Erie Indemnity Co.
ERIE INDEMNITY CO (Form: 10-K, Received: 03/08/2004 10:23:35)    
 
Table of Contents

FORM 10-K

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)

For the fiscal year ended December 31, 2003

OR  

[    ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
(NO FEE REQUIRED)

Commission File Number 0-24000

ERIE INDEMNITY COMPANY


(Exact name of registrant as specified in its charter)
     
Pennsylvania   25-0466020

 
(State or other jurisdiction
of incorporation or organization)

  (I.R.S. Employer
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

Securities registered pursuant to Section 12(b) of the Act: None

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

Class A Common Stock, stated value $.0292 per share
Class B Common Stock, stated value $70 per share


(Title of class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

     Yes [X]    No [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).

     Yes [X]     No [  ]

Aggregate market value of voting stock of non-affiliates: There is no active market for the Class B voting stock and no Class B voting stock has been sold in the last year upon which a price could be established.

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date: 64,048,068 shares of Class A Common Stock and 2,878 shares of Class B Common Stock outstanding on February 20, 2004.

DOCUMENTS INCORPORATED BY REFERENCE:

1.   Portions of the Registrant’s Annual Report to Shareholders for the fiscal year ended December 31, 2003 (the “Annual Report”) are incorporated by reference into Parts I, II and III of this Form 10-K Report.
 
2.   Portions of the Registrant’s Proxy Statement relating to the Annual Meeting of Shareholders to be held April 27, 2004 are incorporated by reference into Parts I and III of this Form 10-K Report.

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TABLE OF CONTENTS

PART I
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
       Executive Officers to the Company
PART II
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Repurchases of Equity Securities
Item 6. Selected Consolidated Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosure about Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosures
Item 9A. Controls and Procedures
PART III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
Item 14. Principal Accountant Fees and Services
Part IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
SIGNATURES
INDEPENDENT AUDITORS’ REPORT
SCHEDULE I - SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES
SCHEDULE IV — REINSURANCE
SCHEDULE VI — SUPPLEMENTAL INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS
SCHEDULE VI — SUPPLEMENTAL INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS (CONTINUED)
EXHIBIT INDEX
Aggregate Excess of Loss Insurance - Amend. No. 3
Addendum to Employment Agreement
Addendum to Employment Agreement
Addendum to Employment Agreement
Addendum to Employment Agreement
Addendum to Employment Agreement
Addendum to Employment Agreement
Addendum to Employment Agreement
Insurance Bonus Agreement
Insurance Bonus Agreement
Insurance Bonus Agreement
Insurance Bonus Agreement
Insurance Bonus Agreement
Insurance Bonus Agreement
Insurance Bonus Agreement
2003 Annual Report
Code of Conduct
Subsidiaries of Registrant
Consent of Independent Auditors
Section 302 Certification of CEO
Section 302 Certification of CFO
Section 906 Certification of CEO and CFO


Table of Contents
 

INDEX

             
PART   ITEM NUMBER AND CAPTION   PAGE

 
 
I   Item 1.   Business   3
I   Item 2.   Properties   17
I   Item 3.   Legal Proceedings   17
I   Item 4.   Submission of Matters to a Vote of Security Holders    
        Exectuive Officers to the Company   17
II   Item 5.   Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Repurchases of Equity Securities   18
II   Item 6.   Selected Consolidated Financial Data   18
II   Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   18
II   Item 7A.   Quantitative and Qualitative Disclosure about Market Risk   19
II   Item 8.   Financial Statements and Supplementary Data   19
II   Item 9.   Changes In and Disagreements With Accountants on Accounting and Financial Disclosures   19
II   Item 9A.   Controls and Procedures   19
III   Item 10.   Directors and Executive Officers of the Registrant   20
III   Item 11.   Executive Compensation   22
III   Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   22
III   Item 13.   Certain Relationships and Related Transactions   22
III   Item 14.   Principal Accountant Fees and Services   22
IV   Item 15.   Exhibits, Financial Statement Schedules and Reports on Form 8-K   23

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PART I

 

