction   (Commission   (I.R.S. Employer
of incorporation)   File Number)   Identification No.)
         
100 Erie Insurance Place, Erie, Pennsylvania       16530
         
(Address of principal executive offices)       (Zip Code)
Registrant’s telephone number, including area code: (814)870-2000
Not Applicable
Former name or former address, if changed since last report
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:
o Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)
o Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)
o Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))
o Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))
 
 

 


 

Item 8.01 Other Events.
The information included in this Form 8-K presents the December 31, 2009 and 2008 consolidated financial statements, related footnote disclosures and management’s discussion and analysis of Erie Indemnity Company (“Indemnity”) prepared in conformity with the new guidance in ASC 810, Consolidation , which became effective January 1, 2010. The consolidated financial statements of Erie Indemnity Company reflect the combined results of Indemnity and its variable interest entity, the Exchange.
Under the new guidance, Erie Indemnity Company (“Indemnity”) is deemed to be the primary beneficiary of Erie Insurance Exchange (“Exchange”) given the significance of the management fee to the Exchange and because Indemnity has the power to direct the activities of the Exchange that most significantly impact the Exchange’s economic performance. Prior to adoption of the new guidance, Indemnity was not deemed the primary beneficiary of the Exchange, and its financial position and operating results were not consolidated with Indemnity’s. Following adoption of the new guidance, as primary beneficiary of the Exchange, Erie Indemnity Company has consolidated Indemnity and the Exchange’s financial position and operating results. Furthermore, upon consolidation of the Exchange, 100% of the ownership of Erie Family Life Insurance Company (“EFL”) resides within the consolidated entity and consequently EFL’s financial results are also consolidated. The financial statements and notes to the financial statements presented herein have all been adjusted to reflect the retrospective adoption of the new accounting principle.
The Exchange’s equity has been shown as noncontrolling interest in the consolidated statements. Indemnity’s net income, assets, liabilities and shareholders’ equity was unchanged by this change in presentation.
As a result of consolidating the Exchange’s results with Indemnity’s, we have increased the number of reportable segments from three to four. Specifically, the segments are management operations, property and casualty insurance operations, life insurance operations and investment operations.
The attached exhibits provide the Consolidated Financial Statements resulting from these changes. Exhibit 99.1 contains management’s discussion and analysis, and the complete set of audited consolidated financial statements and related footnotes from Indemnity’s 2009 Form 10-K for the years ended December 31, 2009 and 2008, that have been recasted to conform to the new consolidation presentation. These financial statements, conformed for the required changes, will become our historical financial statements. We have also included in Exhibit 99.1 an updated Controls and Procedures section previously filed under Item 9A.
Item 9.01 Financial Statements and Exhibits.
Exhibits
99.1 Audited consolidated financial statements and accompanying footnote disclosures of Erie Indemnity Company for the fiscal years ended December 31, 2009 and 2008 conformed to reflect the amended guidance in ASC 810 Consolidation , which became effective January 1, 2010. Also included is the independent auditors’ report dual dated as of February 25, 2010 and May 6, 2010. Management’s Discussion and Analysis of Results of Operation for the fiscal year ended December 31, 2009 conformed to reflect these changes and the Controls and Procedures item.
99.2 Consent of Ernst &Young LLP

 


 

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 hereunto duly authorized.
         
  Erie Indemnity Company
 
 
May 6, 2010   By:    /s/ Marcia A. Dall    
    Name:    Marcia A. Dall    
    Title:    Executive Vice President and CFO    
 

 

Exhibit 99.1
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
      of Erie Indemnity Company
We have audited the accompanying consolidated statements of financial position of Erie Indemnity Company as of December 31, 2009 and 2008, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
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, 2009 and 2008, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, in 2009 the Company changed its method of accounting for recognizing other-than-temporary impairment charges for its debt securities in connection with the adoption of the revised Financial Accounting Standards Board’s other-than-temporary impairment model. As discussed in Note 6 to the consolidated financial statements, in 2008 the Company changed its method of accounting for its common stock portfolio in connection with the adoption of the fair value option.
As discussed in Note 2 to the consolidated financial statements, effective January 1, 2010 the Company adopted and retrospectively applied the Financial Accounting Standards Board’s amended accounting guidance related to the consolidation of variable interest entities.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Erie Indemnity Company’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2010 expressed an unqualified opinion thereon. Our audit of internal control over financial reporting of Erie Indemnity Company as of December 31, 2009 did not include an evaluation of the internal controls over financial reporting of Erie Insurance Exchange and subsidiaries, which are included in the consolidated financial statements of Erie Indemnity Company as a result of the adoption and retrospective application of the Financial Accounting Standards Board’s amended accounting guidance related to the consolidation of variable interest entities described in the fifth paragraph above.
/s/ Ernst & Young LLP
Cleveland, Ohio
February 25, 2010,
except with respect to the effect of retrospective application of the Financial Accounting Standards Board’s amended accounting guidance related to the consolidation of variable interest entities as fully described in Notes 2 and 4 to the consolidated financial statements as to which the date is May 6, 2010

1


 

ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS

Years ended December 31, 2009 and 2008
(As adjusted (Note 2))
                 
(dollars in millions, except per share data)   2009     2008  
Revenues
               
Premiums earned
  $ 3,869     $ 3,834  
Net investment income
    433       438  
Net realized investment gains (losses)
    412       (1,026 )
Net impairment losses recognized in earnings
    (126 )     (571 )
Equity in losses of limited partnerships
    (369 )     (58 )
Other income
    36       34  
 
     
Total revenues
    4,255       2,651  
 
     
Benefits and expenses
               
Insurance losses and loss expenses
    2,728       2,582  
Policy acquisition and underwriting expenses
    1,003       908  
 
     
Total benefits and expenses
    3,731       3,490  
 
     
Income (loss) from operations before income taxes and noncontrolling interests
    524       (839 )
Provision (benefit) for income taxes
    78       (223 )
 
     
Net income (loss)
  $ 446     $ (616 )
 
               
Less: Net income (loss) attributable to noncontrolling interest in consolidated entity — Exchange
    338       (685 )
 
     
 
               
Net income attributable to Indemnity
  $ 108     $ 69  
 
     
 
               
Earnings Per Share
               
Net income attributable to Indemnity per share
               
Class A common stock — basic
  $ 2.10     $ 1.34  
 
     
Class A common stock — diluted
  $ 1.89     $ 1.19  
 
     
Class B common stock — basic and diluted
  $ 312.45     $ 204.20  
 
     
 
               
Weighted average shares outstanding attributable to Indemnity — Basic
               
Class A common stock
    51,250,606       51,824,649  
 
     
Class B common stock
    2,549       2,551  
 
     
 
               
Weighted average shares outstanding attributable to Indemnity— Diluted
               
Class A common stock
    57,385,228       57,967,144  
 
     
Class B common stock
    2,549       2,551  
 
     
See accompanying notes to Consolidated Financial Statements.

2


 

ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
At December 31, 2009 and 2008

(dollars in millions, except per share data)
(As adjusted (Note 2))
                 
    2009     2008  
Assets
               
Investments-Indemnity
               
Available-for-sale securities, at fair value:
               
Fixed maturities (amortized cost of $642 and $598, respectively)
  $ 664     $ 564  
Equity securities (cost of $35 and $60, respectively)
    38       55  
Trading securities, at fair value (cost of $36 and $38, respectively)
    42       33  
Limited partnerships (cost of $281 and $272, respectively)
    235       299  
Other invested assets
    1       1  
Investments-Exchange
               
Available-for-sale securities, at fair value:
               
Fixed maturities (amortized cost of $6,277 and $5,589, respectively)
    6,517       5,223  
Equity securities (cost of $425 and $469, respectively)
    472       411  
Trading securities, at fair value (cost of $1,556 and $1,559, respectively)
    1,835       1,375  
Limited partnerships (cost of $1,392 and $1,214, respectively)
    1,116       1,327  
Other invested assets
    20       21  
 
     
Total investments
    10,940       9,309  
 
               
Cash and cash equivalents (Exchange portion of $158 and $216, respectively)
    234       277  
Premiums receivable from policyholders (Exchange portion of $715 and $764, respectively)
    906       956  
Reinsurance recoverable (Exchange portion of $212 in 2009 and 2008)
    215       215  
Deferred income taxes (Exchange portion of $75 and $325, respectively)
    116       398  
Deferred acquisition costs (Exchange portion of $416 and $452, respectively)
    467       502  
Other assets (Exchange portion of $306 and $742, respectively)
    409       848  
 
     
Total assets
  $ 13,287     $ 12,505  
 
     
Liabilities and shareholders’ equity
               
Liabilities
               
Indemnity liabilities
               
Losses and loss expense reserves
  $ 752     $ 754  
Unearned premiums
    325       319  
Other liabilities
    387       454  
Exchange liabilities
               
Losses and loss expense reserves
    2,846       2,832  
Life policy and deposit contract reserves
    1,540       1,449  
Unearned premiums
    1,656       1,617  
Other liabilities
    56       321  
 
     
Total liabilities
    7,562       7,746  
 
     
 
               
Indemnity’s shareholders’ equity
               
Class A common stock, stated value $0.0292 per share; authorized 74,996,930 shares; 68,289,600 and 68,267,600 issued; 51,203,473 and 51,282,893 shares outstanding, respectively
    2       2  
Class B common stock, convertible at a rate of 2,400 Class A shares for one Class B share, stated value $70 per share; 2,546 and 2,551 authorized, issued and outstanding, respectively
    0       0  
Additional paid-in-capital
    8       8  
Accumulated other comprehensive loss
    (43 )     (136 )
 
               
Retained earnings, before cumulative effect adjustment
    1,743       1,718  
Cumulative effect of accounting changes, net of tax
    6       11  
 
     
Retained earnings, after cumulative effect adjustment
    1,749       1,729  
 
     
Total contributed capital and retained earnings
    1,716       1,603  
Treasury stock, at cost, 17,086,127 and 16,994,707 shares, respectively
    (814 )     (811 )
 
     
Total Indemnity shareholders’ equity
    902       792  
 
               
Noncontrolling interest in consolidated entity — Exchange
    4,823       3,967  
 
     
Total equity
    5,725       4,759  
 
     
Total liabilities, shareholders’ equity and noncontrolling interest
  $ 13,287     $ 12,505  
 
     
See accompanying notes to Consolidated Financial Statements. See Note 22 for supplemental consolidating statements of financial position information.

3


 

ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(dollars in millions, except per share data)
(As adjusted (Note 2))
                                                                                 
            Total                     Accumulated                             Noncontrolling  
            Indemnity                     other     Class A     Class B     Additional           interest  
    Total     shareholders’     Comprehensive     Retained     comprehensive     common     common     paid-in     Treasury     in consolidated  
    Equity     equity     income (loss)     earnings     income     stock     stock     capital     stock     entity - Exchange  
Balance January 1, 2008
  $ 5,969     $ 1,051             $ 1,740     $ 10     $ 2     $ 0     $ 8     $ (709 )   $ 4,918  
Comprehensive income:
                                                                               
Net income
  (616 )     69       69       69                                               (685 )
Other comprehensive income (loss):
                                                                               
Unrealized loss on securities, net of tax (Note 18)
    (310 )     (44 )     (44 )             (44 )                                     (266 )
Cumulative effect of accounting changes, net of tax (Note 6)
    0       0               11       (11 )                                        
Postretirement plans (Note 18):
                                                                               
Prior service cost, net of tax
    0       0       0               0                                          
Net actuarial gain, net of tax
    (91 )     (91 )     (91 )             (91 )                                        
Gain due to amendments, net of tax
    0       0       0               0                                          
Curtailment/settlement loss, net of tax
    0       0       0               0                                          
                                                             
Postretirement plans, net of tax:
    (91 )     (91 )     (91 )             (91 )                                        
                                                           
Comprehensive income
  $ 1,017             $ (66 )                                                   $ (951 )
 
                                                                         
Purchase of treasury stock
    (102 )     (102 )                                                     (102 )        
Dividends declared:
                                                                               
Class A $1.77 per share
    (91 )     (91 )             (91 )                                                
Class B $265.50 per share
    0       0               0                                                  
     
Balance December 31, 2008
  $ 4,759     $ 792             $ 1,729     $ (136 )   $ 2     $ 0     $ 8     $ (811 )   $ 3,967  
     
Comprehensive income:
                                                                               
Net income
    446       108       108       108                                               338  
Other comprehensive income (loss):
                                                                               
Unrealized loss on securities, net of tax (Note 18)
    498       75       75               75                                       423  
Cumulative effect of accounting changes, net of tax (Note 2)
    95       0               6       (6 )                                     95  
Postretirement plans (Note 18):
                                                                               
Prior service cost, net of tax
    0       0       0               0                                          
Net actuarial gain, net of tax
    27       27       27               27                                          
Loss due to amendments, net of tax
    (2 )     (2 )     (2 )             (2 )                                        
Curtailment/settlement loss, net of tax
    (1 )     (1 )     (1 )             (1 )                                        
                                                             
Postretirement plans, net of tax:
    24       24       24               24                                          
                                                           
Comprehensive income
  $ 1,063             $ 207                                                     $ 856  
 
                                                                         
Purchase of treasury stock
    (3 )     (3 )                                                     (3 )        
Conversion of Class B shares to Class A shares
    0       0                               0       0                          
Dividends declared:
                                                                               
Class A $1.83 per share
    (94 )     (94 )             (94 )                                                
Class B $274.50 per share
    0       0               0                                                  
     
Balance December 31, 2009
  $ 5,725     $ 902             $ 1,749     $ (43 )   $ 2     $ 0     $ 8     $ (814 )   $ 4,823  
     
See accompanying notes to Consolidated Financial Statements.

(p.4)


 

ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
At December 31, 2009 and 2008

(in millions)
(As adjusted (Note 2))
                 
    2009     2008  
     
Cash flows from operating activities
               
Premiums collected
  $ 3,964     $ 3,843  
Net investment income received
    421       453  
Limited partnership distributions
    81       315  
Service agreement fee received
    35       32  
Commissions and bonuses paid to agents
    (535 )     (534 )
Losses paid
    (2,241 )     (2,201 )
Loss expenses paid
    (405 )     (384 )
Other underwriting and acquisition costs paid
    (552 )     (530 )
Interest paid on bank line of credit
    0       (1 )
Income taxes recovered (paid)
    121       (273 )
       
Net cash provided by operating activities
    889       720  
       
 
               
Cash flows from investing activities
               
Purchase of investments:
               
Fixed maturities
    (1,938 )     (1,784 )
Preferred stock
    (176 )     (244 )
Common stock
    (1,450 )     (2,232 )
Limited partnerships
    (174 )     (396 )
Sales/maturities of investments:
               
Fixed maturity sales
    510       790  
Fixed maturity calls/maturities
    734       1,002  
Preferred stock
    210       263  
Common stock
    1,394       2,151  
Net policy loans
    1       (2 )
Sale of and returns on limited partnerships
    15       40  
Purchase of property and equipment
    (14 )     (9 )
Net distributions on agent loans
    (2 )     (4 )
       
Net cash used in investing activities
    (890 )     (425 )
       
 
               
Cash flows from financing activities
               
Annuity and supplementary contract deposits and interest
    183       191  
Annuity and supplementary contract surrenders and withdrawals
    (129 )     (147 )
Universal life deposits and interest
    39       21  
Universal life surrenders
    (39 )     (12 )
Purchase of treasury stock
    (3 )     (102 )
Dividends paid to shareholders
    (93 )     (92 )
Decrease in collateral from securities lending
    (285 )     (361 )
Redemption of securities lending collateral
    285       361  
Proceeds from bank line of credit
    0       75  
Payments on bank line of credit
    0       (75 )
       
Net cash used in financing activities
    (42 )     (141 )
       
 
               
Net (decrease) increase in cash and cash equivalents
    (43 )     154  
Cash and cash equivalents at beginning of year
    277       123  
       
Cash and cash equivalents at end of year
  $ 234     $ 277  
       
See accompanying notes to Consolidated Financial Statements. See Note 20 for supplemental cash flow information.

5


 

Note 1. Nature of Operations
Erie Indemnity Company (“Indemnity”) is a publicly held Pennsylvania business corporation that since 1925 has been the managing Attorney-in-Fact for the subscribers (policyholders) of Erie Insurance Exchange (“Exchange”). The Exchange is a subscriber (policyholder) owned Pennsylvania-domiciled reciprocal insurer that writes property and casualty insurance.
Indemnity’s primary function is to perform certain services for the Exchange relating to sales, underwriting and issuance of policies on behalf of the Exchange. This is done in accordance with a subscribers agreement (a limited power of attorney) executed by each subscriber (policyholder), appointing Indemnity as their common attorney-in-fact to transact business on their behalf and to manage the affairs of the Exchange. Indemnity earns a management fee from the Exchange for these services, which is paid from the premiums collected from subscribers (policyholders).
Indemnity also operates as a property and casualty insurer through its wholly-owned subsidiaries, Erie Insurance Company (“EIC”), Erie Insurance Company of New York (“ENY”) and the Erie Insurance Property and Casualty Company (“EPC”).
The “Property and Casualty Group” refers to the Exchange and its wholly-owned subsidiary, Flagship City Insurance Company (“Flagship”) and Indemnity’s wholly-owned subsidiaries. The Property and Casualty Group operates in 11 Midwestern, Mid-Atlantic and Southeastern states and the District of Columbia and primarily writes personal auto insurance, which comprises 48% of its 2009 direct premiums.
Erie Family Life Insurance Company (“EFL”) is an affiliated life insurance company that underwrites and sells nonparticipating individual and group life insurance policies and fixed annuities. Indemnity and the Exchange own 21.6% and 78.4% of EFL, respectively.
“Indemnity shareholder interest” refers to the interest in Erie Indemnity Company owned by the Class A and Class B shareholders. In addition to referring to Erie Insurance Exchange, the term “Exchange” sometimes refers to the noncontrolling interest held for the benefit of the subscribers (policyholders) and includes its interests in Flagship and EFL.
The accompanying consolidated financial statements of Erie Indemnity Company reflect the consolidated results of Indemnity and its variable interest entity, the Exchange, which we refer to collectively as “Erie Insurance Group”.
Note 2. Significant Accounting Policies
Retrospective adoption of new accounting principle
On June 12, 2009, the Financial Accounting Standards Board (FASB) updated ASC 810, Consolidation , which amended the existing guidance for determining whether an enterprise is the primary beneficiary of a variable interest entity (“VIE”). As of January 1, 2010 Erie Indemnity Company adopted the new accounting principle on a retrospective basis since inception.
This guidance changed the methodology for assessing whether an enterprise is the primary beneficiary of a VIE by requiring a qualitative analysis to determine if an enterprise’s variable interest gives it a controlling financial interest. The qualitative analysis looks at the power to direct activities of the VIE that most significantly impact economic performance and the right to receive benefits (or obligation to absorb losses) from the VIE that could be significant.
In accordance with the new accounting guidance, Indemnity is deemed to be the primary beneficiary of the Exchange given the significance of the management fee to the Exchange and Indemnity’s power to direct the Exchange’s significant activities. Under the previously issued accounting guidance, Indemnity was not deemed the primary beneficiary of the Exchange and its financial position and operating results were not consolidated with Indemnity’s. Following adoption of the new accounting guidance, as primary beneficiary of the Exchange, Erie Indemnity Company has consolidated Indemnity and the Exchange’s financial position and operating results. Furthermore, upon consolidation of the Exchange, 100% of the ownership of EFL resides within the consolidated entity and consequently EFL’s financial results are also consolidated. The financial statements and notes to the financial statements presented herein have all been adjusted to reflect the retrospective adoption of the new accounting principle.
There was no cumulative effect to Indemnity’s shareholders’ equity from consolidation of the Exchange and EFL. The noncontrolling interest in total equity represents the amount of the Exchange’s subscribers’ (policyholders’) equity.