Item 1. Business

     Erie Indemnity Company (the “Company”) is a Pennsylvania corporation which operates predominantly as a provider of sales, underwriting and policy issuance services to the policyholders of Erie Insurance Exchange (the “Exchange”). The Company has served since 1925 as attorney-in-fact for the policyholders of the Exchange. Management fees earned in the capacity as attorney-in-fact comprised 74% of total Company revenue in 2003. The Company also operates as a property and casualty insurer through its wholly-owned subsidiaries, Erie Insurance Company, Erie Insurance Property and Casualty Company, and Erie Insurance Company of New York. The Exchange and its property and casualty subsidiary, Flagship City Insurance Company (“Flagship”), and the Company’s three property and casualty subsidiaries (collectively, the “Property and Casualty Group”) write personal and commercial lines property and casualty coverages exclusively through approximately 7,200 independent agents and pool their underwriting results. The Company also owns 21.6% of the common stock of Erie Family Life Insurance Company (“EFL”), an affiliated life insurance company of which the Exchange owns 53.5%. Together with the Exchange, the Company and its subsidiaries and affiliates operate collectively as the “Erie Insurance Group”.

     The Property and Casualty Group underwrites a broad line of personal and commercial coverages. Insurance products are marketed primarily in the Midwest, Mid-Atlantic and Southeast regions through independent agents comprising more than 1,700 insurance agencies. The Property and Casualty Group is licensed to do business in sixteen states and in the District of Columbia and at December 31, 2003, operated in eleven states and the District of Columbia. Twenty-three branch offices are maintained throughout the eleven contiguous states in which the Property and Casualty Group does business. Through December 31, 2003, the Property and Casualty Group also underwrote voluntary assumed reinsurance business. Effective December 31, 2003, the Property and Casualty Group exited the assumed reinsurance business.

     As of December 31, 2003, the Company had over 4,300 full-time employees, of which 2,144 provide claims specific services exclusively for the Property and Casualty Group and 151 perform general services exclusively for EFL. Both the Exchange and EFL reimburse the Company monthly for the cost of these services. None of the Company’s employees is covered by a collective bargaining agreement. As evidenced by a comprehensive survey completed in 2002 by an international human resources consulting firm, the Company’s relationship with its employees continues to be good.

Information About Business Segments

     Reference is made to Note 18 of the “Notes to the Consolidated Financial Statements” included in the Annual Report for information as to total revenue and net income attributable to the three business segments (management operations, insurance underwriting operations and investment operations) in which the Company is engaged.

Management Operations

     The management fee rate charged to the Policyholders of the Exchange is set by the Company’s Board of Directors. The Company’s Board of Directors may change the management fee rate at its discretion. However, the maximum fee level which can be charged the Exchange, is limited by the agreement between each policyholder of the Exchange and the Company to 25% of the direct and affiliated assumed written premiums of the Exchange. The Board considers several factors in determining the management fee rate, including the relative financial position of the Exchange and the Company and the long-term capital needs of the Exchange to ensure its continued growth, competitiveness, and superior financial strength. For 2003, the management fee rate was 24%. From 1999 through December 31, 2002, the management fee rate charged the Exchange was at its maximum permitted level of 25%. In December 2003, the Board voted to lower the management fee rate to 23.5% beginning January 1, 2004.

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     All premiums collected, less the management fee retained by the Company, are used by the Exchange for the purpose of paying losses, loss adjustment expenses, investment expenses and other miscellaneous expenses including insurance-related taxes, licenses and fees and for other purposes that are to the benefit of the policyholders including certain information technology costs covered under a technology cost-sharing agreement.

     The Company recognizes management fees due from the Exchange as income when the premiums are written because at that time the Company has performed substantially all of the services required to be performed, including sales, underwriting and policy issuance activities, but currently such fees are not paid to the Company by the Exchange until premiums are collected. Historically, due to policy renewal and sales patterns, management fees earned are greater in the second and third quarters of the calendar year. While loss and loss adjustment expenses are not entirely predictable, historically such costs have been greater during the third and fourth quarters, influenced by the weather in the geographic regions, including the Midwest, Mid-Atlantic and Southeast regions, where the Property and Casualty Group operates.

     The Company receives a service agreement fee from the Exchange, at the rate of 6% of voluntary assumed written premium as compensation for the management and administration of its voluntary assumed reinsurance business from non-affiliated insurers. The service agreement rate was 7% during 2002 and 2001. Service agreement revenue is recognized over the time period of the reinsurance policies to which the service revenue relates. Effective December 31, 2003, the Exchange exited the assumed voluntary reinsurance business. As the remaining assumed voluntary premiums dissipate, this service agreement revenue will also decrease.

     The Company also collects service charges from Policyholders for providing extended payment terms 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 when each additional billing is rendered to the policyholder.

     The cost of management operations includes all independent agent commission expenses as well as personnel and benefit costs, underwriting and policy issuance costs and other administrative expenses of the Company.

     The largest component of the cost of management operations is the cost of independent agent commissions and other incentive programs for the Company’s independent agents. Included in commission costs is the cost of scheduled commissions earned on premiums written, agency contingency awards based on the three-year average underwriting profitability of the business written with the Property & Casualty Group, accelerated commissions earned by start-up agencies and promotional incentives to agents.

     Personnel and benefit costs related to the sales, underwriting and issuance of policies and the administrative staff of the Company are the second largest component of the cost of management operations. Expenses other than personnel and benefit costs related to the underwriting and issuance of new business vary with the number of new policies. Underwriting reports, printing, postage and other cost of materials necessary for the underwriting and issuance of policies are included in the cost of management operations.

     Additional costs are incurred for general administrative expenses of the Company including the cost of office facilities, travel, telephone and communication costs, the cost of data processing and information technology. Beginning in 2001, Erie Insurance Group initiated the eCommerce program and committed to new information technology infrastructure expenditures as part of the program. The Company’s share of these eCommerce infrastructure expenditures are included in the cost of management operations. Non-infrastructure costs of the eCommerce program which are subject to an inter-company cost-sharing agreement are included in the insurance underwriting operations segment.

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     The Company’s management operations are affected by factors such as regulation, competition, insurance industry market conditions and changes in insurance distribution systems as well as general economic and investment conditions.

Insurance Underwriting Operations

     The Company’s property and casualty insurance subsidiaries participate in the underwriting results of the Property and Casualty Group under an arrangement through which all direct business written by the Property and Casualty Group is pooled. The Exchange has a 94.5% participation in the underwriting results of the Property and Casualty Group pool, while the Company’s property and casualty insurance subsidiaries, the Erie Insurance Company and the Erie Insurance Company of New York together, have a 5.5% participation. As such, the Company has a direct interest in the underwriting profitability of the business written by the Property and Casualty Group as well as the volume of premium written. An excess-of-loss reinsurance agreement between the Exchange, Erie Insurance Company and Erie Insurance Company of New York limits the amount of sustained ultimate net losses in any applicable accident year for the Erie Insurance Company and the Erie Insurance Company of New York. The excess of loss reinsurance agreement is excluded from the pooling arrangement.

Industry

     One of the distinguishing features of the property and casualty insurance industry is that in general its products are priced before its costs are known, as premium rates are generally determined before losses are reported. Current prices must be established from forecasts of the ultimate costs expected to arise from exposures underwritten during the coverage period when the rates are applied. Changes in statutory, regulatory and case law can significantly affect the liabilities associated with known risks after the insurance contract is in place. Property and casualty insurance companies’ ability to increase prices in response to declines in profitability are limited by the large number of competitors and the similarity of products offered, as well as regulatory constraints.

     The profitability of the property and casualty insurance business is influenced by many external factors some of which include rate competition, the severity and frequency of claims, terrorist actions, natural disasters, state regulation of premium rates, and other areas of competition, defaults of reinsurers, investment market conditions, general business conditions, court decisions that define and may expand the extent of coverage and the amount of compensation due for injuries and losses.

     Inflation also affects the loss costs of property and casualty insurers and, as a consequence, insurance rates. Insurance premiums are established before losses and loss adjustment expenses and the extent to which inflation may impact such expenses, are known. Consequently, in establishing premium rates, the Company attempts to anticipate the potential impact of inflation.

Lines of Business

     The Property and Casualty Group underwrites direct insurance business as well as assumed reinsurance business. The Property and Casualty Group underwrites a broad range of insurance. In 2003, personal lines comprised 70.2% of direct written premium revenue of the Property & Casualty Group while commercial lines constituted the remaining 29.8%. The core products in the personal lines are private passenger automobile (72.5%) and homeowners (24.0%) while the core commercial lines consist principally of multi-peril (39.5%), automobile (28.2%) and workers’ compensation (29.4%). In 2003, property lines comprised 80.6% of the assumed written premium revenue of the Property and Casualty Group while liability lines constituted the remaining 19.5%.

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     See “Selected Segment Information” contained in the Annual Report, for the distribution of direct premiums written by the Property and Casualty Group.