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Basis of presentation and principles of consolidation
The accompanying consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) and include the accounts of Indemnity together with its affiliate companies in which Indemnity holds a majority voting or economic interest. In addition, we consolidate the Exchange as a variable interest entity for which Indemnity is the primary beneficiary. All intercompany accounts and transactions have been eliminated in consolidation. The required presentation of noncontrolling interests is reflected in the consolidated financial statements. Noncontrolling interests represent the ownership interests of the Exchange, all of which is held by parties other than Indemnity (i.e. the Exchange’s subscribers (policyholders)). Noncontrolling interests also include the Exchange subscribers’ 78.4% ownership interest in EFL.
Presentation of assets and liabilities — While the assets of the Exchange are presented separately in the Consolidated Statements of Financial Position, the Exchange’s assets can only be used to satisfy the Exchange’s liabilities or for other unrestricted activities. ASC 810, Consolidation, does not require separate presentation of the Exchange’s assets. However, because the shareholders of Indemnity have no rights to the assets of the Exchange and, conversely, the Exchange has no rights to the assets of Indemnity, we have presented the invested assets of the Exchange separately on the Consolidated Statements of Financial Position along with the remaining consolidated assets reflecting the Exchange’s portion parenthetically. Liabilities are required under ASC 810, Consolidation, to be presented separately for the Exchange on the Consolidated Statements of Financial Position as the Exchange’s creditors do not have recourse to the general credit of Indemnity.
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 benefit of its subscribers (policyholders), who have no rights or interest in the Indemnity shareholder interest income or equity.
All intercompany assets and liabilities between Indemnity and the Exchange have been eliminated in the Consolidated Statements of Financial Position.
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
FASB ASC 855, Subsequent Events , was issued in June 2009 to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued or available to be issued. This statement became effective for periods ending after June 15, 2009.
On July 1, 2009, we adopted new accounting guidance related to the codification of accounting standards and the hierarchy of GAAP established by the FASB. This accounting guidance established two levels of GAAP, authoritative and nonauthoritative. The FASB Accounting Standards Codification (the “Codification”) is the source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of the SEC, which are also sources of authoritative GAAP for SEC registrants. All other accounting literature is nonauthoritative. There was no impact on our consolidated financial statements upon adoption of this standard.
In April 2009, the FASB provided additional application guidance and enhanced disclosure requirements regarding fair value measurements and impairments of securities as follows:
    FASB ASC 820, Fair Value Measurements and Disclosures , provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased in relation to normal market activity. This guidance states a reporting entity shall evaluate circumstances to determine whether the transaction is orderly based on the weight of the evidence. The additional disclosures required by this guidance, including the inputs and valuation techniques used to measure fair values and any changes in such, have been included in Note 6.
 
    FASB ASC 825, Financial Instruments , requires disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements. We adopted this guidance in the second quarter of 2009 and the additional fair value disclosures were provided in the interim periods. See annual disclosures in Note 6.
 
    On April 1, 2009, we adopted new accounting guidance under FASB ASC 320, Investments – Debt and Equity Securities . This guidance amended the other-than-temporary impairment (OTTI) model for debt securities and requires that credit-related losses and securities in an unrealized loss position that we intend to

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      sell be recognized in earnings, with the remaining decline recognized in other comprehensive income. Additionally, this accounting guidance modified the presentation of OTTI in the statement of operations with the total OTTI presented along with an offset for the amount of OTTI recognized in other comprehensive income. Disclosures include further disaggregation of securities, methodology, inputs related to credit-related loss impairments and a rollforward of credit-related loss impairments. The adoption of this guidance required a cumulative effect adjustment to reclass previously recognized non-credit other-than-temporary impairments from retained earnings to other comprehensive income. The net impact of the cumulative effect adjustment increased Indemnity retained earnings and decreased Indemnity other comprehensive income by $6 million, net of tax. The net impact of the cumulative effect adjustment increased Exchange retained earnings and decreased Exchange other comprehensive income by $95 million, net of tax. Disclosures regarding our impairment methodology are included in this note under the caption Investments. The remaining disclosures regarding credit and non-credit related impairments have been provided in Note 7.
Investments
Available-for-sale securities – Fixed maturity and preferred stock securities are classified as available-for-sale and are reported at fair value. Unrealized holding gains and losses, net of related tax effects, on fixed maturities and preferred stock are charged or credited directly to shareholders’ equity as accumulated other comprehensive income (loss).
Realized gains and losses on sales of fixed maturity and preferred stock securities are recognized in income based upon the specific identification method. Interest and dividend income are recognized as earned.
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 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.
Debt securities that have experienced a decline in fair value and that we do not intend to sell, and that will not be required to sell before recovery, are evaluated to determine if the decline in fair value is other-than-temporary.
Some factors considered in this evaluation include:
    the extent and duration to which fair value is less than cost;
 
    historical operating performance and financial condition of the issuer;
 
    short and long-term prospects of the issuer and its industry based on analysts’ recommendations;
 
    specific events that occurred affecting the issuer, including a ratings downgrade;
 
    near term liquidity position of the issuer; and
 
    compliance with financial covenants.
If a decline is deemed to be other-than-temporary, an assessment is made to determine the amount of the total impairment related to a credit loss and that related to all other factors. Consideration is given to all available information relevant to the collectability of the security in this determination. If the entire amortized cost basis of the security will not be recovered, a credit loss exists. Currently, we have the intent to sell all of our securities that have been determined to have a credit-related impairment. As a result, the entire amount of the impairment has been recognized in earnings. If we had securities with credit impairments that we did not intend to sell, the non-credit portion of the impairment would have been recorded in other comprehensive income.
Impairment charges on non-redeemable preferred securities and hybrid securities with equity characteristics are included in earnings consistent with the treatment for equity securities. This is a more conservative approach since the lack of a final maturity and unlikelihood of a call means recovery is uncertain and would occur over a multi-year period.
Trading securities – Our common stock securities are trading securities which are reported at fair value. Unrealized holding gains and losses on these securities are included in net realized gains (losses) in the Consolidated Statement of Operations. Realized gains and losses on sales of common stock are recognized in income based on the specific identification method. Dividend income is recognized as earned.

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Limited partnerships – Limited partnerships include U.S. and foreign private equity, real estate and mezzanine debt investments. The private equity limited partnerships invest primarily in small- to medium-sized companies. The general partners for our limited partnerships determine the market value of investments in the partnerships, including any other-than-temporary impairments of these individual investments. The primary basis for the valuation of limited partnership interests are financial statements prepared by the general partner. Because of the timing of the preparation and delivery of these financial statements, the use of the most recently available financial statements provided by the general partners 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 yet reflect the market conditions experienced in the fourth quarter of 2009.
Nearly all of the underlying investments in our limited partnerships are valued using a source other than quoted prices in active markets. The fair value amounts for our private equity and mezzanine debt partnerships are based on the financial statements of the general partners, who use multiple methods to estimate fair value including the market approach, income approach and/or the cost approach. The market approach uses prices and other pertinent information from market-generated transactions involving identical or comparable assets or liabilities. Such valuation techniques often use market multiples derived from a set of comparables. The income approach uses valuation techniques to convert future cash flows or earnings to a single discounted present value amount. The measurement is based on the value indicated by current market expectations on those future amounts. The cost approach is derived from the amount that is currently required to replace the service capacity of an asset. If information becomes available that would impair the cost of these partnerships, then the general partner would generally adjust to the net realizable value.
For real estate limited partnerships, the general partners record these at fair value based on an independent appraisal or internal estimates of fair value.
We perform various procedures in review of the general partners’ valuations. While we generally rely on the general partners’ financial statements as the best available information to record our share of the partnership unrealized gains and losses resulting from valuation changes, we adjust our financial statements for impairments at the fund level as necessary. There were no valuation changes in 2009 or 2008. As there is a limited market for these investments, they have the greatest potential for market price variability.
Unrealized gains and losses for these investments are reflected in equity in losses of limited partnerships in our Consolidated Statements of Operations in accordance with the equity method of accounting. Cash contributions made to and distributions received from the partnerships are recorded in the period in which the transaction occurs.
Cash and cash equivalents – Cash and cash equivalents are principally comprised of investments in money market funds and approximate fair value.
Deferred acquisition costs
Acquisition costs that vary with and relate to the production of insurance and investment-type contracts are deferred. Such costs consist principally of commissions, premium taxes and policy issuance expenses.
Property and casualty insurance – Deferred acquisition costs (DAC) for property and casualty insurance contracts, which is primarily composed of commissions and certain underwriting expenses, is amortized on a pro rata basis over the applicable policy term. The amount of costs to be deferred would be reduced to the extent future policy premiums and anticipated investment income would not exceed related losses, expenses and policyholder dividends. There was no reduction in costs deferred in any periods presented. The DAC 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 and expense margins and surrender charges. Both historical and anticipated investment returns, including realized gains and losses, are considered in determining the amortization of DAC.

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Estimated gross profits are adjusted monthly to reflect actual experience to date and/or for the unlocking of underlying key assumptions based on experience studies. DAC is periodically reviewed for recoverability. For traditional life products, if the benefit reserves plus anticipated future premiums and interest earnings for a line of business are less than the current estimate of future benefits and expenses (including any unamortized DAC), a charge to income is recorded for additional DAC amortization or for increased benefit reserves. For universal life and deferred annuities, if the current present value of future expected gross profits is less than the unamortized DAC, a charge to income is recorded for additional DAC amortization.
Deferred taxes
Deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements, using the statutory tax rates in effect for the year in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date under the law. Valuation allowances on deferred tax assets are estimated based on our assessment of the realizability of such amounts.
Property and casualty unpaid losses and loss expenses
Unpaid losses and loss expenses include estimates for claims that have been reported and those that have been incurred but not reported, as well as estimates of all expenses associated with processing and settling these claims, less estimates of anticipated salvage and subrogation recoveries. Unpaid loss and loss expense reserves are set at full expected cost, except for workers compensation loss reserves, which have been discounted using an interest rate of 2.5%. Estimating the ultimate cost of future losses and loss expenses is an uncertain and complex process. This estimation process is based on the assumption that past developments are an appropriate indicator of future events, and involves a variety of actuarial techniques that analyze experience, trends and other relevant factors. The uncertainties involved with the reserving process include internal factors, such as changes in claims handling procedures, as well as external factors, such as economic trends and changes in the concepts of legal liability and damage awards. Accordingly, final loss settlements may vary from the present estimates, particularly when those payments may not occur until well into the future.
We regularly review the adequacy of our estimated loss and loss expense reserves by line of business. Adjustments to previously established reserves are reflected in the operating results of the period in which the adjustment is determined to be necessary. Such adjustments could possibly be significant, reflecting any variety of new and adverse or favorable trends.
Life insurance reserves
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.
Deferred annuity future benefit reserves are established at accumulated account values without reduction for surrender charges. These account values are credited with varying interest rates determined at the discretion of EFL subject to certain minimums.
Agent bonus estimates
Agent bonuses are based on an individual agency’s property and casualty underwriting profitability and also include a component for growth in agency property and casualty premiums if the agency’s underwriting profitability targets for our book of business are met. The estimate for agent bonuses, which are based on the performance over 36 months, is modeled on a monthly basis using actual underwriting data by agency for the two prior years combined with the current year-to-date actual data. At December 31 of each year, we use actual data available and record an accrual based on the expected payment amount. These costs are included in the policy acquisition and underwriting expenses in the Consolidated Statements of Operations.

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Recognition of premium revenues and losses
Property and casualty insurance – Insurance premiums written are earned over the terms of the policies on a pro-rata basis. Unearned premiums represent that portion of premiums written which is applicable to the unexpired terms of policies in force. Losses and loss expenses are recorded as incurred.
Life insurance – Premiums on traditional life insurance products are recognized as earned when due. Reserves for future policy benefits are established as premiums are earned. Premiums received for annuity and universal life products are not reported as revenue, but as deposits, and included in liabilities. For universal life products, revenue is recognized as amounts are assessed against the policyholder’s account for mortality coverage and contract expenses. The primary source of revenue on annuity deposits is derived from the interest earned by EFL, which is reflected in net investment income.
Reinsurance
Property and casualty insurance – Property and casualty assumed involuntary and ceded reinsurance premiums are earned over the terms of the reinsurance contracts. Premiums ceded to other companies are reported as a reduction of premium income. Reinsurance contracts do not relieve the Property and Casualty Group from its obligations to policyholders.
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.
Recognition of management fee revenue
Indemnity earns management fees from the Exchange for providing sales, underwriting and policy issuance services. The management fee revenue is calculated as a percentage of the direct written premium of the Property and Casualty Group. The Exchange issues policies with annual terms only. Management fees are recorded as revenue upon policy issuance or renewal, as substantially all of the services required to be performed by us have been satisfied at that time. Certain activities are performed and related costs are incurred by us subsequent to policy issuance in connection with the services provided to the Exchange; however, these activities are inconsequential and perfunctory. Management fee revenue is eliminated in consolidation.
Recognition of service agreement revenue
Included in service agreement revenue are service charges Indemnity collects from policyholders for providing multiple payment plans on policies written by the Property and Casualty Group. Service charges, which are flat dollar charges for each installment billed beyond the first installment, are recognized as revenue when bills are rendered to the policyholder. Service agreement revenue also includes late payment and policy reinstatement fees. Service agreement revenue is included in other income in the Consolidated Statements of Operations.
Note 3. Earnings Per Share
Basic earnings per share are calculated under the two-class method, which allocates earnings to each class of stock based on its dividend rights. Class B shares are convertible into Class A shares at a conversion ratio of 2,400 to 1. See Note 17. Class A diluted earnings per share are calculated under the if-converted method which reflects the conversion of Class B shares and the effect of potentially dilutive outstanding employee stock-based awards and awards not yet vested related to the outside directors’ stock compensation plan.

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A reconciliation of the numerators and denominators used in the basic and diluted per-share computations is presented as follows for each class of Indemnity common stock:
                                                 
    Indemnity Earnings Per Share Calculation  
  For the years ended December 31,  
    2009     2008  
    Allocated     Weighted     Per-     Allocated     Weighted     Per-  
(dollars in millions,   net income     shares     share     net income     shares     share  
except per share data)   (numerator)     (denominator)     amount     (numerator)     (denominator)     amount  
         
Class A – Basic EPS:
                                               
Income available to Class A stockholders
  $ 107       51,250,606     $ 2.10     $ 68       51,824,649     $ 1.34  
         
Dilutive effect of stock awards
    0       17,022             0       20,095        
         
Assumed conversion of Class B shares
    1       6,117,600             1       6,122,400        
         
Class A – Diluted EPS:
                                               
Income available to Class A stockholders on Class A equivalent shares
  $ 108       57,385,228     $ 1.89     $ 69       57,967,144     $ 1.19  
         
Class B – Basic and diluted EPS:
                                               
Income available to Class B stockholders
  $ 1       2,549     $ 312.45     $ 1       2,551     $ 204.20  
         
Note 4. Variable Interest Entity
Exchange
The Exchange is a reciprocal insurance exchange domiciled in Pennsylvania, for which Indemnity serves as attorney-in-fact. Indemnity holds a variable interest in the Exchange because of the absence of decision-making capabilities by the equity owners (subscribers) of the Exchange and because of the significance of the management fees the Exchange pays to Indemnity as the decision maker. The new accounting guidance, which we adopted on January 1, 2010, requires entities to perform a qualitative analysis to determine the primary beneficiary of variable interest entities. As a result of adopting the new guidance, Indemnity is deemed to have a controlling financial interest in the Exchange and is considered the primary beneficiary. The Exchange’s results have been consolidated with those of Indemnity. We have retrospectively applied the new accounting guidance and have consolidated the Exchange for all periods presented in this report for comparability purposes. See Note 2.
Consolidation of the Exchange is required given the significance of the management fee to the Exchange and because Indemnity has the power to direct the activities of the Exchange that most significantly impact the Exchange’s economic performance. Indemnity earns management fee revenues from the Exchange for services provided as attorney-in-fact for the Exchange. Indemnity’s management fee revenues are based on the direct written premiums of the Exchange and the other members of the Property and Casualty Group. Indemnity’s Board of Directors determines the management fee rate paid by the Exchange to Indemnity. This rate cannot exceed 25% of the direct and affiliated assumed written premiums of the Exchange, as defined by the subscriber agreement signed by each policyholder. The management fee revenues and management fee expenses are eliminated in consolidation.
Indemnity participates in the underwriting results of the Exchange through the pooling arrangement in which its insurance subsidiaries have a 5.5% participation. If the Exchange were to default, Indemnity’s insurance subsidiaries would be liable for the policies that they wrote directly. Indemnity’s property and casualty insurance subsidiaries wrote approximately 16% of the direct written premiums of the Property and Casualty Group in 2009. Indemnity’s Board of Directors determines the continuation and participation percentage of Indemnity’s property and casualty subsidiaries in the reinsurance pooling arrangement.
Indemnity has no obligation related to any underwriting and/or investment losses experienced by the Exchange. Indemnity would however be adversely impacted if the Exchange incurred significant underwriting and/or investment losses. If the surplus of the Exchange were to decline significantly from its current level, its financial strength ratings could be reduced and as a consequence the Exchange could find it more difficult to retain its existing business and attract new business. A decline in the business of the Exchange would have an adverse effect on the amount of the management fees Indemnity receives and the underwriting results of the Property and Casualty Group in which Indemnity has a 5.5% participation. In addition, a decline in the surplus of the Exchange from its current level may impact the management fee rate received by Indemnity. Indemnity also has an exposure to a concentration of credit risk related to the unsecured receivables due from the Exchange for its management fee, reinsurance recoverables from unpaid losses and loss expenses and unearned premium balances ceded under the pooling arrangement and cost reimbursements.

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Indemnity has not provided financial or other support to the Exchange for the reporting periods presented. At December 31, 2009, there are no explicit or implicit arrangements that would require Indemnity to provide future financial support to the Exchange. Indemnity is not liable if the Exchange were to be in violation of its debt covenants or were unable to meet its obligation for unfunded commitments to limited partnerships.
Note 5. Segment Information
As a result of the changes in our reporting entity at January 1, 2010 (see Note 2), our reportable segments have increased from three to four. Our reportable segments now include management operations, property and casualty insurance operations, life insurance operations and investment operations. The segment information presented below includes reclassification of all comparative prior period segment information. Accounting policies for segments are the same as those described in the summary of significant accounting policies. See Note 2. 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.
Our management operations segment consists of serving as attorney-in-fact for the Exchange. Indemnity operates in this capacity solely for the Exchange. We evaluate profitability of our management operations segment principally on the gross margin from management operations.
Indemnity earns management fees from the Exchange for providing sales, underwriting and policy issuance services. The management fee revenue, which is eliminated in consolidation, is calculated as a percentage of the direct written premium of the Property and Casualty Group. The Exchange issues policies with annual terms only. Management fees are recorded upon policy issuance or renewal, as substantially all of the services required to be performed by Indemnity have been satisfied at that time. Certain activities are performed and related costs are incurred by us subsequent to policy issuance in connection with the services provided to the Exchange; however, these activities are inconsequential and perfunctory. Although these management fee revenues and expenses are eliminated in consolidation, the amount of the fee directly impacts the allocation of our consolidated net income between noncontrolling interest, which bears the management fee expense and represents the interests of the Exchange subscribers, and Indemnity’s interest which earns the management fee revenue and represents Indemnity shareholder interest in net income.
Our property and casualty insurance 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 Indemnity subsidiaries and the Exchange, which includes assumed voluntary reinsurance from nonaffiliated domestic and foreign sources, assumed involuntary and ceded reinsurance business. The Exchange exited the assumed voluntary reinsurance business effective December 31, 2003, and therefore unaffiliated reinsurance includes only run-off activity of the previously assumed voluntary reinsurance business. We evaluate profitability of the property and casualty operations principally based on 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 operations. We evaluate profitability of the life insurance segment principally based on 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 2009, investment activities on life insurance-related assets generated revenues of $63 million resulting in EFL reporting income before income taxes of $10 million, before intercompany eliminations. In 2008, investment activities on life insurance-related assets generated a loss of $6 million resulting in EFL reporting losses before income taxes of $54 million, before intercompany eliminations. See EFL supplemental information in Note 23.
The investment operations segment performance is evaluated based on appreciation of assets, rate of return and overall return. Investment-related income for the life operations is included in the investment segment results.

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The following tables summarize the components of the Consolidated Statements of Operations by reportable business segments:
                                                 
    Erie Insurance Group  
    For the year ended December 31, 2009  
            Property                          
            and     Life                    
    Management     casualty     insurance                    
(in millions)   operations     operations     operations     Investments     Eliminations     Consolidated  
     
Premiums earned/life policy revenue
          $ 3,808     $ 63             $ (2 )   $ 3,869  
Net investment income
                          $ 444       (11 )     433  
Net realized investment gains
                            412               412  
Net impairment losses recognized in earnings
                            (126 )             (126 )
Equity in losses of limited partnerships
                            (369 )             (369 )
Management fee revenue
  $ 965                               (965 )      
Service agreement and other revenue
    35               1                       36  
     
Total revenues (losses)
    1,000       3,808       64       361       (978 )     4,255  
     
Cost of management operations
    813                               (813 )      
Insurance losses and loss expenses
            2,644                       (5 )     2,639  
Benefits and other changes in policy reserves
                    89                       89  
Policy acquisition and underwriting expense
            1,135       28               (160 )     1,003  
     
Total benefits and expenses
    813       3,779       117             (978 )     3,731  
     
Income (loss) before income taxes
    187       29       (53 )     361             524  
Provision (benefit) for income taxes
    60       10       (19 )     27             78  
     
Net income (loss)
  $ 127     $ 19     $ (34 )   $ 334     $     $ 446  
     
                                                 
    Erie Insurance Group  
                    For the year ended December 31, 2008              
    Management     Property and     Life insurance                    
(in millions)   operations     casualty operations     operations     Investments (1)     Eliminations     Consolidated  
     
Premiums earned/life policy revenue
          $ 3,771     $ 65             $ (2 )   $ 3,834  
Net investment income
                          $ 449       (11 )     438  
Net realized investment losses
                            (1,026 )             (1,026 )
Net impairment losses recognized in earnings
                            (571 )             (571 )
Equity in losses of limited partnerships
                            (58 )             (58 )
Management fee revenue
  $ 950                               (950 )      
Service agreement and other revenue
    33               1                       34  
     
Total revenues (losses)
    983       3,771       66       (1,206 )     (963 )     2,651  
     
Cost of management operations
    810                               (810 )      
Insurance losses and loss expenses
            2,494                       (5 )     2,489  
Benefits and other changes in policy reserves
                    93                       93  
Policy acquisition and underwriting expense
            1,035       21               (148 )     908  
     
Total benefits and expenses
    810       3,529       114             (963 )     3,490  
     
Income (loss) before income taxes
    173       242       (48 )     (1,206 )           (839 )
Provision (benefit) for income taxes
    56       84       (17 )     (346 )           (223 )
     
Net income (loss)
  $ 117     $ 158     $ (31 )   $ (860 )   $     $ (616 )
     
 
(1)   The more significant realized losses, impairment charges and market value adjustments on limited partnership investments were impacted by the significant disruption in the financial markets, primarily in the third and fourth quarters of 2008.
See the “Results of the Erie Insurance Group’s operations by interest” table in the Management’s Discussion and Analysis for the composition of income attributable to Indemnity and income attributable to the noncontrolling interest (Exchange).

14


 

Note 6. Fair Value
Our available-for-sale and trading securities are recorded at fair value, which is the price that would be received to sell the asset in an orderly transaction between willing market participants as of the measurement date.
Valuation techniques used to derive the fair value of our available-for–sale and trading securities are based on observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources.
Unobservable inputs reflect our own assumptions regarding fair market value for these securities. Although the majority of our prices are obtained from third party sources, we also perform an internal pricing review for securities with low trading volumes in the current market conditions. Financial instruments are categorized based upon the following characteristics or inputs to the valuation techniques:
         
 
  Level 1   Quoted prices for identical instruments in active markets not subject to adjustments or discounts
 
       
 
  Level 2   Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
 
       
 
  Level 3   Instruments whose significant value drivers are unobservable and reflect management’s estimate of fair value based on assumptions used by market participants in an orderly transaction as of the valuation date.
The following table represents the fair value measurements on a recurring basis for our consolidated available-for-sale and trading securities by major category and level of input at December 31, 2009:
                                 
    Erie Insurance Group  
            At December 31, 2009        
            Fair value measurements using:        
            Quoted prices in              
            active markets for     Significant     Significant  
            identical assets     observable inputs     unobservable inputs  
(in millions)   Total     Level 1     Level 2     Level 3  
Indemnity    
Available-for-sale securities:
                               
Fixed maturities
  $ 664     $ 6     $ 648     $ 10  
Preferred stock
    38       9       28       1  
Trading securities – common stock
    42       42       0       0  
     
Total – Indemnity
  $ 744     $ 57     $ 676     $ 11  
Exchange
                               
Available-for-sale securities:
                               
Fixed maturities
  $ 6,517     $ 31     $ 6,415     $ 71  
Preferred stock
    472       157       311       4  
Trading securities – common stock
    1,835       1,826       0       9  
     
Total – Exchange
  $ 8,824     $ 2,014     $ 6,726     $ 84  
     
Total – Erie Insurance Group
  $ 9,568     $ 2,071     $ 7,402     $ 95  
     

15


 

Level 3 Assets – Quarterly Change:
                                                 
    Erie Insurance Group  
    Beginning           Included in other                   Ending  
    balance at     Included in     comprehensive     Purchases, sales     Transfers in and     balance at  
(in millions)   September 30, 2009     earnings (1)     income     and adjustments     (out) of Level 3 (2)     December 31, 2009  
Indemnity    
Available-for-sale securities:
                                               
Fixed maturities
  $ 12     $ (1 )   $ 0     $ 0     $ (1 )   $ 10  
Preferred stock
    1       0       0       0       0       1  
Trading securities – common stock
    0       0       0       0       0       0  
     
Total Level 3 assets – Indemnity
  $ 13     $ (1 )   $ 0     $ 0     $ (1 )   $ 11  
Exchange
                                               
Available-for-sale securities:
                                               
Fixed maturities
  $ 99     $ (4 )   $ 0     $ 1     $ (25 )   $ 71  
Preferred stock
    15       0       0       (5 )     (6 )     4  
Trading securities – common stock
    1       2       0       6       0       9  
     
Total Level 3 assets – Exchange
  $ 115     $ (2 )   $ 0     $ 2     $ (31 )   $ 84  
     
Total Level 3 assets – Erie Insurance Group
  $ 128     $ (3 )   $ 0     $ 2     $ (32 )   $ 95  
     
     Level 3 Assets – Year-to-Date Change (3) :
                                                 
    Erie Insurance Group  
    Beginning           Included in other                   Ending  
    balance at December     Included in     comprehensive     Purchases, sales     Transfers in and     balance at December  
(in millions)   31, 2008     earnings (1)     income     and adjustments     (out) of Level 3 (2)     31, 2009  
Indemnity    
Available-for-sale securities:
                                               
Fixed maturities
  $ 14     $ (1 )   $ 2     $ 1     $ (6 )   $ 10  
Preferred stock
    12       0       0       0       (11 )     1  
Trading securities – common stock
    0       0       0       0       0       0  
     
Total Level 3 assets – Indemnity
  $ 26     $ (1 )   $ 2     $ 1     $ (17 )   $ 11  
Exchange
                                               
Available-for-sale securities:
                                               
Fixed maturities
  $ 103     $ (7 )   $ 10     $ (9 )   $ (26 )   $ 71  
Preferred stock
    50       0       2       (5 )     (43 )     4  
Trading securities – common stock
    0       3       0       6       0       9  
     
Total Level 3 assets – Exchange
  $ 153     $ (4 )   $ 12     $ (8 )   $ (69 )   $ 84  
     
Total Level 3 assets – Erie Insurance Group
  $ 179     $ (5 )   $ 14     $ (7 )   $ (86 )   $ 95  
     
 
(1)   Includes losses as a result of other-than-temporary impairments and accrual of discount and amortization of premium. These amounts are reported in the Consolidated Statement of Operations. There were no unrealized gains or losses included in earnings for the three or twelve months ended December 31, 2009 on Level 3 securities.
 
(2)   Transfers in and out of Level 3 would be attributable to changes in the availability of market observable information for individual securities within the respective categories.
 
(3)   Year-to-date rollforward amounts may include inter-category eliminations from prior quarter activity due to security transfers in and out of Level 3.

16


 

The following table represents the fair value measurements on a recurring basis for our consolidated available-for-sale and trading securities by major category and level of input at December 31, 2008:
                                 
    Erie Insurance Group  
            At December 31, 2008        
            Fair value measurements using:        
            Quoted prices in              
            active markets for     Significant     Significant  
            identical assets     observable inputs     unobservable inputs  
(in millions)   Total     Level 1     Level 2     Level 3  
     
Indemnity
                               
Available-for-sale securities:
                               
Fixed maturities
  $ 564     $ 7     $ 543     $ 14  
Preferred stock
    55       35       8       12  
Trading securities – common stock
    33       33       0       0  
     
Total – Indemnity
  $ 652     $ 75     $ 551     $ 26  
Exchange
                               
Available-for-sale securities:
                               
Fixed maturities
  $ 5,223     $ 20     $ 5,100     $ 103  
Preferred stock
    411       285       76       50  
Trading securities – common stock
    1,375       1,375       0       0  
     
Total – Exchange
  $ 7,009     $ 1,680     $ 5,176     $ 153  
     
Total – Erie Insurance Group
  $ 7,661     $ 1,755     $ 5,727     $ 179  
     
Level 3 Assets – Quarterly Change:
                                                 
    Erie Insurance Group  
    Beginning             Included in other                     Ending  
    balance at     Included in     comprehensive     Purchases, sales     Transfers in and     balance at December  
(in millions)   September 30, 2008     earnings (1)     income     and adjustments     (out) of Level 3 (2)     31, 2008  
     
Indemnity
                                               
Available-for-sale securities:
                                               
Fixed maturities
  $ 28     $ (2 )   $ (3 )   $ (7 )   $ (2 )   $ 14  
Preferred stock
    13       0       (1 )     0       0       12  
Trading securities – common stock
    0       0       0       0       0       0  
     
Total Level 3 assets – Indemnity
  $ 41     $ (2 )   $ (4 )   $ (7 )   $ (2 )   $ 26  
Exchange
                                               
Available-for-sale securities:
                                               
Fixed maturities
  $ 110     $ (2 )   $ (14 )   $ 9     $ 0     $ 103  
Preferred stock
    49       (1 )     (3 )     5       0       50  
Trading securities – common stock
    0       0       0       0       0       0  
     
Total Level 3 assets – Exchange
  $ 159     $ (3 )   $ (17 )   $ 14     $ 0     $ 153  
     
Total Level 3 assets – Erie Insurance Group
  $ 200     $ (5 )   $ (21 )   $ 7     $ (2 )   $ 179  
     

17


 

Level 3 Assets-Year-to-Date Change:
                                                 
    Erie Insurance Group  
    Beginning             Included in other                     Ending  
    balance at December     Included in     comprehensive     Purchases, sales     Transfers in and     balance at December  
(in millions)   31, 2007     earnings (1)     income     and adjustments     (out) of Level 3 (2)     31, 2008  
     
Indemnity
                                               
Available-for-sale securities:
                                               
Fixed maturities
  $ 11     $ (4 )   $ (3 )   $ (5 )   $ 15     $ 14  
Preferred stock
    6       (2 )     (2 )     2       8       12  
Trading securities – common stock
    0       0       0       0       0       0  
     
Total Level 3 assets – Indemnity
  $ 17     $ (6 )   $ (5 )   $ (3 )   $ 23     $ 26  
Exchange
                                               
Available-for-sale securities:
                                               
Fixed maturities
  $ 152     $ (56 )   $ (8 )   $ 15     $ 0     $ 103  
Preferred stock
    54       (8 )     (9 )     13       0       50  
Trading securities – common stock
    0       0       0       0       0       0  
     
Total Level 3 assets – Exchange
  $ 206     $ (64 )   $ (17 )   $ 28     $ 0     $ 153  
     
Total Level 3 assets – Erie Insurance Group
  $ 223     $ (70 )   $ (22 )   $ 25     $ 23     $ 179  
     
 
(1)   Includes losses as a result of other-than-temporary impairments and accrual of discount and amortization of premium. These amounts are reported in the Consolidated Statement of Operations. There were no unrealized gains or losses included in earnings for the three or twelve months ended December 31, 2008 on Level 3 securities.
 
(2)   Transfers in and out of Level 3 would be attributable to changes in the availability of market observable information for individual securities within the respective categories.
Estimates of fair values for our investment portfolio are obtained primarily from a nationally recognized pricing service. Our Level 1 category includes those securities valued using an exchange traded price provided by the pricing service. The methodologies used by the pricing service that support a Level 2 classification of a financial instrument include multiple verifiable, observable inputs including benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Pricing service valuations for Level 3 securities are based on proprietary models and are used when observable inputs are not available in illiquid markets. In limited circumstances we adjust the price received from the pricing service when in our judgment a better reflection of fair value is available based on corroborating information and our knowledge and monitoring of market conditions. At December 31, 2009, we adjusted some prices received by the pricing service to reflect an alternate fair market value based on observable market data such as a disparity in price of comparable securities and/or non-binding broker quotes.
The following table displays the number and values of these adjustments for the years ended December 31:
                         
                    Value of securities  
            Value of securities     used in the  
    Number of     using pricing     financial  
(dollars in millions)   holdings     service     statements  
 
Indemnity
    8     $ 9     $ 9  
Exchange
    13       43       46  
             
Total – Erie Insurance Group
          $ 52     $ 55  
             
We perform continuous reviews of the prices obtained from the pricing service. This includes evaluating the methodology and inputs used by the pricing service to ensure we determine the proper level classification of the financial instrument. Price variances, including large periodic changes, are investigated and corroborated by market data. We have reviewed the pricing methodologies of our pricing service and believe that their prices adequately consider market activity in determining fair value.
In cases in which a price from the pricing service is not available, values are determined by obtaining non-binding broker quotes and/or market comparables. When available, we obtain multiple quotes for the same security. The ultimate value for these securities is determined based on our best estimate of fair value using corroborating market information. Our evaluation includes the consideration of benchmark yields, reported trades, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data.

18


 

For certain structured securities in an illiquid market, there may be no prices available from a pricing service and no comparable market quotes available. In these situations, we value the security using an internally-developed risk-adjusted discounted cash flow model.
The following table sets forth the fair value of the consolidated fixed maturity and preferred stock securities by pricing source:
                                 
    Erie Insurance Group  
            December 31, 2009        
(in millions)   Total     Level 1     Level 2     Level 3  
     
Indemnity
                               
Fixed maturity securities:
                               
Priced via pricing services
  $ 649     $ 6     $ 643     $ 0  
Priced via market comparables/non-binding broker quote (1)
    6       0       5       1  
Priced via internal modeling (2)
    9       0       0       9  
     
Total fixed maturity securities
    664       6       648       10  
     
Preferred stock securities:
                               
Priced via pricing services
    32       9       23       0  
Priced via market comparables/non-binding broker quote (1)
    5       0       5       0  
Priced via internal modeling (2)
    1       0       0       1  
     
Total preferred stock securities
    38       9       28       1  
     
Common stock securities:
                               
Priced via pricing services
    42       42       0       0  
Priced via market comparables/non-binding broker quote (1)
    0       0       0       0  
Priced via internal modeling (2)
    0       0       0       0  
     
Total common stock securities
    42       42       0       0  
     
Total available-for-sale/trading securities – Indemnity
  $ 744     $ 57     $ 676     $ 11  
     
Exchange
                               
Fixed maturity securities:
                               
Priced via pricing services
  $ 6,365     $ 31     $ 6,334     $ 0  
Priced via market comparables/non-binding broker quote (1)
    55       0       43       12  
Priced via internal modeling (2)
    97       0       38       59  
     
Total fixed maturity securities
    6,517       31       6,415       71  
     
Preferred stock securities:
                               
Priced via pricing services
    431       157       274       0  
Priced via market comparables/non-binding broker quote (1)
    31       0       31       0  
Priced via internal modeling (2)
    10       0       6       4  
     
Total preferred stock securities
    472       157       311       4  
     
Common stock securities:
                               
Priced via pricing services
    1,826       1,826       0       0  
Priced via market comparables/non-binding broker quote (1)
    0       0       0       0  
Priced via internal modeling (2)
    9       0       0       9  
     
Total common stock securities
    1,835       1,826       0       9  
     
Total available-for-sale/trading securities – Exchange
  $ 8,824     $ 2,014     $ 6,726     $ 84  
     
Total available-for-sale/trading securities – Erie Insurance Group
  $ 9,568     $ 2,071     $ 7,402     $ 95  
     
 
(1)   All broker quotes obtained for securities were non-binding. When a non-binding broker quote was the only price available, the security was classified as Level 3
 
(2)   Internal modeling using a discounted cash flow model was performed on 36 fixed maturities representing less than 1.4% of the total available-for-sale portfolio.
We have no assets that were measured at fair value on a nonrecurring basis during the year ended December 31, 2009.
Fair Value Option
Effective January 1, 2008, Indemnity adopted the fair value option for our common stock portfolio. See Note 2. The following table represents the December 31, 2007 carrying value of these assets, the transition adjustment booked to retained earnings and the carrying value as of January 1, 2008.
                         