Reinsurance

     The Property and Casualty Group conducts business in only 11 states and the District of Columbia, primarily in the Mid-Atlantic, Midwestern and Southeastern portions of the United States. A substantial portion of the business is private passenger and commercial automobile, homeowners and workers’ compensation insurance in Ohio, Maryland, Virginia and particularly, Pennsylvania. As a result, a single catastrophic occurrence or destructive weather pattern could materially adversely affect the results of operations and surplus position of the members of the Property and Casualty Group. Common catastrophe events include hurricanes, earthquakes, tornadoes and wind and hail storms. From 1993 to 2001, the Property and Casualty Group had not purchased catastrophe reinsurance because management concluded the benefits of such coverage were outweighed by the costs of the coverage in light of the Exchange’s substantial surplus position and its ratio of net premiums written to surplus. In 2002, the lower surplus levels of the Exchange, along with increasing catastrophe risk exposure as a result of accelerating policy growth, resulted in management’s decision to purchase catastrophe reinsurance coverage. During 2003, the Property and Casualty Group purchased catastrophe reinsurance to mitigate future potential catastrophe loss exposure. The property catastrophe reinsurance treaty provides coverage of up to 95% of a loss of $415 million in excess of the Property and Casualty Group’s loss retention of $115 million per occurrence. Effective January 1, 2004, this reinsurance treaty was renewed under the terms to provide coverage of up to 95% of a loss of $460 million in excess of the Property and Casualty Group’s loss retention of $140 million per occurrence.

     Reference is also made to Note 14 of the “Notes to Consolidated Financial Statements” contained in the Annual Report for the year ended December 31, 2003, incorporated herein by reference, for a complete discussion of reinsurance transactions.

Combined Ratios

     The combined ratio is a standard industry measurement of the results of property and casualty insurance underwriting operations. The statutory combined ratio is the sum of the ratio of incurred losses and loss adjustment expenses to net premiums earned (“loss ratio”), the ratio of underwriting expenses incurred to net premiums written (“expense ratio”) and, the ratio of dividends to policyholders to net premiums earned (“dividend ratio”). The combined ratio computed under generally accepted accounting principles (“GAAP”) is calculated in the same manner except that it is based on GAAP reported amounts and the denominator for each component is net premiums earned. A combined ratio under 100% generally indicates an underwriting profit; a combined ratio over 100% generally indicates an underwriting loss before contemplation of the time value of money. Investment income, federal income taxes and other non-underwriting income or expense are not reflected in the combined ratio. The profitability of the Property and Casualty Group is a function of income and expense from both its underwriting and investment operations.

     The ratios shown in the table that follows for the Company’s property and casualty insurance subsidiaries Erie Insurance Company and Erie Insurance Company of New York, are prepared in accordance with GAAP and with the National Association of Insurance Commissioners (NAIC) Codified Statutory Accounting Practices (“SAP”). The ratios are based on the property and casualty insurance subsidiaries’ 5.5% proportionate share of insurance underwriting operations from the intercompany pooling agreement.

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      Combined Ratios
      Years Ended December 31,
      2003   2002   2001
     
 
 
GAAP Combined Ratio
    113.0 %     116.5 %     114.9 %
 
   
     
     
 
Statutory operating ratios:
                       
 
Loss ratio
    79.9       83.8       84.5  
 
Expense and dividend ratio
    28.3       30.9       30.1  
 
   
     
     
 
Statutory Combined Ratio
    108.2 %     114.7 %     114.6 %
 
   
     
     
 

     The 2003 combined ratios were impacted by increased claim severity and increased catastrophe losses. The all-lines aggregate excess-of-loss reinsurance agreement with the Exchange had a favorable impact of reducing the GAAP combined ratio by 1.9 points in 2003. Overall the combined ratio improved in 2003 over 2002 as 2003 had little adverse development of loss reserves on prior accident years whereas the adverse development on prior accident years in 2002 and 2001 was significant. The 2003 GAAP combined ratio was also impacted by 3.9 points by a fourth quarter 2003 charge of $7.6 million to reduce the company’s deferred acquisition cost (DAC) asset. The acquisition costs were reduced to reflect only the underlying policy acquisition costs to the Company. Previously the acquisition costs were deferred at the full amount of the management fee, which included an intercompany profit component. The 2002 loss ratio reflected continued prior accident year adverse loss development of $5.7 million. In 2002, fourth quarter adjustments to strengthen reserves and increases in catastrophe losses on direct business were offset slightly by the effect of premium rate increases. The excess-of-loss reinsurance agreement reduced the 2002 GAAP combined ratio by 3.8 points. The high loss ratio in 2001 was the result of increased loss severity in the Company’s private passenger automobile and workers’ compensation lines of business, combined with unaffiliated assumed voluntary reinsurance losses from the September 11th terrorist attack on the World Trade Center. The 2001 GAAP combined ratio was reduced by 4.0 points as a result of the excess-of-loss reinsurance agreement.