(in thousands)   December 31, 2007
(carrying value
prior to adoption)
    Cumulative effect
adjustment to January 1,
2008 retained earnings
    January 1, 2008
fair value
(carrying value
after adoption)
 
                   
Common stock
  $ 108     $ 17     $ 108  
                     
Deferred tax adjustment
            (6 )        
                       
Carrying value, net of deferred tax adjustment
            11          
                       

19


 

Note 7. Investments
The following tables summarize the cost and fair value of our available-for-sale securities at December 31, 2009 and 2008:
                                 
    Erie Insurance Group  
            December 31, 2009        
(in millions)   Amortized     Gross unrealized     Gross unrealized     Estimated  
Available-for-sale securities   cost     gains     losses     fair value  
     
Indemnity
                               
Fixed maturities
                               
U.S. treasuries and government agencies
  $ 3     $ 0     $ 0     $ 3  
U.S. government sponsored enterprises
    14       0       0       14  
Foreign government
    2       0       0       2  
Municipal securities
    235       9       0       244  
U.S. corporate debt — non-financial
    172       10       1       181  
U.S. corporate debt — financial
    135       7       4       138  
Foreign corporate debt — non-financial
    26       2       0       28  
Foreign corporate debt — financial
    19       2       1       20  
Structured securities:
                               
Asset-backed securities — auto loans
    4       0       0       4  
Collateralized debt obligations
    10       0       2       8  
Commercial mortgage-backed
    5       0       0       5  
Residential mortgage-backed:
                               
Government sponsored enterprises
    14       0       0       14  
Non-government sponsored enterprises
    3       0       0       3  
     
Total fixed maturities-Indemnity
  $ 642     $ 30     $ 8     $ 664  
     
Equity securities
                               
U.S. nonredeemable preferred securities:
                               
Financial
  $ 20     $ 3     $ 1     $ 22  
Non-financial
    9       1       0       10  
Government sponsored enterprises
    0       0       0       0  
Foreign nonredeemable preferred securities:
                               
Financial
    5       0       0       5  
Non-financial
    1       0       0       1  
     
Total equity securities — Indemnity
  $ 35     $ 4     $ 1     $ 38  
     
Total available-for-sale securities — Indemnity
  $ 677     $ 34     $ 9     $ 702  
     
Exchange
                               
Fixed maturities
                               
U.S. treasuries and government agencies
  $ 5     $ 0     $ 0     $ 5  
U.S. government sponsored enterprises
    76       1       0       77  
Foreign government
    10       1       0       11  
Municipal securities
    1,389       55       3       1,441  
U.S. corporate debt — non-financial
    2,078       125       10       2,193  
U.S. corporate debt — financial
    1,498       82       28       1,552  
Foreign corporate debt — non-financial
    375       22       2       395  
Foreign corporate debt — financial
    292       11       4       299  
Structured securities:
                               
Asset-backed securities — auto loans
    48       3       0       51  
Asset-backed securities — credit cards
    5       0       0       5  
Asset-backed securities — other
    35       0       2       33  
Collateralized debt obligations
    88       5       16       77  
Commercial mortgage-backed
    127       5       5       127  
Residential mortgage-backed:
                               
Government sponsored enterprises
    192       6       0       198  
Non-government sponsored enterprises
    59       0       6       53  
     
Total fixed maturities — Exchange
  $ 6,277     $ 316     $ 76     $ 6,517  
     
Equity securities
                               
U.S. nonredeemable preferred securities:
                               
Financial
  $ 259     $ 53     $ 11     $ 301  
Non-financial
    111       4       2       113  
Government sponsored enterprises
    1       2       0       3  
Foreign nonredeemable preferred securities:
                               
Financial
    46       4       3       47  
Non-financial
    8       0       0       8  
     
Total equity securities — Exchange
  $ 425     $ 63     $ 16     $ 472  
     
Total available-for-sale securities — Exchange
  $ 6,702     $ 379     $ 92     $ 6,989  
     
Total available-for-sale securities — Erie Insurance Group
  $ 7,379     $ 413     $ 101     $ 7,691  
     

20


 

                                 
    Erie Insurance Group  
            At December 31, 2008        
(in millions)   Amortized     Gross unrealized     Gross unrealized     Estimated  
Available-for-sale securities   cost     gains     losses     fair value  
     
Indemnity
                               
Fixed maturities
                               
U.S. treasuries and government agencies
  $ 3     $ 0     $ 0     $ 3  
Foreign government
    2       0       0       2  
Municipal securities
    212       3       4       211  
U.S. corporate debt — non-financial
    165       2       13       154  
U.S. corporate debt — financial
    131       5       16       120  
Foreign corporate debt — non-financial
    35       0       3       32  
Foreign corporate debt — financial
    22       0       3       19  
Structured securities:
                               
Asset-backed securities — auto loans
    4       0       0       4  
Collateralized debt obligations
    11       0       4       7  
Commercial mortgage-backed
    5       1       1       5  
Residential mortgage-backed:
                               
Government sponsored enterprises
    4       0       0       4  
Non-government sponsored enterprises
    4       0       1       3  
     
Total fixed maturities-Indemnity
  $ 598     $ 11     $ 45     $ 564  
     
Equity securities
                               
U.S. nonredeemable preferred securities:
                               
Financial
  $ 34     $ 3     $ 5     $ 32  
Non-financial
    20       0       2       18  
Government sponsored enterprises
    0       0       0       0  
Foreign nonredeemable preferred securities:
                               
Financial
    4       0       0       4  
Non-financial
    2       0       1       1  
     
Total equity securities — Indemnity
  $ 60     $ 3     $ 8     $ 55  
     
Total available-for-sale securities — Indemnity
  $ 658     $ 14     $ 53     $ 619  
     
Exchange
                               
Fixed maturities
                               
U.S. treasuries and government agencies
  $ 16     $ 1     $ 0     $ 17  
Foreign government
    10       0       1       9  
Municipal securities
    1,325       26       18       1,333  
U.S. corporate debt — non-financial
    1,719       25       147       1,597  
U.S. corporate debt — financial
    1,232       35       147       1,120  
Foreign corporate debt — non-financial
    362       4       36       330  
Foreign corporate debt — financial
    291       2       39       254  
Structured securities:
                               
Asset-backed securities — auto loans
    49       0       5       44  
Asset-backed securities — credit cards
    5       0       1       4  
Asset-backed securities — other
    34       0       5       29  
Collateralized debt obligations
    95       1       35       61  
Commercial mortgage-backed
    162       2       15       149  
Residential mortgage-backed:
                               
Government sponsored enterprises
    162       4       0       166  
Non-government sponsored enterprises
    127       0       17       110  
     
Total fixed maturities — Exchange
  $ 5,589     $ 100     $ 466     $ 5,223  
     
Equity securities
                               
U.S. nonredeemable preferred securities:
                               
Financial
  $ 296     $ 15     $ 51     $ 260  
Non-financial
    121       2       15       108  
Government sponsored enterprises
    2       0       0       2  
Foreign nonredeemable preferred securities:
                               
Financial
    42       0       7       35  
Non-financial
    8       0       2       6  
     
Total equity securities — Exchange
  $ 469     $ 17     $ 75     $ 411  
     
Total available-for-sale securities — Exchange
  $ 6,058     $ 117     $ 541     $ 5,634  
     
Total available-for-sale securities — Erie Insurance Group
  $ 6,716     $ 131     $ 594     $ 6,253  
     

21


 

The amortized cost and estimated fair value of fixed maturities at December 31, 2009, are shown below by remaining contractual term to maturity. Mortgage-backed securities are allocated based on their stated maturity dates. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
                 
    Erie Insurance Group  
    Amortized     Estimated  
(in millions)   cost     fair value  
Indemnity
               
Due in one year or less
  $ 39     $ 40  
Due after one year through five years
    253       265  
Due after five years through ten years
    253       261  
Due after ten years
    97       98  
 
           
Total fixed maturities — Indemnity
  $ 642     $ 664  
 
           
Exchange
               
Due in one year or less
  $ 354     $ 357  
Due after one year through five years
    2,362       2,483  
Due after five years through ten years
    2,306       2,403  
Due after ten years
    1,255       1,274  
 
           
Total fixed maturities — Exchange
  $ 6,277     $ 6,517  
 
           
Total fixed maturities — Erie Insurance Group
  $ 6,919     $ 7,181  
 
           
Fixed maturities and equity securities in a gross unrealized loss position at December 31, 2009 are as follows for Indemnity. Data is provided by length of time securities were in a gross unrealized loss position.
December 31, 2009
                                                         
    Erie Insurance Group  
    Less than 12 months     12 months or longer     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized     No. of  
(dollars in millions)   value     losses     value     losses     Value     losses     holdings  
Indemnity
                                                       
Fixed maturities:
                                                       
U.S. government sponsored enterprises
  $ 8     $ 0     $ 0     $ 0     $ 8     $ 0       2  
Municipal securities
    18       0       5       0       23       0       12  
U.S. corporate debt — non-financial
    19       0       8       1       27       1       16  
U.S. corporate debt — financial
    16       1       40       3       56       4       42  
Foreign corporate debt — non-financial
    0       0       4       0       4       0       3  
Foreign corporate debt — financial
    2       0       3       1       5       1       4  
Structured securities:
                                                       
Collateralized debt obligations
    0       0       3       2       3       2       6  
Commercial mortgage-backed
    0       0       1       0       1       0       1  
Residential mortgage-backed:
                                                       
Government sponsored enterprises
    6       0       0       0       6       0       2  
Non-government sponsored enterprises
    0       0       3       0       3       0       2  
             
Total fixed maturities — Indemnity
  $ 69     $ 1     $ 67     $ 7     $ 136     $ 8       90  
             
Equity securities:
                                                       
U.S. nonredeemable preferred securities:
                                                       
Financial
  $ 5     $ 0     $ 5     $ 1     $ 10     $ 1       8  
Non-financial
    3       0       4       0       7       0       3  
Foreign nonredeemable preferred securities:
                                                       
Financial
    0       0       1       0       1       0       1  
             
Total equity securities — Indemnity
  $ 8     $ 0     $ 10     $ 1     $ 18     $ 1       12  
             
Quality breakdown of fixed maturities at December 31, 2009
                                                         
    Less than 12 months     12 months or longer     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized     No. of  
(dollars in millions)   value     losses     value     losses     value     losses     holdings  
Indemnity
                                                       
Investment grade
  $ 69     $ 1     $ 49     $ 4     $ 118     $ 5       71  
Non-investment grade
    0       0       18       3       18       3       19  
 
                                         
Total fixed maturities — Indemnity
  $ 69     $ 1     $ 67     $ 7     $ 136     $ 8       90  
 
                                         

22


 

Fixed maturities and equity securities in a gross unrealized loss position at December 31, 2009 are as follows for the Exchange. Data is provided by length of time securities were in a gross unrealized loss position.
December 31, 2009
                                                         
    Erie Insurance Group  
    Less than 12 months     12 months or longer     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized     No. of  
(dollars in millions)   value     losses     value     losses     value     losses     holdings  
Exchange
                                                       
Fixed maturities:
                                                       
U.S. government sponsored enterprises
  $ 50     $ 0     $ 0     $ 0     $ 50     $ 0       6  
Municipal securities
    105       2       26       1       131       3       24  
U.S. corporate debt — non-financial
    128       3       129       7       257       10       56  
U.S. corporate debt — financial
    159       2       318       26       477       28       98  
Foreign corporate debt — non-financial
    12       0       36       2       48       2       9  
Foreign corporate debt — financial
    17       0       68       4       85       4       17  
Structured securities:
                                                       
Asset backed — credit cards
    0       0       5       0       5       0       1  
Asset backed — other
    0       0       18       2       18       2       3  
Collateralized debt obligations
    8       1       28       15       36       16       15  
Commercial mortgage-backed
    1       0       34       5       35       5       6  
Residential mortgage-backed:
                                                       
Government sponsored enterprises
    28       0       0       0       28       0       4  
Non-government sponsored enterprises
    0       0       45       6       45       6       9  
             
Total fixed maturities — Exchange
  $ 508     $ 8     $ 707     $ 68     $ 1,215     $ 76       248  
             
Equity securities:
                                                       
U.S. nonredeemable preferred securities:
                                                       
Financial
  $ 36     $ 2     $ 72     $ 9     $ 108     $ 11       20  
Non-financial
    14       0       43       2       57       2       10  
Foreign nonredeemable preferred securities:
                                                       
Financial
    0       0       18       3       18       3       4  
             
Total equity securities — Exchange
  $ 50     $ 2     $ 133     $ 14     $ 183     $ 16       34  
             
Quality breakdown of fixed maturities at December 31, 2009
                                                         
    Less than 12 months     12 months or longer     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized     No. of  
(dollars in millions)   value     losses     value     losses     value     losses     holdings  
Exchange
                                                       
Investment grade
  $ 494     $ 8     $ 522     $ 50     $ 1,016     $ 58       191  
Non-investment grade
    14       0       185       18       199       18       57  
 
                                         
Total fixed maturities — Exchange
  $ 508     $ 8     $ 707     $ 68     $ 1,215     $ 76       248  
 
                                         
The above securities for Indemnity and the Exchange have been evaluated and determined to be temporary impairments for which we expect to recover our entire principal. The primary components of this analysis are a general review of market conditions and financial performance of the issuer along with the extent and duration of which fair value is less than cost. A large portion of the unrealized losses greater than 12 months are related to U.S. financial securities. The continued unrealized loss positions in these securities are reflective of wide credit spreads due to the uncertain condition in the U.S. financial sectors. Any debt securities that we intend to sell or will more likely than not be required to sell before recovery are included in other-than-temporary impairments with the impairment charges recognized in earnings.

23


 

Fixed maturities and equity securities in a gross unrealized loss position at December 31, 2008 are as follows for Indemnity. Data is provided by length of time securities were in a gross unrealized loss position.
December 31, 2008
                                                         
    Less than 12 months     12 months or longer     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized     No. of  
(dollars in millions)   value     losses     value     losses     value     losses     holdings  
Indemnity
                                                       
Fixed maturities:
                                                       
U.S. treasuries and government agencies
  $ 1     $ 0     $ 0     $ 0     $ 1     $ 0       1  
Foreign government
    2       0       0       0       2       0       1  
Municipal securities
    82       3       4       1       86       4       53  
U.S. corporate debt — non-financial
    98       8       19       5       117       13       92  
U.S. corporate debt — financial
    71       11       18       5       89       16       84  
Foreign corporate debt — non-financial
    24       2       1       1       25       3       18  
Foreign corporate debt — financial
    11       2       2       1       13       3       11  
Structured securities:
                                                       
Asset-backed securities — auto loans
    4       0       0       0       4       0       3  
Collateralized debt obligations
    6       4       1       0       7       4       13  
Commercial mortgage-backed
    2       0       1       1       3       1       4  
Residential mortgage-backed:
                                                       
Non-government sponsored enterprises
    2       1       1       0       3       1       5  
             
Total fixed maturities — Indemnity
  $ 303     $ 31     $ 47     $ 14     $ 350     $ 45       285  
             
 
                                                       
Equity securities:
                                                       
U.S. nonredeemable preferred securities:
                                                       
Financial
  $ 18     $ 5     $ 1     $ 0     $ 19     $ 5       17  
Non-financial
    11       1       5       1       16       2       9  
Government sponsored enterprises
    0       0       0       0       0       0       1  
Foreign nonredeemable preferred securities:
                                                       
Financial
    1       0       0       0       1       0       1  
Non-financial
    2       1       0       0       2       1       1  
             
Total equity securities — Indemnity
  $ 32     $ 7     $ 6     $ 1     $ 38     $ 8       29  
             
Quality breakdown of fixed maturities at December 31, 2008
                                                         
    Less than 12 months     12 months or longer     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized     No. of  
(dollars in millions)   value     losses     value     losses     value     losses     holdings  
Indemnity
                                                       
Investment grade
  $ 296     $ 29     $ 42     $ 13     $ 338     $ 42       271  
Non-investment grade
    7       2       5       1       12       3       14  
 
                                         
Total fixed maturities — Indemnity
  $ 303     $ 31     $ 47     $ 14     $ 350     $ 45       285  
 
                                         

24


 

Fixed maturities and equity securities in a gross unrealized loss position at December 31, 2008 are as follows for the Exchange. Data is provided by length of time securities were in a gross unrealized loss position.
December 31, 2008
                                                         
    Less than 12 months     12 months or longer     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized     No. of  
(dollars in millions)   value     losses     value     losses     value     losses     holdings  
Exchange
                                                       
Fixed maturities:
                                                       
U.S. treasuries and government agencies
  $ 4     $ 0     $ 0     $ 0     $ 4     $ 0       1  
Foreign government
    9       1       0       0       9       1       2  
Municipal securities
    404       15       10       3       414       18       101  
U.S. corporate debt — non-financial
    946       104       176       43       1,122       147       254  
U.S. corporate debt — financial
    610       103       188       44       798       147       200  
Foreign corporate debt — non-financial
    223       27       35       9       258       36       57  
Foreign corporate debt — financial
    160       30       43       9       203       39       43  
Structured securities:
                                                       
Asset-backed securities — auto loans
    44       5       0       0       44       5       9  
Asset-backed securities — credit cards
    0       0       4       1       4       1       1  
Asset-backed securities — other
    12       2       7       3       19       5       6  
Collateralized debt obligations
    45       33       7       2       52       35       27  
Commercial mortgage-backed
    64       10       35       5       99       15       19  
Residential mortgage-backed:
                                                       
Non-government sponsored enterprises
    86       15       14       2       100       17       19  
             
Total fixed maturities — Exchange
  $ 2,607     $ 345     $ 519     $ 121     $ 3,126     $ 466       739  
             
 
                                                       
Equity securities:
                                                       
U.S. nonredeemable preferred securities:
                                                       
Financial
  $ 151     $ 42     $ 27     $ 9     $ 178     $ 51       41  
Non-financial
    69       9       30       6       99       15       22  
Foreign nonredeemable preferred securities:
                                                       
Financial
    24       6       2       1       26       7       8  
Non-financial
    7       2       0       0       7       2       1  
             
Total equity securities — Exchange
  $ 251     $ 59     $ 59     $ 16     $ 310     $ 75       72  
             
Quality breakdown of fixed maturities at December 31, 2008
                                                         
    Less than 12 months     12 months or longer     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized     No. of  
(dollars in millions)   value     losses     value     losses     value     losses     holdings  
Exchange
                                                       