Investment Operations

     The Company’s primary invested assets include fixed maturities, equity securities and limited partnerships that constitute 74.2%, 16.0% and 9.4%, of total invested assets, respectively. Investment operations include investment income and realized gains and losses generated by those assets of the Company’s management and insurance underwriting operations. Investment operations performance is evaluated based on appreciation of assets and overall rate of return. Reference is made to Note 4 of the “Notes to Consolidated Financial Statements” contained in the Annual Report for the year ended December 31, 2003, incorporated herein by reference for a complete discussion of investment operations.

Financial Condition-Investments

     The Company’s investment strategy takes a long-term perspective emphasizing investment quality, diversification and investment returns providing for liquidity to meet the short and long-term commitments of the Company. Investments are managed on a total return approach that focuses on current income and capital appreciation. The Company’s investment portfolio, at market value, increased to $1,185.2 million at December 31, 2003, which represents 43.0% of total assets. Investment income reflected on the Consolidated Statements of Operations is affected by shifts in the types of investments in the portfolio, changes in interest rates and other factors. Net investment income was $58.3 million in 2003 compared to $55.4 million in 2002 and $49.9 million in 2001.

     The Company reviews the investment portfolio to evaluate positions that might have incurred

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other-than-temporary declines in value. For all investment holdings, general economic conditions and/or conditions specifically affecting the underlying issuer or its industry are considered in evaluating impairment in value. In addition to these factors, the primary factors considered in the Company’s review of investment valuation are the length of time the market value is below cost, the amount the market value is below cost and the Company’s intent and ability to hold the security until recovery in value has occurred. Reference is made to the Financial Condition section of the “Management’s Discussion and Analysis” contained in the Annual Report for the year ended December 31, 2003 incorporated herein by reference, for a complete discussion of the investment impairment policy.

     If the Company’s policy for determining the recognition of impaired positions were different, the Company’s Consolidated Statements of Financial Position and Statements of Operations could be significantly impacted. Management believes its investment valuation philosophy and accounting practices result in appropriate and timely measurement of value and recognition of impairment.

     The Company also has a 21.6% common stock interest in EFL of $56.1 million at December 31, 2003, which is accounted for under the equity method of accounting. EFL, which was organized in 1967 as a Pennsylvania-domiciled life insurance company, has an A.M. Best and Company Inc. (“A.M. Best”) rating of A (Excellent). EFL is primarily engaged in the business of underwriting and selling non-participating individual and group life insurance policies, including universal life, disability income and individual and group annuity products in ten states and the District of Columbia.

     Reference is made to the Financial Condition section of the “Management Discussion and Analysis” contained in the Annual Report for the year ended December 31, 2003 incorporated herein by reference, for a complete discussion of investments.

Financial Ratings

     The financial status of the Company is not rated, however, its property/casualty insurance subsidiaries are rated by rating agencies. Insurance companies are rated by rating agencies to provide insurance consumers with meaningful information on the financial strength of insurance entities. Higher ratings generally indicate financial stability and a strong ability to pay claims. The ratings are generally based upon factors relevant to policyholders and are not directed toward return to investors.

     Each member of the Property and Casualty Group currently has an A+ (“superior”) rating from A.M. Best. The A+ rating that A.M. Best gives to insurance companies represents a superior ability to meet ongoing obligations to policyholders. In evaluating an insurer’s financial and operating performance, A.M. Best reviews the insurer’s profitability, leverage and liquidity as well as the insurer’s book of business, the adequacy and soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy of its loss reserves and the experience and competency of its management. Each member of the Property and Casualty Group also has a rating of A pi (“strong”) from Standard & Poors. A rating of “A” means that the insurer has strong financial security characteristics. The subscript “pi” means the rating was based on publicly available information of the Exchange. Management believes that financial ratings are among many important factors in marketing the Property and Casualty Group’s insurance to its agents and customers.