Investment grade
  $ 2,466     $ 306     $ 464     $ 100     $ 2,930     $ 406       684  
Non-investment grade
    141       39       55       21       196       60       55  
 
                                         
Total fixed maturities — Exchange
  $ 2,607     $ 345     $ 519     $ 121     $ 3,126     $ 466       739  
 
                                         

25


 

Investment income, net of expenses, was generated from the following portfolios as follows for the years ended December 31:
                 
    Erie Insurance Group  
(in millions)   2009     2008  
     
Indemnity
               
Fixed maturities
  $ 36     $ 36  
Equity securities
    5       9  
Cash equivalents and other
    1       2  
     
Total investment income
    42       47  
Less: investment expenses
    0       3  
     
Investment income, net of expenses – Indemnity
  $ 42     $ 44  
     
Exchange
               
Fixed maturities
  $ 343     $ 319  
Equity securities
    68       88  
Cash equivalents and other
    4       13  
     
Total investment income
    415       420  
Less: investment expenses
    24       26  
     
Investment income, net of expenses – Exchange
  $ 391     $ 394  
     
Total consolidated investment income, net of expenses – Erie Insurance Group
  $ 433     $ 438  
     
Dividend income is recognized as earned and recorded to net investment income.
There were no sales of limited partnerships in 2009. In 2008, Indemnity sold its interest in ten partnerships and the Exchange sold its interest in ten partnerships, which generated net realized gains. Realized gains (losses) on Indemnity’s investments were as follows:
                 
    Erie Insurance Group  
    Years ended December 31,  
(in millions)   2009     2008  
     
Indemnity
               
Available-for-sale securities:
               
Fixed maturities
               
Gross realized gains
  $ 5     $ 3  
Gross realized losses
    (4 )     (5 )
     
Net realized (losses) gains
    1       (2 )
     
Equity securities
               
Gross realized gains
    8       8  
Gross realized losses
    (7 )     (13 )
     
Net realized (losses) gains
    1       (5 )
     
Trading securities:
               
Common stock
               
Gross realized gains
    2       12  
Gross realized losses
    (5 )     (28 )
Valuation adjustments
    11       (22 )
     
Net realized (losses) gains
    8       (38 )
Limited partnerships:
               
Gross realized gains
    0       4  
Gross realized losses
    0       (2 )
     
Net realized gains
    0       2  
     
Net realized gains (losses) on investments – Indemnity
  $ 10     $ (43 )
     

26


 

Realized gains (losses) on the Exchange’s investments were as follows:
                 
    Years ended December 31,  
(in millions)   2009     2008  
     
Exchange
               
Available-for-sale securities:
               
Fixed maturities
               
Gross realized gains
  $ 22     $ 13  
Gross realized losses
    (37 )     (53 )
     
Net realized losses
    (15 )     (40 )
     
Equity securities
               
Gross realized gains
    39       33  
Gross realized losses
    (26 )     (68 )
     
Net realized gains (losses)
    13       (35 )
     
Trading securities:
               
Common stock
               
Gross realized gains
    143       155  
Gross realized losses
    (203 )     (654 )
Valuation adjustments
    464       (416 )
     
Net realized gains (losses)
    404       (915 )
Limited partnerships:
               
Gross realized gains
    0       15  
Gross realized losses
    0       (8 )
     
Net realized gains
    0       7  
     
Net realized gains (losses) on investments – Exchange
  $ 402     $ (983 )
     
Net realized gains(losses) on investments – Erie Insurance Group
  $ 412     $ (1,026 )
     
The components of other-than-temporary impairments on investments are included below.
                 
    Erie Insurance Group  
    Years ended December 31  
(in millions)   2009     2008  
     
Indemnity
               
Fixed maturities
  $ (7 )   $ (36 )
Equity securities
    (5 )     (34 )
     
Total
    (12 )     (70 )
Portion recognized in other comprehensive income
    0       0  
     
Net impairment losses recognized in earnings – Indemnity
  $ (12 )   $ (70 )
Exchange
               
Fixed maturities
  $ (54 )   $ (306 )
Equity securities
    (60 )     (195 )
     
Total
    (114 )     (501 )
Portion recognized in other comprehensive income
    0       0  
     
Net impairment losses recognized in earnings – Exchange
  $ (114 )   $ (501 )
     
Net impairment losses recognized in earnings – Erie Insurance Group
  $ (126 )   $ (571 )
     
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. Prior to the second quarter of 2009 when new impairment guidance was issued for debt securities, the impairment policy for fixed maturities was consistent with that of equity securities. See also Note 2.

27


 

Limited partnerships
Our limited partnership investments are recorded using the equity method of accounting as we do not exercise significant influence over any of these partnerships. As these investments are generally reported on a one-quarter lag, our limited partnership results through December 31, 2009 are comprised of general partnership financial results for the fourth quarter of 2008 and the first, second, and third quarters of 2009. Therefore, the volatility in market conditions experienced in these periods is included in our 2009 results. Given the lag in reporting, our limited partnership results do not reflect the market conditions of the fourth quarter of 2009. Private equity and mezzanine debt sectors appear to be stabilizing; however, there may be additional deterioration in the real estate sector. Such declines could be significant. Cash contributions made to and distributions received from the partnerships are recorded in the period in which the transaction occurs.
We have provided summarized financial information in the following table for the years ended December 31, 2009 and 2008. Amounts provided in the table are presented using the latest available financial statements received from the partnerships. Limited partnership financial information has been presented based on the investment percentage in the partnerships for the Erie Insurance Group consistent with how management evaluates the investments.

28


 

As these investments are generally reported on a one-quarter lag, our limited partnership results through December 31, 2009 include the general partnership results for the fourth quarter of 2008 and the first three quarters of 2009.
                                 
(dollars in millions)   As of and for the year ended December 31, 2009  
                    (Loss) Income        
                    recognized        
                    due to        
                    valuation        
                    adjustments     (Loss)  
Investment percentage in partnership   Number of     Asset     by the     income  
for Erie Insurance Group   partnerships     recorded     partnerships     recorded  
 
Indemnity
                               
Private equity:
                               
Less than 10%
    26     $ 76     $ (11 )   $ (1 )
Greater than or equal to 10% but less than 50%
    3       6       0       0  
Greater than 50%
    1       3       0       0  
     
Total private equity
    30       85       (11 )     (1 )
Mezzanine debt:
                               
Less than 10%
    12       30       (4 )     (1 )
Greater than or equal to 10% but less than 50%
    3       18       (2 )     2  
Greater than 50%
    1       3       (1 )     0  
     
Total mezzanine debt
    16       51       (7 )     1  
Real estate:
                               
Less than 10%
    19       65       (31 )     1  
Greater than or equal to 10% but less than 50%
    5       17       (6 )     1  
Greater than 50%
    4       17       (21 )     (2 )
     
Total real estate
    28       99       (58 )     0  
     
Total limited partnerships – Indemnity
    74     $ 235     $ (76 )   $ 0  
     
 
                               
Exchange
                               
Private equity:
                               
Less than 10%
    41     $ 466     $ (46 )   $ 14  
Greater than or equal to 10% but less than 50%
    3       31       1       (1 )
Greater than 50%
    1       6       (1 )     (1 )
     
Total private equity
    45       503       (46 )     12  
Mezzanine debt:
                               
Less than 10%
    14       138       (11 )     4  
Greater than or equal to 10% but less than 50%
    4       48       (4 )     9  
Greater than 50%
    3       30       (2 )     2  
     
Total mezzanine debt
    21       216       (17 )     15  
Real estate:
                               
Less than 10%
    32       302       (164 )     (8 )
Greater than or equal to 10% but less than 50%
    7       61       (40 )     (1 )
Greater than 50%
    4       34       (48 )     4  
     
Total real estate
    43       397       (252 )     (5 )
     
Total limited partnerships – Exchange
    109     $ 1,116     $ (315 )   $ 22  
     
Total limited partnerships – Erie Insurance Group
          $ 1,351     $ (391 )   $ 22  
         
Per the limited partner financial statements, total partnership assets were $53 billion and total partnership liabilities were $11 billion at December 31, 2009 (as recorded in the September 30, 2009 limited partnership financial statements). For the twelve month period comparable to that presented in the preceding table (fourth quarter of 2008 and first three quarters of 2009), total partnership valuation adjustment losses were $8 billion and total partnership net losses were $1 billion.

29


 

As these investments are generally reported on a one-quarter lag, our limited partnership results through December 31, 2008 include the general partnership financial results for the fourth quarter of 2007 and the first three quarters of 2008.
                                 
(dollars in millions)   As of and for the year ended December 31, 2008  
                    (Loss)        
                    income        
                    recognized        
                    due to        
                    valuation        
                    adjustments        
Investment percentage in partnership   Number of     Asset     by the     Income  
for Erie Insurance Group   partnerships     Recorded     partnerships     recorded  
 
Indemnity
                               
Private equity:
                               
Less than 10%
    27     $ 85     $ (3 )   $ 7  
Greater than or equal to 10% but less than 50%
    4       6       (1 )     2  
Greater than 50%
    1       3       0       0  
     
Total private equity
    32       94       (4 )     9  
Mezzanine debt:
                               
Less than 10%
    12       36       1       4  
Greater than or equal to 10% but less than 50%
    3       16       0       1  
Greater than 50%
    1       3       (1 )     0  
     
Total mezzanine debt
    16       55       0       5  
Real estate:
                               
Less than 10%
    17       99       (14 )     9  
Greater than or equal to 10% but less than 50%
    7       29       (2 )     1  
Greater than 50%
    5       22       (1 )     3  
     
Total real estate
    29       150       (17 )     13  
     
Total limited partnerships – Indemnity
    77     $ 299     $ (21 )   $ 27  
     
Exchange
                               
Private equity:
                               
Less than 10%
    43     $ 479     $ (61 )   $ 15  
Greater than or equal to 10% but less than 50%
    4       32       (3 )     6  
Greater than 50%
    2       6       (17 )     18  
     
Total private equity
    49       517       (81 )     39  
Mezzanine debt:
                               
Less than 10%
    14       148       1       14  
Greater than or equal to 10% but less than 50%
    4       39       0       10  
Greater than 50%
    3       20       (1 )     1  
     
Total mezzanine debt
    21       207       0       25  
Real estate:
                               
Less than 10%
    28       412       (82 )     32  
Greater than or equal to 10% but less than 50%
    9       106       (5 )     1  
Greater than 50%
    5       85       (8 )     15  
     
Total real estate
    42       603       (95 )     48  
     
Total limited partnerships – Exchange
    112     $ 1,327     $ (176 )   $ 112  
     
Total limited partnerships – Erie Insurance Group
          $ 1,626     $ (197 )   $ 139  
             
Per the limited partner financial statements, total partnership assets were $64 billion and total partnership liabilities were $12 billion at December 31, 2008 (as recorded in the September 30, 2008 limited partnership financial statements). For the twelve month period comparable to that presented in the preceding table (fourth quarter of 2007 and first three quarters of 2008), total partnership valuation adjustment losses were $5 billion and total partnership net gains were $1 billion.
See also Note 19 for investment commitments related to limited partnerships.

30


 

Securities lending program
We previously participated in a program whereby marketable securities from our investment portfolio were lent to independent brokers or dealers based on, among other things, their creditworthiness, in exchange for collateral initially equal to 102% of the value of the securities on loan and are thereafter maintained at a minimum of 100% of the fair value of the securities loaned. The process of terminating this program was completed in 2009. Indemnity and Exchange had loaned securities included as part of invested assets at a fair value of $18 million and $259 million, respectively, at December 31, 2008.
Note 8. Bank Line of Credit
As of December 31, 2009, Indemnity has available a $100 million line of credit with a bank that expires on December 31, 2011. There were no borrowings outstanding on the line of credit as of December 31, 2009. Bonds with a fair value of $133 million are pledged as collateral on the line at December 31, 2009.
As of December 31, 2009, the Exchange has available a $200 million revolving line of credit that expires on September 30, 2012. There were no borrowings outstanding on the line of credit as of December 31, 2009. Bonds with a fair value of $259 million are pledged as collateral on the lines at December 31, 2009.
Securities pledged as collateral on both lines have no restrictions and are reported as available-for-sale fixed maturities in the Consolidated Statements of Financial Position as of December 31, 2009. The banks require compliance with certain covenants which include statutory surplus and risk based capital ratios for the Exchange line of credit and minimum net worth and leverage ratios for Indemnity’s line of credit. We are in compliance with all covenants at December 31, 2009.
Note 9. Income Taxes
The provision (benefit) for income taxes consists of the following for the years ended December 31:
                 
    Erie Insurance Group  
(in millions)   2009     2008  
     
Indemnity
               
Current income taxes
  $ 56     $ 63  
Deferred income taxes
    (7 )     (23 )
     
Total provision for income taxes – Indemnity
    49       40  
     
 
               
Exchange
               
Current income taxes
    7       (40 )
Deferred income taxes
    22       (223 )
     
Total provision (benefit) for income taxes – Exchange
    29       (263 )
     
Total provision (benefit) for income taxes – Erie Insurance Group
  $ 78     $ (223 )
     
The deferred income tax benefit in 2008 was primarily driven by impairments and unrealized losses on common stock. The more significant impairment losses in 2008 related to bonds and preferred stocks in the financial services industry.

31


 

A reconciliation of the provision (benefit) for income taxes with amounts determined by applying the statutory federal income tax rates to pre-tax income is as follows for the years ended December 31:
                 
    Erie Insurance Group  
(in millions)   2009     2008  
     
Indemnity
               
Income tax at statutory rates
  $ 53     $ 43  
Tax-exempt interest
    (3 )     (3 )
Dividends received deduction
    (1 )     (2 )
Deferred tax valuation allowance
    0       1  
Other, net
    0       1  
     
Provision for income taxes — Indemnity
    49       40  
 
               
Exchange
               
Income tax at statutory rates
    130       (337 )
Tax-exempt interest
    (17 )     (17 )
Dividends received deduction
    (11 )     (14 )
Deferred tax valuation allowance
    (71 )     110  
Other, net
    (2 )     (5 )
     
Provision (benefit) for income taxes — Exchange
    29       (263 )
     
 
               
Provision (benefit) for income taxes — Erie Insurance Group
  $ 78     $ (223 )
     
Temporary differences and carry-forwards, which give rise to consolidated deferred tax assets and liabilities, are as follows:
                 
    Erie Insurance Group  
(in millions)   2009     2008  
     
Indemnity
               
Deferred tax assets:
               
Loss reserve discount
  $ 5     $ 5  
Unearned premiums
    7       7  
Net allowance for service fees and premium cancellations
    3       3  
Other employee benefits
    6       6  
Pension and other postretirement benefits
    19       34  
Write-downs of impaired securities
    10       22  
Capital loss carryover
    4       2  
Unrealized loss on investments
    0       15  
Limited partnerships
    18       0  
Other
    3       4  
     
Total deferred tax assets
    75       98  
     
 
               
Deferred tax liabilities:
               
Deferred policy acquisition costs
    6       6  
Unrealized gains on investments
    12       0  
Equity interest in EFL
    4       3  
Limited partnerships
    0       6  
Depreciation
    1       1  
Prepaid expenses
    4       6  
Capitalized internally developed software
    3       0  
Other
    2       2  
     
Total deferred tax liabilities
    32       24  
     
Valuation allowance
    (2 )     (1 )
     
Net deferred income tax asset — Indemnity
  $ 41     $ 73  
     

32


 

                 
    Erie Insurance Group (Continued)  
(in millions)   2009     2008  
     
Exchange
               
Deferred tax assets:
               
Loss reserve discount
  $ 80     $ 91  
Liability for future life and annuity policy benefits
    12       13  
Unearned premiums
    140       136  
Limited partnerships
    102       10  
Write-downs of impaired securities
    114       171  
Unrealized loss on investments
    0       186  
Wash sales
    11       0  
Capital loss carryover
    10       5  
Other
    4       4  
     
Total deferred tax assets
    473       616  
     
 
               
Deferred tax liabilities:
               
Deferred policy acquisition costs
    148       161  
Unrealized gains on investments
    232       0  
Net allowance for service fees and premium cancellations
    3       3  
Other
    11       9  
     
Total deferred tax liabilities
    394       173  
     
Valuation allowance
    (4 )     (118 )
     
Net deferred income tax asset — Exchange
  $ 75     $ 325  
     
Net deferred income tax asset — Erie Insurance Group
  $ 116     $ 398  
     
Indemnity had deferred tax asset valuation allowances of $2 million and $1 million recorded at December 31, 2009 and December 31, 2008, respectively, related to impairments on investments where it is more likely than not that the related deferred tax asset will not be realized.
The Exchange had deferred tax asset valuation allowances of $4 million and $118 million recorded at December 31, 2009 and December 31, 2008, respectively, related to impairments on investments where it is more likely than not that the related deferred tax asset will not be realized.
We have one uncertain income tax position for which a current liability was recorded. As a related temporary tax difference was also recognized, there was no impact on our operations or financial position. We recognize interest related to our remaining uncertain tax position in income tax expense. Accrued estimated interest on our unrecognized tax benefit was $0.3 million and $0.4 million at December 31, 2009 and 2008, respectively. The IRS has examined tax filings through 2005 and is currently examining our federal income tax returns for 2006 and 2007. We do not currently estimate that our unrecognized tax benefits will change significantly in the next 12 months.
Indemnity is the attorney-in-fact for the Exchange, a reciprocal insurance company. In that capacity Indemnity provides the Exchange with all services and facilities necessary for it to conduct its insurance business. Consequently, Indemnity is not subject to state corporate income or franchise taxes in most jurisdictions in which it does business because the one insurance business that Indemnity conducts with the Exchange pays taxes based on gross premiums in lieu of taxes based on income or capital.

33


 

Note 10. Deferred Policy Acquisition Costs
The following table summarizes the components of the Property and Casualty Group’s and EFL’s deferred policy acquisition costs asset for the years ended December 31:
                 
    Erie Insurance Group  
(in millions)   2009     2008  
     
Property and Casualty Group
               
Deferred policy acquisition costs asset at beginning of year
  $ 301     $ 294  
Capitalized deferred policy acquisition costs
    623       606  
Amortized deferred policy acquisition costs
    (611 )     (599 )
     
Deferred policy acquisition costs asset at end of year — Property and Casualty Group
  $ 313     $ 301  
     
Erie Family Life Insurance Company
               
Deferred policy acquisition costs asset at beginning of year
  $ 201     $ 145  
Capitalized deferred policy acquisition costs
    19       20  
Amortized deferred policy acquisition costs
    (13 )     (3 )
Amortized shadow deferred policy acquisition costs
    (53 )     39  
     
Deferred policy acquisition costs asset at end of year — EFL
  $ 154     $ 201  
     
 
               
Deferred policy acquisition costs asset — Erie Insurance Group
  $ 467     $ 502  
     
Note 11. Property and Casualty Unpaid Losses and Loss Expenses
The following table provides a reconciliation of property and casualty beginning and ending loss and loss expense liability balances for the years ended December 31:
                 
    Erie Insurance Group  
(in millions)   2009     2008  
     
Total gross unpaid losses and loss expenses at January 1,
  $ 3,586     $ 3,684  
Less reinsurance recoverable
    187       190  
     
Net liability at January 1,
    3,399       3,494  
     
 
               
Incurred losses and loss expenses related to:
               
Current accident year
    2,732       2,675  
Prior accident years
    (93 )     (186 )
     
Total incurred losses and loss expenses
    2,639       2,489  
     
 
               
Paid losses and loss expenses related to:
               
Current accident year
    1,608       1,546  
Prior accident years
    1,032       1,038  
     
Total paid losses and loss expenses
    2,640       2,584  
     
 
               
Total net liability at December 31,
    3,398       3,399  
Plus reinsurance recoverables
    200       187  
     
 
               
Total gross unpaid losses and loss expenses at December 31,
  $ 3,598     $ 3,586  
     

34


 

As discussed in Note 14, the members of the Property and Casualty Group participate in an intercompany reinsurance pooling arrangement, under which the Exchange retains 94.5% of the property and casualty insurance business and Indemnity’s property and casualty insurance subsidiaries retain 5.5%. The following table reconciles the loss and loss expense reserve balances on the Consolidated Statements of Financial Position, which is exclusive of intercompany transactions, to the ultimate liability of the Exchange and Indemnity when factoring in intercompany pooling transactions and reinsurance recoverables.
                                 
    Erie Insurance Group  
            Intercompany              
    Gross liability at     pooling     Reinsurance     Net liability at  
(in millions)   December 31, 2009     eliminations     recoverables     December 31, 2009  
     
At December 31, 2009:
                               
Indemnity losses and loss expense reserves
  $ 752     $ (554 )   $ (11 )   $ 187  
Exchange losses and loss expense reserves
    2,846       554       (189 )     3,211  
     
Losses and loss expense reserves
  $ 3,598     $     $ (200 )   $ 3,398  
     
                                 
    Erie Insurance Group  
            Intercompany              
    Gross liability at     pooling     Reinsurance     Net liability at  
(in millions)   December 31, 2008     eliminations     recoverables     December 31, 2008  
     
At December 31, 2008:
                               
Indemnity losses and loss expense reserves
  $ 754     $ (557 )   $ (10 )   $ 187  
Exchange losses and loss expense reserves
    2,832       557       (177 )     3,212  
     
Losses and loss expense reserves
  $ 3,586     $     $ (187 )   $ 3,399  
     
Loss reserves are set at full expected cost, except for workers compensation loss reserves, which have been discounted using an interest rate of 2.5% for all periods presented. This discounting reduced unpaid losses and loss expenses by $136 million and $98 million at December 31, 2009 and 2008, respectively. The increased discount in 2009 was the result of segregating large individual workers compensation claims that have longer payout patterns in the discount calculation. The reserves for losses and loss expenses are reported net of receivables for salvage and subrogation of $133 million and $121 million at December 31, 2009 and 2008, respectively.
Favorable development in 2009 on prior accident year reserves is primarily due to changes in our mortality rate and medical cost assumptions in our workers compensation line of business and the change in the workers compensation discount discussed above. Driving the favorable development in 2008 on prior accident year reserves were improved frequency and severity trends for automobile bodily injury and uninsured/underinsured motorist bodily injury claims.
Note 12. Life Policy and Deposit Contract Reserves
                 
    Erie Insurance Group  
(in millions)   2009     2008  
     
Deferred annuities
  $ 1,076     $ 1,017  
Ordinary/traditional life
    229       207  
Universal life
    211       209  
Other
    24       16  
       
Life policy and deposit contract reserves
  $ 1,540     $ 1,449  
       
The reinsurance credit related to these reserves was $82 million and $70 million at December 31, 2009 and 2008, respectively, and are presented in other assets in the Consolidated Statements of Financial Position.

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Note 13. Unearned premiums
Unearned premiums are reflected net of intercompany eliminations on the Consolidated Statements of Financial Position. Unearned premiums after the intercompany pooling transactions are presented below.
                         
    Erie Insurance Group  
            Intercompany     Net unearned  
    Balance at December     pooling     premiums at  
(in millions)   31, 2009     transactions     December 31, 2009  
     
At December 31, 2009:
                       
Indemnity unearned premiums
  $ 325     $ (216 )   $ 109  
Exchange unearned premiums
    1,656       216       1,872  
     
Unearned premium
  $ 1,981     $     $ 1,981  
     
                         
            Intercompany     Net unearned  
    Balance at December     pooling     premiums at  
    31, 2008     transactions     December 31, 2008  
     
At December 31, 2008:
                       
Indemnity unearned premiums
  $ 319     $ (213 )   $ 106  
Exchange unearned premiums
    1,617       213       1,830  
     
Unearned premium
  $ 1,936     $     $ 1,936  
     
Note 14. Reinsurance
Members of the Property and Casualty Group participate in an intercompany reinsurance pooling agreement. Under the pooling agreement, all insurance business of the Property and Casualty Group is pooled in the Exchange. The Erie Insurance Company and Erie Insurance Company of New York share in the underwriting results of the reinsurance pool through retrocession. Since 1995, the Board of Directors has set the allocation of the pooled underwriting results at 5.0% participation for Erie Insurance Company, 0.5% participation for Erie Insurance Company of New York and 94.5% participation for the Exchange. Intercompany accounts are settled by payment within 30 days after the end of each quarterly accounting period. The purpose of the pooling agreement is to spread the risks of the members of the Property and Casualty Group collectively across the different lines of business they underwrite and geographic regions in which each operates. This agreement may be terminated by any party as of the end of any calendar year by providing not less than 90 days advance written notice.
Reinsurance contracts do not relieve the Property and Casualty Group or EFL from their 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 a property catastrophe treaty with nonaffiliated reinsurers to mitigate future potential catastrophe loss exposure. During 2009, this reinsurance treaty provided coverage of up to 95% of a loss of $400 million in excess of the Property and Casualty Group’s loss retention of $450 million per occurrence. This treaty was renewed for 2010, providing coverage of up to 95% of a loss of $500 million in excess of the Property and Casualty Group’s loss retention of $400 million per occurrence. There have been no losses subject to this treaty.
EFL maintains several reinsurance treaties with nonaffiliated life reinsurance companies in order to reduce claims volatility. EFL had direct life insurance in force totaling $39 billion and $38 billion at December 31, 2009 and 2008, respectively. Of the amount, EFL ceded $21 billion and $19 billion of life insurance in force at December 31, 2009 and 2008, respectively. At December 31, 2009 and 2008, the largest amount of in-force life insurance ceded to one reinsurer totaled $10 billion and $9 billion, respectively.

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The following tables summarize the direct insurance and reinsurance for the property and casualty and life insurance activities, respectively, for the years ended December 31.
                 
    Erie Insurance Group  
(in millions)   2009     2008  
     
Property and casualty insurance
               
Premiums earned:
               
Direct
  $ 3,806     $ 3,784  
Assumed
    42       35  
Ceded
    (40 )     (48 )
     
Premiums earned, net
    3,808       3,771  
     
Insurance losses and loss expenses:
               
Direct
    2,655       2,507  
Assumed
    12       (11 )
Ceded
    (28 )     (7 )
     
Insurance losses and loss expenses, net
  $ 2,639     $ 2,489  
     
                 
    Erie Insurance Group  
(in millions)   2009     2008  
     
Life insurance
               
Premiums earned:
               
Direct
  $ 100     $ 98  
Ceded
    (39 )     (35 )
     
Premiums earned, net
    61       63  
     
Insurance losses and loss expenses:
               
Direct
    114       106  
Ceded
    (25 )     (13 )
     
Insurance losses and loss expenses, net
  $ 89     $ 93  
     
                 
    Erie Insurance Group  
(in millions)   2009     2008  
     
Total
               
Premiums earned:
               
Property and casualty
  $ 3,808     $ 3,771  
Life
    61       63  
     
Premiums earned, net
    3,869       3,834  
       
Insurance losses and loss expenses:
               
Property and casualty
    2,639       2,489  
Life
    89       93  
     
Insurance losses and loss expenses, net
  $ 2,728     $ 2,582  
       
Note 15. Postretirement Benefits
Pension and retiree health benefit plans
Our pension plans consist of a noncontributory defined benefit pension plan covering substantially all employees and an unfunded supplemental employee retirement plan (SERP) for certain members of executive and senior management of the Erie Insurance Group. The pension plans provide benefits to covered individuals satisfying certain age and service requirements. The defined benefit pension plan and SERP provide benefits through a final average earnings formula and a percent of average monthly compensation formula, respectively.
We previously provided retiree health benefits in the form of medical and pharmacy health plans for eligible retired employees and eligible dependents. In 2006, the retiree health benefit plan was curtailed by an amendment that restricted eligibility to those who attained age 60 and 15 years of service on or before July 1, 2010.
The liabilities for the plans described in this note are presented in total for all employees of the Erie Insurance Group. The gross liability for postretirement benefits is presented in the Consolidated Statements of Financial Position as employee benefit obligations. Approximately 50% of postretirement benefit expenses are reimbursed to Indemnity from the Exchange and EFL.

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Our affiliated entities are charged an allocated portion of net periodic benefit costs under the benefit plans. For our funded pension plan, amounts are settled in cash throughout the year for related entities’ share of net periodic benefit costs. For our unfunded plans, we pay the obligations when due. Amounts are settled in cash between affiliates when there is a payout under the unfunded plans.
Assumptions used to determine benefit obligations at the periods ended December 31:
                 
    2009     2008  
Employee pension plan:
               
Discount rate
    6.11 %     6.06 %
Expected return on plan assets
    8.25       8.25  
Rate of compensation increase (1)
    4.15       4.25  
SERP:
               
Discount rate
    6.11       6.06  
Rate of compensation increase
    6.00       6.00  
Assumptions used to determine net periodic benefit cost:
                 
    2009     2008  
Employee pension plan:
               
Discount rate
    6.06 %     6.62 %
Expected return on plan assets
    8.25       8.25  
Rate of compensation increase
    4.15       4.25  
SERP:
               
Discount rate
    6.06       6.62  
Rate of compensation increase
    6.00       6.00  
 
(1)   Rate of compensation increase is age-graded. An equivalent single compensation increase rate of 4.15% in 2009 and 4.25% in 2008 would produce similar results.
The two economic assumptions that have the most impact on the postretirement benefit expense are the discount rate and the long-term rate of return on plan assets. The discount rate assumption used to determine the benefit obligation was 6.11% for 2009 and was based on a bond-matching study that compared projected pension plan benefit flows to the cash flows from a comparable portfolio of fixed maturity instruments rated AA- or better with duration similar to plan liabilities. This same bond matching methodology was used in 2008. The change in the discount rate to 6.06% in 2008 from 6.62% in 2007 was due to the turmoil in the fixed income markets at the end of 2008. The approach used to determine the long-term rate of return assumption derives expected future returns for each asset category based on applicable indices and their historical relationships under various market conditions. These expected future returns are then weighted based on our target asset allocation percentages for each asset category.
There was a shift in our target asset allocation percentage in late 2009 to 60% equity securities and 40% fixed income securities compared to 2008’s target of 65% equity securities and 35% fixed income securities.

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Pension benefit plans
The following tables set forth change in benefit obligation, plan assets and funded status of the pension plans as well as the net periodic benefit cost.
                 
Pension benefits for the years ended December 31,            
(in millions)   2009     2008  
Change in benefit obligation
               
Benefit obligation at beginning of period
  $ 326     $ 276  
Service cost
    15       13  
Interest cost
    19       18  
Amendments
    3       0  
Actuarial (gain) loss
    (12 )     34  
Benefits paid
    (4 )     (4 )
Impact due to curtailment
    0       0  
Impact due to settlement
    (3 ) (1)     (11 ) (1)
Impact due to termination benefits
    0       0 (1)
 
           
Benefit obligation at end of period
  $ 344     $ 326  
 
           
Change in plan assets
               
Fair value of plan assets at beginning of period
  $ 218     $ 288  
Actual return (loss) on plan assets
    51       (82 )
Employer contributions
    14       15  
Benefits paid
    (4 )     (3 )
 
           
Fair value of plan assets at end of period
  $ 279     $ 218  
 
           
Funded status at end of period
  $ (65 )   $ (108 )
 
           
Accumulated benefit obligation, December 31,
  $ 252     $ 238  
 
           
Amounts recognized in accumulated other comprehensive income, before tax
               
Net actuarial loss
  $ 104     $ 145  
Prior service cost
    5       3  
 
           
Net amount recognized
  $ 109     $ 148  
 
           
Amounts recognized in Consolidated Statements of Financial Position
               
Pension plan asset (defined benefit plan)
  $ 0     $ 0  
Accrued benefit liability
    (65 )     (108 )
Accumulated other comprehensive income, net of tax
    71       96  
 
           
Net amount recognized
  $ 6     $ (12 )
 
           
Components of net periodic benefit cost
               
Service cost
  $ 15     $ 12  
Interest cost
    19       18  
Expected return on plan assets (2)
    (24 )     (24 )
Amortization of prior service cost
    0       0  
Recognized net actuarial loss
    3       0  
Curtailment cost
    0       0  
Settlement (gain) cost
    (1 ) (1)     0 (1)
Termination charge
    0     1 (1)
 
           
Net periodic benefit expense before allocation to affiliates
  $ 12     $ 7  
 
           
 
(1)   In December 2007, employment agreements for certain members of executive management were signed which incorporated a payment in full of accrued SERP benefits as of December 2008 in a lump sum payment, after which time no additional SERP benefits would accrue. This resulted in the curtailment in 2007 and the subsequent settlement gains in 2008 and 2009. The 2008 termination charge relates to two of these members of executive management whose SERP payouts were to occur, and did occur, in 2009.
 
(2)   The market-related value of plan assets is used to determine the expected return component of pension benefit cost. We use a four year averaging method to determine the market-related value, under which asset gains or losses that result from returns that differ from our long-term rate of return assumption are recognized in the market-related value of assets on a level basis over a four year period. Once factored into the market-related asset value, these experience losses will be amortized over a period of 15 years, which is the average remaining service period of the employee group in the plan.
The cumulative net actuarial loss was offset in 2009 by an actuarial gain resulting from actual investment returns that were greater than expected. Also contributing to the gain were assumption changes made based on actual experience, such as the decrease in the assumed rate of compensation increase. The 2008 actuarial loss was primarily due to a significant difference in the plan’s actual investment returns in 2008 from the expected returns assumed and the decrease in the discount rate assumption used to estimate the future benefit obligations to 6.06% in 2008 from 6.62% in 2007. The component of the $145 million actuarial loss produced in 2008 that related to the difference between actual and expected investment returns was $106 million. Recognition of this loss is being deferred over the subsequent four year period.

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Amounts recognized in other comprehensive income for the years ended December 31 for pension plans were as follows:
                 
    Pension plans  
(in millions)   2009     2008  
Amortization of net actuarial loss
  $ (3 )   $ 0  
Amortization of prior service cost
    0       0  
Net actuarial (gain) loss arising during the year
    (39 )     140 (3)
Amendments
    3 (1)     0  
Impact due to settlement/termination
    1 (2)     0  
 
           
Total recognized in other comprehensive (income) loss
  $ (38 )   $ 140  
 
           
 
(1)   The charges recognized as amendments were the result of factoring in the prior service cost for six new plan participants in 2009.
 
(2)   Settlement charges relate to SERP payouts for certain executives.
 
(3)   Actuarial loss was due to the difference in the actual return on plan assets versus the expected return on plan assets, driven by the volatile market conditions experienced in 2008 and the decrease in the discount rate to 6.06% in 2008 from 6.62% in 2007.
The estimated net actuarial loss and prior service cost for the pension plans that will be amortized from accumulated other comprehensive income into net periodic benefit cost during 2010 are $4 million and $1 million, respectively.
                 
(dollars in millions)   2009     2008  
Expected future cash flows
               
1 st Year following the disclosure date
  $ 6     $ 8  
2 nd Year following the disclosure date
    7       6  
3 rd Year following the disclosure date
    8       7  
4 th Year following the disclosure date
    10       8  
5 th Year following the disclosure date
    11       10  
Years 6 through 10 following disclosure date
    87       77  
 
               
Pension plan asset allocations (employee pension plan)
               
Equity securities
    61.0 %     64.7 %
Debt securities
    39.0       35.3  
Due in one year
    0.4       0.8  
Due beyond one year
    38.6       34.5  
Other
    0.0       0.0  
Total
    100.0       100.0  
 
               
Information for pension plans with an accumulated benefit obligation in excess of plan assets
               
Projected benefit obligation
  $ 8     $ 326  
Accumulated benefit obligation
    4       238  
Our policy is to fund the employee pension plan for an amount equal to the normal cost for the plan but at least equal to the IRS minimum required contribution in accordance with the Pension Protection Act of 2006. For 2010, the expected contribution amount is $15 million.
The employee pension plan utilizes a return seeking and liability asset matching allocation strategy. It is based on the understanding that 1) equity investments are expected to outperform debt investments over the long-term, 2) the potential volatility of short-term returns from equities is acceptable in exchange for the larger expected long-term returns and 3) a portfolio structured across investment styles and markets (both domestic and foreign) reduces volatility. As a result, the employee pension plan’s investment portfolio utilizes a broadly diversified asset allocation across domestic and foreign equity and debt markets. The investment portfolio is composed of commingled pools that are dedicated exclusively to the management of employee benefit plan assets.

40


 

The target asset allocation for the portfolio is:
         
    Target Allocation  
Return seeking:
       
US equity index
    17 %
US large cap core equity
    16  
International risk-controlled equity
    15  
US small capitalization core equity
    8  
International small capitalization risk-controlled equity
    2  
Emerging markets equity
    2  
 
     
 
    60 %
 
       
Liability matching:
       
Long duration fixed income
    16  
Broad market fixed income
    15  
Long duration corporate fixed income
    8  
Money market
    1  
 
     
 
    40 %
 
     
 
    100 %
 
     
The following table represents the fair value measurements for our pension plan assets by major category and level of input:
                                 
    At December 31, 2009  
            Fair value measurements using:        
            Quoted prices in              
            active markets for     Significant     Significant  
            identical assets     observable inputs     unobservable inputs  
(in millions)   Total     Level 1     Level 2     Level 3  
     
Institutional money market fund
  $ 2     $ 2     $ 0     $ 0  
Return seeking assets:
                               
US equity index (1)
    48       0       48       0  
US large capitalization core equity (2)
    45       0       45       0  
International risk-controlled equity (3)
    43       0       43       0  
US small capitalization core equity (4)
    21       0       21       0  
International small capitalization risk-controlled equity (5)
    6       0       6       0  
Emerging markets equity (6)
    7       0       7       0  
 
                               
Liability matching assets:
                               
Long duration fixed income (7)
    42       0       42       0  
Broad market fixed income (8)
    42       0       42       0  
Long duration corporate fixed income (9)
    23       0       23       0  
     
Total
  $ 279     $ 2     $ 277     $ 0  
     
 
(1)   This category comprises equity index funds not actively managed that track the S&P 500.
 
(2)   This category includes equity securities that seek to achieve excess returns relative to the S&P 500 while maintaining portfolio risk characteristics similar to the index.
 
(3)   This category seeks long-term capital growth with an emphasis on controlling return volatility relative to an international market index.
 
(4)   This category includes equity securities that seek to achieve excess returns relative to the Russell 2000 Index while maintaining portfolio risk characteristics similar to the index.
 
(5)   This category seeks to provide excess returns relative to an international small cap index, while matching the regional weights of the index.
 
(6)   This category seeks long-term capital growth in securities of companies that have their principal business activities in countries in the Morgan Stanley Capital International Emerging Markets Free Index.
 
(7)   This category seeks to generate returns that exceed the Barclays Capital Long Government/Credit Index through investment-grade fixed income securities.
 
(8)   This category seeks to generate returns that exceed the Barclays Capital US Aggregate Bond Index through investment-grade fixed income securities.
 
(9)   This category seeks to generate returns that exceed the Barclays Capital US Long Corporate Bond A or Better Index investing in US Corporate Bonds with an emphasis on long duration bonds rated A or better.

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Estimates of fair values of the pension plan assets are obtained primarily from a nationally recognized pricing service. Our Level 1 category includes a money market fund that is a mutual fund for which the fair value is determined using an exchange traded price provided by the pricing service. Our Level 2 category includes commingled pools. Estimates of fair values for securities held by our commingled pools are obtained primarily from the pricing service. The methodologies used by the pricing service that support a Level 2 classification of a financial instrument include multiple verifiable, observable inputs including benchmark yields, reported trades, broker/dealer quotes, issuers spreads, two-sided markets, benchmark securities, bids, offers and reference data. There were no Level 3 investments during 2009.
Retiree health benefit plan
The retiree health benefit plan was terminated in 2006. We continue to provide retiree health benefits only to employees who met certain age and service requirements on or before July 1, 2010. The accumulated benefit obligation and net periodic benefit cost of this plan were not material to our consolidated financial statements. At December 31, 2009 and 2008, the accumulated benefit obligation associated with these benefits was $8 million and $9 million, respectively. This plan is funded only as claims are incurred. During 2009, we recognized an increase in other comprehensive income of $0.5 million. During 2008, we recognized a decrease in other comprehensive income (loss) of $0.5 million. Periodic benefit costs for the Erie Insurance Group were $0.3 million and $0.2 million in 2009 and 2008, respectively.
Employee savings plan
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 $8 million in both 2009 and 2008. Employees are permitted to invest the employer-matching contributions in our Class A common stock and may sell the shares at any time without restriction. The plan acquires shares in the open market necessary to meet the obligations of the plan. Plan participants held 0.2 million of our Class A shares at December 31, 2009 and 0.1 million shares at December 31, 2008. Liabilities for the 401(k) plan are presented in the Consolidated Statements of Financial Position as accounts payable and accrued expenses.
Note 16. Incentive plans and deferred compensation
We have separate annual and long-term incentive plans for our executive and senior management and regional vice presidents. We also make available deferred compensation plans for executive and senior management and outside directors.
Annual incentive plan
The annual incentive plan is a bonus plan that annually pays cash bonuses to our executive, senior and regional vice presidents.
The incentives under the annual incentive plan are based on the achievement of certain predetermined performance targets. These targets are established by the Executive Compensation and Development Committee of the Board and can include various financial measures. Incentives for the 2009 plan were based on measures specific to each member of executive and senior management, primarily on statutory reported combined ratio, policies in force of the Property and Casualty Group and direct written premium of the Property and Casualty Group, as defined in the plan. Incentives for the 2008 plan were based primarily on statutory reported combined ratio and policies in force of the Property and Casualty Group, as defined in the plan.
The cost of the plan is charged to operations as the compensation is earned over the performance period of one year. The after-tax compensation cost charged to operations for the annual incentive plan bonus for the Erie Insurance Group was $2.2 million and $2.5 million for 2009 and 2008, respectively.
Long-term incentive plan
The long-term incentive plan (LTIP) is a performance based incentive plan designed to reward executive, senior and regional vice presidents who can have a significant impact on our long-term performance.

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Pre-2004 LTIP — Prior to 2004, restricted stock awards were determined based on the achievement of predetermined financial performance goals for actual growth in our retained earnings. The 2003-2005 performance period was the final open award period under the pre-2004 LTIP. At December 31, 2008, all shares awarded for the 2003-2005 performance period were vested. The average grant price for the 2003-2005 performance period was $52.65. The plan award of $0.5 million was paid in January 2009.
2004 LTIP — Beginning in 2004, the LTIP award is based on the level of achievement of objective measures of performance over a three-year period as compared to a peer group of property and casualty companies that write predominately personal lines insurance. The 2009 and 2008 awards were based on the reported combined ratio, growth in direct written premiums and total return on invested assets as defined by the Erie Insurance Group. These internal measures are compared to the same performance measures of a peer group of companies. Because the award is based on a comparison to results of a peer group over a three-year period, the award accrual is based on estimates of results for the remaining performance period. This estimate is subject to variability if our results or the results of the peer group are substantially different than the results we project.
Beginning with the 2009-2011 performance period awards can be granted as either restricted performance shares and/or performance units. Restricted performance shares represent the right to receive shares of common stock. Performance units represent the right to receive a cash payment. Previously only restricted performance shares were awarded and were granted at the beginning of a performance period. The Compensation Committee now determines the form of the award to grant at the beginning of each performance period. Both the restricted performance shares and performance units are considered vested at the end of a performance period. The 2009-2011 performance period awards were granted as performance units.
The maximum number of shares which may be earned under the plan by any single participant during any one performance period is limited to 250,000 shares. The aggregate number of Class A common stock that may be issued pursuant to awards granted under the LTIP is 1.0 million shares. With respect to an award of performance units, the maximum dollar amount which may be earned under the plan by any single participant during any one performance period is $3 million. A liability is recorded and compensation expense is recognized ratably over the performance period.
At December 31, 2009, the awards for the 2007—2009 performance period were fully vested in accordance with the 2004 LTIP plan. The awards for this performance period will be calculated upon receipt of final financial information for the peer group. The estimated award based on the peer group information as of September 30, 2009, is 49,552 shares. The grant price will be the average of the high and low stock price on the date the award is paid. Our stock price as of January 29, 2010 was $39.00.
Earned amounts are allocated to related entities and settled in cash once the payout is made. The after-tax compensation cost charged to operations for these restricted stock awards for the Erie Insurance Group was $2.4 million for both 2009 and 2008.
Deferred compensation plans
The deferred compensation plans are arrangements for our executive, senior and regional vice presidents whereby the participants can elect to defer receipt of a portion of their compensation until a later date. Supplemental employee contributions to the deferred compensation plan are deferrals that cannot be credited to our tax-qualified 401(k) plan because they exceed the annual contribution or compensation limits of that plan. However, these contributions are credited with a company-matching contribution using the same formula as in our 401(k) plan. The deferred compensation plan for directors allows them to defer receipt of a portion of their director and meeting fees until a later date. Employees or directors participating in the respective plans select hypothetical investment funds for their deferrals and are credited with the hypothetical returns generated.

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The awards, payments, deferrals and liabilities under the deferred compensation, annual and long-term incentive plans for officers and directors were as follows for the years ended December 31:
                 
    Erie Insurance Group  
(in millions)   2009     2008  
Plan awards, employer match and hypothetical earnings
               
Long-term incentive plan awards
  $ 4     $ 4  
Annual incentive plan awards
    3       4  
Deferred compensation plan, employer match and hypothetical earnings (losses)
    1       (4 )
 
           
Total plan awards and earnings
    8       4  
 
           
Total plan awards paid
    8       11  
 
           
Compensation deferred under the plans
    1       1  
 
           
Distributions from the deferred compensation plans
    (1 )     (2 )
 
           
Gross incentive plan and deferred compensation liabilities
  $ 15     $ 15  
 
           
Stock compensation plan for outside directors
We have a stock compensation plan for our outside directors to further align the interests of directors with shareholders by providing for a portion of annual compensation for the directors’ services in shares of our Class A common stock. Each director vests in the grant 25% every three months over the course of a year. Dividends paid by us are reinvested into each director’s account with additional shares of our Class A common stock. In 2009, the annual charge related to this plan totaled $0.4 million. In 2008, compensation expense for this plan was offset by market value adjustments to the directors’ accounts resulting in a net credit of $0.2 million.
Note 17. Capital Stock
Class A and B shares
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 for each Class B share. In 2009, five shares of Class B voting common stock were converted into 12,000 shares of Class A nonvoting common stock. There were no conversions of Class B shares to Class A shares in 2008.
There is no provision for conversion of Class A shares to Class B shares and Class B shares surrendered for conversion cannot be reissued. Each share of Class A common stock outstanding at the time of the declaration of any dividend upon shares of Class B common stock shall be entitled to a dividend payable at the same time, at the same record date, and in an amount at least equal to 2/3 of 1.0% of any dividend declared on each share of Class B common stock. We may declare and pay a dividend in respect to Class A common stock without any requirement that any dividend be declared and paid in respect to Class B common stock. Sole shareholder voting power is vested in Class B common stock except insofar as any applicable law shall permit Class A common shareholders to vote as a class in regards to any changes in the rights, preferences and privileges attaching to Class A common stock.
Stock repurchase plan
A stock repurchase program was authorized for our outstanding Class A common stock beginning January 1, 2004. In May 2009, our Board of Directors approved a continuation of the current stock repurchase program through June 30, 2010. Treasury shares are recorded in the Consolidated Statements of Financial Position at cost. Shares repurchased under this plan totaled 0.1 million at a total cost of $3 million during 2009 and 2.1 million at a cost of $102 million during 2008. Cumulative shares repurchased under this plan through 2009 totaled 11.8 million at a total cost of $613 million.

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Note 18. Comprehensive Income
The components of changes to comprehensive (loss) income follow for the periods ended December 31:
                 
    Erie Insurance Group  
(in millions)   2009     2008  
     
Indemnity
               
Unrealized gain (loss) on securities:
               
Gross unrealized holding gains (losses) on investments arising during period
  $ 128     $ (159 )
Reclassification adjustment for gross (gains) losses included in net income
    (13 )     91  
     
Unrealized holding gains (losses) excluding realized (gains) losses, gross
    115       (68 )
Income tax (expense) benefit related to unrealized gains (losses)
    (40 )     24  
     
Net unrealized holding gains (losses) on investments arising during year
    75       (44 )
Postretirement plans:
               
Amortization of prior service cost
    0       0  
Amortization of actuarial loss
    3       0  
Net actuarial gain (loss) during year
    38       (139 )
Losses due to plan changes during year
    (3 )     0  
Curtailment/settlement loss arising during year
    (1 )     0  
     
Postretirement benefits, gross
    37       (139 )
Income tax (expense) benefit related to postretirement benefits
    (13 )     48  
     
Postretirement plans, net
    24       (91 )
     
Change in other comprehensive income (loss), net of tax — Indemnity
    99       (135 )
     
 
               
Change in other comprehensive income (loss), net of tax — Exchange
    423       (266 )
     
Change in other comprehensive income (loss), net of tax — Erie Insurance Group
  $ 522     $ (401 )
     
The components of accumulated other comprehensive (loss) income, net of tax for the periods ended December 31, are as follows:
                 
    Erie Insurance Group  
(in millions)   2009     2008  
     
Indemnity
               
Accumulated net appreciation (depreciation) of investments
  $ 28     $ (40 )
Accumulated net losses associated with post-retirement benefits
    (71 )     (96 )
     
Accumulated other comprehensive loss — Indemnity
    (43 )     (136 )
     
Exchange
               
Accumulated other comprehensive income (loss) — Exchange
  $ 176     $ (247 )
     
Note 19. Commitments and Contingencies
Indemnity has contractual commitments to invest up to $69 million related to its limited partnership investments at December 31, 2009. These commitments are split between private equity securities of $32 million, real estate activities of $21 million and mezzanine debt securities of $16 million. These commitments will be funded as required by the partnership agreements.
The Exchange, including EFL, has contractual commitments to invest up to $538 million related to its limited partnership investments at December 31, 2009. These commitments are split between private equity securities of $257 million, real estate activities of $191 million and mezzanine debt securities of $90 million. These commitments will be funded as required by the partnership agreements.
We are involved in litigation arising in the ordinary course of business. In our opinion, the effects, if any, of such litigation are not expected to be material to our consolidated financial condition, operations or cash flows.

45


 

Note 20. Supplementary Data on Cash Flows
A reconciliation of net income to net cash provided by operating activities as presented in the Consolidated Statements of Cash Flows is as follows for the years ended December 31:
                 
Indirect method of cash flows  
    Erie Insurance Group  
(in millions)   2009     2008  
     
Cash flows from operating activities:
               
Net income (loss)
  $ 446     $ (616 )
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Depreciation
    9       7  
Amortization of deferred policy acquisition costs
    624       602  
Deferred income tax expense (benefit)
    15       (246 )
Realized (gains) losses and impairments on investments
    (285 )     1,597  
Equity in losses of limited partnerships
    369       58  
Net amortization of bond (discount) premium
    (12 )     6  
Decrease in deferred compensation
    0       (10 )
Limited partnership distributions
    81       315  
Decrease (increase) in receivables, reinsurance recoverables and reserve credits
    209       (222 )
Increase in prepaid expenses
    (9 )     0  
Increase in deferred policy acquisition costs
    (642 )     (626 )
Decrease in accounts payable and accrued expenses
    (4 )     (13 )
Decrease in accrued agent bonuses
    (12 )     (17 )
Increase (decrease) in loss reserves
    12       (155 )
Increase in future life policy benefits and claims reserves
    37       19  
Increase in unearned premiums
    51       21  
     
Net cash provided by operating activities
  $ 889     $ 720  
     
Note 21. Statutory Information
Accounting principles used to prepare statutory financial statements differ from those used to prepare financial statements under U.S. GAAP. Prescribed statutory accounting practices (SAP) include state laws, regulations, and general administration rules, as well as a variety of publications from the National Association of Insurance Commissioners (NAIC). Indemnity’s wholly-owned property and casualty subsidiaries, EIC and EPC, prepare statutory financial statements in accordance with accounting practices prescribed and permitted by the Pennsylvania Insurance Department. ENY prepares its statutory financial statements in accordance with accounting practices prescribed by the New York Insurance Department. The statutory financial statements of the Exchange and its subsidiaries, Flagship and EFL, are prepared in accordance with accounting practices prescribed and permitted by the Pennsylvania Insurance Department.
Financial statements prepared under statutory accounting principles focus on the solvency of the insurer and generally provide a more conservative approach than under GAAP. Differences between SAP and GAAP include the valuation of investments, deferred policy acquisition cost assets, the actuarial assumptions used in life reserves, deferred tax assets, and unearned subscriber fees.
Statutory net income and capital and surplus as determined in accordance with SAP prescribed or permitted by insurance regulatory authorities are as follows:
                                 
    SAP Net Income (Loss)     Capital and Surplus  
    Years ended December 31,     At December 31,  
(in millions)   2009     2008     2009     2008  
     
Erie Insurance Company
  $ 16     $ (10 )   $ 232     $ 210  
Erie Insurance Company of New York
    2       1       22       20  
Erie Insurance Property & Casualty Company
    0       0       10       10  
     
Total — Indemnity subsidiaries
  $ 18     $ (9 )   $ 264     $ 240  
     
Erie Insurance Exchange
    (56 )     (363 )     4,518       4,046  
Flagship City Insurance Company
    0       0       10       10  
Erie Family Life Insurance Company
    3       (66 )     174       106  

46


 

The minimum statutory capital and surplus requirements under Pennsylvania and New York law for Indemnity’s stock property and casualty subsidiaries amounts to $10 million. Indemnity’s subsidiaries’ total statutory capital and surplus significantly exceed these minimum requirements, totaling $264 million at December 31, 2009. 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 $13 million were deposited by the property and casualty and life entities with regulatory authorities under statutory requirements at December 31, 2009.
As prescribed by the Insurance Department of the Commonwealth of Pennsylvania, the Exchange records unearned subscriber fees (fees to 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 $4.0 billion at December 31, 2009. EIC’s NAIC prepared statutory surplus, excluding the impact of the Pennsylvania prescribed practices, would have been $225 million at December 31, 2009. 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 their financial statements.
The amount of dividends EIC and EPC, Indemnity’s Pennsylvania-domiciled property and casualty subsidiaries, can pay without the prior approval of the Pennsylvania Insurance Commissioner is limited to not more than the greater of: (a) 10% of its statutory surplus as reported on its last annual statement, or (b) the net income as reported on its last annual statement. The amount of dividends that the EIC’s New York-domiciled property and casualty subsidiary, ENY, can pay without the prior approval of the New York Superintendent of Insurance is limited to the lesser of: (a) 10% of its statutory surplus as reported on its last annual statement, or (b) 100% of its adjusted net investment income during such period. In 2010, the maximum dividend Indemnity could receive from its property and casualty insurance subsidiaries would be $26 million. No dividends were paid by these property and casualty insurance subsidiaries in 2009 or 2008.
The amount of dividends the Flagship, Exchange’s Pennsylvania-domiciled property and casualty subsidiary, can pay without the prior approval of the Pennsylvania Insurance Commissioner is limited to not more than the greater of: (a) 10% of its statutory surplus as reported on its last annual statement, or (b) the net income as reported on its last annual statement. In 2010, the maximum dividend the Exchange could receive from Flagship would be $1 million. No dividends were paid to the Exchange by Flagship in 2009.
The amount of dividends EFL, a Pennsylvania-domiciled life insurer, can pay to its shareholders without the prior approval of the Pennsylvania Insurance Commissioner is limited by statute to the greater of: (a) 10% of its statutory surplus as shown on its last annual statement on file with the commissioner, or (b) the net income as reported on its last annual statement, but shall not include pro-rata distribution of any class of the insurer’s own securities. Accordingly, our share of the maximum dividend payout which may be made in 2010 without prior Pennsylvania Commissioner approval is $4 million. There were no dividends paid to us in 2009.

47


 

Note 22. Indemnity supplemental information
                                 
    Consolidating Statement of Financial Position  
December 31, 2009                      
(in millions)   Indemnity     Exchange     Reclassifications     Erie  
    shareholder     noncontrolling     and     Insurance  
    interest     interest     eliminations     Group  
     
Assets
                               
Investments
                               
Available-for-sale securities, at fair value:
                               
Fixed maturities
  $ 664     $ 6,517     $     $ 7,181  
Equity securities
    38       472             510  
Trading securities, at fair value
    42       1,835             1,877  
Limited partnerships
    235       1,116             1,351  
Other invested assets
    1       20             21  
     
Total investments
    980       9,960             10,940  
Cash and cash equivalents
    76       158             234  
Premiums receivable from policyholders
    237       872       (203 )     906  
Reinsurance recoverable
    2       213           215  
Deferred income taxes
    41       75             116  
Deferred acquisition costs
    17       450             467  
Other assets
    102       308       (1 )     409  
Reinsurance recoverables and receivables from Exchange and other affiliates
    1,115             (1,115 )      
Note receivable from EFL
    25             (25 )      
Equity in EFL
    72             (72 )      
     
Total assets
  $ 2,667     $ 12,036     $ (1,416 )   $ 13,287  
     
Liabilities
                               
Losses and loss expense reserves (1)
  $ 965     $ 3,424     $ (791 )   $ 3,598  
Life policy and deposit contract reserves
          1,540             1,540  
Unearned premiums (1)
    434       1,872       (325 )     1,981  
Other liabilities
    366       305       (228 )     443  
     
Total liabilities
    1,765       7,141       (1,344 )     7,562  
     
Shareholders’ equity and noncontrolling interest
                               
Total Indemnity shareholders’ equity
    902                   902  
Noncontrolling interest for the benefit of policyholders — Exchange
          4,895       (72 )     4,823  
     
Total equity
    902       4,895       (72 )     5,725  
     
Total liabilities, shareholders’ equity and noncontrolling interest
  $ 2,667     $ 12,036     $ (1,416 )   $ 13,287  
     
 
(1)   Indemnity’s insurance related accounts in this table include its wholly-owned property and casualty insurance subsidiaries’ direct business in addition to their share of the pooling transactions, which represents 5.5% of the total Property and Casualty Group business. The Consolidated Statements of Financial Position include direct business only as the 5.5% of activity assumed in accordance with the intercompany pooling arrangement has been eliminated in the consolidated presentation.

48


 

                                 
    Consolidating Statement of Financial Position  
December 31, 2008                      
(in millions)   Indemnity     Exchange     Reclassifications     Erie  
    shareholder     noncontrolling     and     Insurance  
    interest     interest     eliminations     Group  
     
Assets
                               
Investments
                               
Available-for-sale securities, at fair value:
                               
Fixed maturities
  $ 564     $ 5,223     $     $ 5,787  
Equity securities
    55       411             466  
Trading securities, at fair value
    33       1,375             1,408  
Limited partnerships
    299       1,327             1,626  
Other invested assets
    1       21             22  
     
Total investments
    952       8,357             9,309  
Cash and cash equivalents
    61       216             277  
Premiums receivable from policyholders
    245       913       (202 )     956  
Reinsurance recoverable
    2       213           215  
Deferred income taxes
    73       325             398  
Deferred acquisition costs
    17       485             502  
Other assets
    104       745       (1 )     848  
Reinsurance recoverables and receivables from Exchange and other affiliates
    1,105             (1,105 )      
Note receivable from EFL
    25             (25 )      
Equity in EFL
    29             (29 )      
     
Total assets
  $ 2,613     $ 11,254     $ (1,362 )   $ 12,505  
     
Liabilities
                               
Losses and loss expense reserves (1)
  $ 965     $ 3,407     $ (786 )   $ 3,586  
Life policy and deposit contract reserves
          1,449             1,449  
Unearned premiums (1)
    424       1,829       (317 )     1,936  
Other liabilities
    432       573       (230 )     775  
     
Total liabilities
    1,821       7,258       (1,333 )     7,746  
     
Shareholders’ equity and noncontrolling interest
                               
Total Indemnity shareholders’ equity
    792                   792  
Noncontrolling interest for the benefit of policyholders — Exchange
          3,996       (29 )     3,967  
     
Total equity
    792       3,996       (29 )     4,759  
     
Total liabilities, shareholders’ equity and noncontrolling interest
  $ 2,613     $ 11,254     $ (1,362 )   $ 12,505  
     
 
(1)   Indemnity’s insurance related accounts in this table include its wholly-owned property and casualty insurance subsidiaries’ direct business in addition to their share of the pooling transactions, which represents 5.5% of the total Property and Casualty Group business. The Consolidated Statements of Financial Position include direct business only as the 5.5% of activity assumed in accordance with the intercompany pooling arrangement has been eliminated in the consolidated presentation.
Receivables from 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.
Premiums due from policyholders of Indemnity’s wholly-owned property and casualty insurance subsidiaries equaled $237 million and $245 million at December 31, 2009 and 2008, respectively. A significant amount of these receivables are ceded to the Exchange as part of the intercompany pooling arrangement.
Indemnity has a receivable due from the Exchange for reinsurance recoverable from unpaid losses and loss expenses and unearned premium balances ceded under the intercompany pooling arrangement totaling $902 million and $887 million at December 31, 2009 and 2008, respectively. Management fee and expense allocation amounts due from the Exchange were $210 million and $215 million at December 31, 2009 and 2008, respectively. The receivable from EFL for expense allocations totaled $3 million at December 31, 2009, compared to $4 million at December 31, 2008.

49


 

Indemnity is due $25 million from EFL in the form of a surplus note that was issued in 2003. The note may be repaid only out of unassigned surplus of EFL. Both principal and interest payments are subject to prior approval by the Pennsylvania Insurance Commissioner. The note bears an annual interest rate of 6.7% and will be payable on demand on or after December 31, 2018, with interest scheduled to be paid semi-annually. EFL paid annual interest to Indemnity of $2 million in both 2009 and 2008.
                         
    Indemnity shareholder interest  
            Years ended December 31,  
(in millions)   Percent     2009     2008  
     
Management operations
                       
Management fee revenue, net
    100.0 %   $ 965     $ 950  
Service agreement revenue
    100.0 %     35       33  
             
Total revenue from management operations
            1,000       983  
Cost of management operations
    100.0 %     813       810  
             
Income from management operations before taxes
            187       173  
             
Property and casualty operations
                       
Premiums earned
    5.5 %     209       207  
Losses and loss expenses
    5.5 %     145       137  
Underwriting expenses
    5.5 %     63       57  
             
Income from property and casualty operations before taxes
            1       13  
             
Life insurance operations
                       
Total revenue
    21.6 %     27       13  
Total benefits and expenses
    21.6 %     25       25  
             
Income (loss) from life operations before taxes
            2       (12 )
             
Investment operations
                       
Investment income, net of expenses
            42       44  
Net realized gain (loss) on investments
            10       (43 )
Impairment losses recognized in earnings
            (12 )     (70 )
Equity in (losses) earnings of limited partnerships
            (76 )     6  
             
Total investment loss before taxes
            (36 )     (63 )
             
Income from operations before income taxes and noncontrolling interests
            154       111  
Provision for income taxes
            46       42  
             
Net income
          $ 108     $ 69  
             
Expense allocations
The claims handling services of the Exchange are performed by personnel who are entirely dedicated to and paid for by the Exchange from its own policyholder revenues. The Exchange’s claims function and its management and administration are exclusively the responsibility of the Exchange and not a part of the service Indemnity provides under the subscriber’s agreement. Likewise, personnel who perform activities within the life insurance operations of EFL are paid for by EFL from its revenues. However, Indemnity, as the legal entity that employs personnel on behalf of the Exchange and EFL, functions as a common paymaster for all employees. Common overhead expenses included in the expenses paid by Indemnity are allocated based on appropriate utilization statistics (employee count, square footage, vehicle count, project hours, etc.) specifically measured to accomplish proportional allocations. Executive compensation is allocated based on each executive’s primary responsibilities (management services, property 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.

50


 

Payments on behalf of related entities
We make certain payments for the account of the Erie Insurance Group’s related entities. Cash transfers are settled quarterly. The amounts of these cash settlements made for the account of related entities were as follows for the years ended December 31:
                 
(in millions)   2009     2008  
Exchange
  $ 282     $ 267  
Erie Family Life Insurance
    32       36  
 
           
Total cash settlements
  $ 314     $ 303  
 
           
Office leases
Indemnity leases office space on a year-to-year basis from the Exchange including three field office facilities. Rent expenses under these leases totaled $6 million in 2009 and 2008. Indemnity has a lease commitment until 2018 with EFL for a branch office. Annual rentals paid to EFL under this lease totaled $0.3 million in 2009 and 2008.
Indemnity’s components of direct cash flows as included in the Consolidated Statements of Cash Flows is as follows for the years ended December 31:
                 
Direct method of cash flows  
    Indemnity  
(in millions)   2009     2008  
     
Management fee received
  $ 912     $ 898  
Service agreement fee received
    35       32  
Premiums collected
    214       208  
Net investment income received
    45       52  
Limited partnership distributions
    13       29  
Increase (decrease) in reimbursements collected from affiliates
    3       (8 )
Commissions paid to agents
    (454 )     (439 )
Agents bonuses paid
    (81 )     (95 )
Salaries and wages paid
    (110 )     (111 )
Pension contribution and employee benefits paid
    (32 )     (48 )
Losses paid
    (123 )     (121 )
Loss expenses paid
    (22 )     (21 )
Other underwriting and acquisition costs paid
    (54 )     (52 )
General operating expenses paid
    (104 )     (104 )
Interest paid on bank line of credit
    0       (1 )
Income taxes paid
    (62 )     (68 )
     
Net cash provided by operating activities
    180       151  
Net cash (used in) provided by investing activities
    (69 )     73  
Net cash used in financing activities
    (96 )     (194 )
     
Net increase in cash
    15       30  
Cash and cash equivalents at beginning of year
    61       31  
     
Cash and cash equivalents at end of year
  $ 76     $ 61  
     

51


 

Note 23. EFL supplemental information
EFL is a Pennsylvania-domiciled life insurance company operating in 10 states and the District of Columbia. Indemnity owns 21.6% of EFL’s common shares outstanding and accounted for its ownership interest using the equity method of accounting. Indemnity’s share of EFL’s undistributed earnings included in retained earnings as of December 31, 2009 and 2008, totaled $55 million and $44 million, respectively.
The following presents condensed financial information for EFL on a U.S. GAAP basis for the years ended December 31:
                 
(in millions)   2009   2008
     
Policy and other revenues
  $ 64     $ 66  
Net investment income (expense)
    66       (3 )
Benefits and expenses
    120       117  
Income (loss) before income taxes
    10       (54 )
Income tax (benefit) expense
    (16 )     14  
Net income (loss)
    26       (68 )
Comprehensive income (loss)
    142       (138 )
The increase in net investment income in 2009 was the result of impairment charges of $23 million in 2009 compared to $84 million in 2008. The more significant impairment charges in 2008 were primarily related to bonds and preferred stocks in the financial services industry.
Net income in 2009 was positively impacted by a reduction in the deferred tax valuation allowance of $19 million. A deferred tax valuation allowance of $33 million was recorded in the Statements of Operations for 2008 related to the more significant impairment charges and contributed to the net loss reported in 2008.
In 2008 a deferred tax valuation allowance of $7 million was recorded in accumulated other comprehensive income for unrealized losses on securities where the related deferred tax asset was not expected to be realized. This amount was reduced in 2009 driven by unrealized gains during the year. The deferred tax valuation allowance was $4 million at December 31, 2009.
Comprehensive income was positively impacted by the $27 million cumulative effect of implementing new other-than-temporary impairment guidance in the second quarter of 2009. Additionally, EFL experienced unrealized gains, after tax of $90 million in 2009 which contributed to the increase in comprehensive income and investments. The comprehensive loss for 2008 included unrealized losses after tax of $70 million resulting from the 2008 market conditions.
                 
    As of December 31,
(in millions, except per share data)   2009   2008
Investments
  $ 1,639     $ 1,328  
Total assets
    1,941       1,645  
Liabilities
    1,609       1,510  
Accumulated other comprehensive income (loss)
    18       (72 )
Cumulative effect adjustment
    27        
Total shareholders’ equity
    333       135  
Book value per share
  $ 35.19     $ 14.30  
In June 2009, Indemnity made a $12 million capital contribution to EFL and the Exchange made a $43 million capital contribution to EFL to strengthen its surplus. The $55 million in capital contributions increased EFL’s investments and total shareholders’ equity.
During the second quarter of 2009, a required cumulative effect adjustment reclassified previously recognized non-credit other-than-temporary impairments of $27 million out of retained earnings. Deferred taxes of $9 million related to this cumulative effect adjustment were offset by a reduction in the valuation allowance in the same amount related to previously recognized impairments.
Total shareholders’ equity increased over $197 million at December 31, 2009 compared to December 31, 2008. The

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main factors driving this increase were $90 million in unrealized gains, net of tax, the capital contribution of $55 million, the cumulative effect adjustment of $27 million and net income of $26 million.
Note 24. Subsequent events
We have evaluated for recognized and nonrecognized subsequent events through the date of financial statement issuance. No items were identified in this period subsequent to the financial statement date that required adjustment or disclosure.

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Management’s Discussion and Analysis of Financial Condition and Results of Operations
On June 12, 2009, the Financial Accounting Standards Board (FASB) updated ASC 810, Consolidation , which amended the existing guidance for determining whether an enterprise is the primary beneficiary of a variable interest entity (“VIE”). As of January 1, 2010 Erie Indemnity Company adopted the new accounting principle on a retrospective basis since inception.
The following discussion of financial condition and results of operations highlights significant factors influencing Erie Insurance Group (“we,” “us,” “our”). This discussion should be read in conjunction with the audited financial statements and related notes and all other items contained within this report.
INDEX
         
    Page Number
Cautionary statement regarding forward-looking information
    54  
Recent accounting pronouncements
    55  
Operating review
    56  
Critical accounting estimates
    60  
Results of operations
    69  
Management operations
    69  
Property and casualty insurance operations
    71  
Life insurance operations
    75  
Investment operations
    76  
Financial condition
    78  
Investments
    78  
Liabilities
    82  
Shareholders’ equity
    83  
Impact of inflation
    84  
Liquidity and capital resources
    84  
Transactions/agreements between Indemnity and noncontrolling interest (Exchange)
    89  
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements contained herein are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are not in the present or past tense and can generally be identified by the use of words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “likely,” “plan,” “project,” “seek,” “should,” “target,” “will,” “may,” and other expressions that indicate future trends and events. Forward-looking statements include, without limitation, statements and assumptions on which such statements are based that are related to our plans, strategies, objectives, expectations, intentions and adequacy of resources. Examples of such statements are discussions relating to underwriting, premium and investment income volumes, expenses and agency appointments. Such statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Among the risks and uncertainties that could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements are the following:
    factors affecting the property and casualty and life insurance industries generally, including price competition, legislative and regulatory developments;
 
    government regulation of the insurance industry including approval of rate increases;
 
    the frequency and severity of claims;
 
    natural disasters;
 
    exposure to environmental claims;
 
    fluctuations in interest rates;
 
    inflation and general business conditions;
 
    the geographic concentration of our business as a result of being a regional company;
 
    the accuracy of our pricing and loss reserving methodologies;
 
    changes in driving habits;
 
    our ability to maintain our business operations including our information technology system;
 
    our dependence on the independent agency system;
 
    the quality and liquidity of our investment portfolio;
 
    Indemnity’s dependence on its relationship with Exchange; and

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    the other risks and uncertainties discussed or indicated in all documents filed by the Company with the Securities and Exchange Commission, including those described in Part I, “Item 1A. Risk Factors” of the 2009 Form 10-K, which information is incorporated by reference.
A forward-looking statement speaks only as of the date on which it is made and reflects the Erie Insurance Group’s analysis only as of that date. The Erie Insurance Group undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changes in assumptions, or otherwise.
RECENT ACCOUNTING PRONOUNCEMENTS
Erie Indemnity Company (“Indemnity”) adopted amended consolidation guidance that became effective January 1, 2010. As a result of this new guidance, Indemnity is considered to have a controlling financial interest in its affiliated entity, the Erie Insurance Exchange (“Exchange”). Indemnity is named as, and serves as, the Exchange’s attorney-in-fact. Consolidation of the Exchange is required given the significance of the management fee to the Exchange and because Indemnity has the power to direct the activities of the Exchange that most significantly impact the Exchangė’s economic performance. The 2009 and 2008 financial information has been conformed to this consolidated presentation. The consolidation of the Exchange resulted in no change to Indemnity’s net income or equity. The Exchange’s net income and equity is identified as the noncontrolling interest net income or equity.

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OPERATING REVIEW
Overview
Erie Insurance Group represents the consolidated results of Indemnity and the results of its variable interest entity, the Exchange. Erie Insurance Group operates as a property and casualty insurer through its regional insurance carriers that write a broad line of personal and commercial lines coverages. The property and casualty insurance companies include the Exchange, a consolidated affiliate and its property and casualty insurance subsidiary, Flagship City Insurance Company (“Flagship”), and Indemnity’s three wholly-owned property and casualty insurance subsidiaries, Erie Insurance Company (“EIC”), Erie Insurance Property and Casualty Company (“EPC”) and Erie Insurance Company of New York (“ENY”). These entities operate collectively as the Property and Casualty Group. The Erie Insurance Group also operates as a life insurer through its affiliate, Erie Family Life (“EFL”), which is owned 21.6% by Indemnity and 78.4% by the Exchange and it underwrites and sells nonparticipating individual and group life insurance policies and fixed annuities.
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. As attorney-in-fact, Indemnity is required to perform certain services relating to the sales, underwriting and issuance of policies on behalf of the Exchange. The Exchange is a variable interest entity.
The Exchange’s equity, which is comprised of its retained earnings and accumulated other comprehensive income, is held for the benefit of its subscribers and meets the definition of a noncontrolling interest and is reflected as such in our consolidated financial statements. The shareholders of Indemnity benefit from their interest in Indemnity’s income and equity but not the noncontrolling interest’s income or equity.
Generally, Indemnity shareholders’ interest in income comprises:
    a 25% management fee on all property and casualty insurance policies written, less the costs associated with the sales, underwriting and issuance of these policies,
 
    a 5.5% interest in the net underwriting results of the property and casualty lines operations,
 
    a 21.6% equity interest in the net earnings of EFL,
 
    net investment income and results on investments that do not belong to the Exchange or its subsidiaries, and
 
    other income and expenses, including income taxes, that are not the responsibility of the Exchange or its subsidiaries.
Generally, the noncontrolling interest in income comprises:
    a 94.5% interest in the net underwriting results of the property and casualty lines operations,
 
    a 78.4% equity interest in the net earnings of EFL,
 
    net investment income and related results on investments that belong to the Exchange and its subsidiaries, and
 
    other income and expenses, including income taxes, that are the responsibility of the Exchange and its subsidiaries.
“Indemnity shareholder interest” refers to the interest in Erie Indemnity Company owned by the Class A and Class B shareholders. Exchange refers to the noncontrolling interest held for the benefit of the subscribers and includes its interests in Flagship and EFL.

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The following table represents a breakdown of the composition of the income attributable to Indemnity and the income attributable to the noncontrolling interest (Exchange). For purposes of this discussion, EFL’s investments are included in the life insurance operations.
Results of the Erie Insurance Group’s operations by interest
                                                                                 
    Indemnity           Eliminations of related        
( in millions)   shareholder interest     Noncontrolling interest (Exchange)     party transactions     Erie Insurance Group  
            Years ended             Years ended     Years ended     Years ended  
            December 31,             December 31,     December 31,     December 31,  
    Percent