Competition

     The markets in which the Property and Casualty Group operates are highly competitive. Property and casualty insurers generally compete on the basis of customer service, price, brand recognition, coverages offered, claim handling ability, financial stability and geographic coverage. In addition, because the insurance products of the Property and Casualty Group are marketed exclusively through independent insurance agents, these agents have the opportunity to represent more than one company. The Property and Casualty Group,

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thus, potentially faces competition within its appointed agencies based on product, price and service relationships.

     Market competition bears directly on the price charged for insurance products and services subject to the regulatory limitations. Growth is driven by a company’s ability to provide insurance services at a price that is reasonable and acceptable to the customer. In addition, the marketplace is affected by available capacity of the insurance industry. Industry surplus expands and contracts primarily in conjunction with profit levels generated by the industry. Growth is a product of a company’s ability to retain existing customers and to attract new customers, as well as movement in the average premium per policy charged by the Property and Casualty Group.

     The Erie Insurance Group has followed several strategies which management believes will result in long-term underwriting performance which exceeds those of the property and casualty industry in general. First, the Erie Insurance Group employs an underwriting philosophy and product mix targeted to produce a Property and Casualty Group underwriting profit on a long-term basis, through careful risk selection and rational pricing. The careful selection of risks allows for lower claims frequency and loss severity, thereby enabling insurance to be offered at favorable prices. The industry as a whole has been experiencing increases in claims severity. See the discussion in the Reserves section that follows on how the Company is addressing underwriting profitability.

     Second, Erie Insurance Group’s management focuses on consistently providing superior service to policyholders and agents. Policy retention (the percentage of existing policyholders who renew their policies) remained strong at 90.2%, 91.2% and 90.9% for the years ended December 31, 2003, 2002 and 2001, respectively, for all lines of business combined. Policies in force increased 6.7% to 3.7 million in 2003 from 3.5 million in 2002 from 3.1 million in 2001. While these numbers remained positive, new business policies decreased 14.0% to .6 million in 2003 compared to .7 million in 2002. The Company has placed an emphasis on rigorous underwriting practices which is impacting new policy growth. Also, 2002 was positively impacted by an agent incentive contract. See the discussion on underwriting profitability initiatives in the Reserve section that follows. See “Selected Segment Information” contained in the Annual Report for policy in force counts and retention rates for the Property and Casualty Group.

     Third, the Erie Insurance Group’s business model is designed to provide the advantages of localized marketing and claims servicing with the economies of scale from centralized accounting, administrative, underwriting, investment, information management and other support services.

     Finally, the Company carefully selects the independent agencies that represent the Property and Casualty Group. The Property and Casualty Group seeks to be the lead insurer with its agents in order to enhance the agency relationship and the likelihood of receiving the most desirable underwriting opportunities from its agents. The Company has ongoing, direct communications with the agency force. Agents have access to a number of Company-sponsored venues designed to promote sharing of ideas, concerns and suggestions with the senior management of the Property and Casualty Group with the goal of improving communications and service. These efforts have resulted in outstanding agency penetration and the ability to sustain long-term agency partnerships. The higher agency penetration and long term relationships allow for greater efficiency in providing agency support and training.

Reserves

     Loss reserves are established to account for the estimated ultimate costs of loss and loss adjustment expenses for claims that have been reported but not yet settled and claims that have been incurred but not yet reported. The estimated loss reserve for reported claims is based primarily upon a case-by-case evaluation of the type of risk involved and knowledge of the circumstances surrounding each claim and the insurance policy

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provisions relating to the type of loss. Estimates of reserves for unreported claims and loss settlement expenses are determined on the basis of costs, trends and reviews of historical reserving results.

     The Property and Casualty Group establishes loss and loss expense reserves for the Property and Casualty Group and for all states as a whole for various lines of business groupings. Bulk and incurred but not reported reserves are allocated to each company, state, and line of business. The Property and Casualty Group reviews the insurance laws of all states in which it operates, not just domiciliary states, to ensure that carried loss and loss adjustment expense reserves meet requirements. The statutory annual statements filed by the companies comprising the Property and Casualty Group contain actuarial opinions as to reserve adequacy as required by the states in which the Property and Casualty Group does business.

     The loss and loss adjustment expense reserves are computed in accordance with accepted loss reserving standards and principles for the purpose of making a reasonable provision for all unpaid loss and loss expense obligations under the terms of the Property and Casualty Group’s policies and agreements. However, the process of estimating the liability for unpaid losses and loss adjustment expenses is inherently judgmental and can be influenced by factors subject to variation. Possible sources of variation include claim frequency and severity, changing rates of inflation as well as changes in other economic conditions, judicial trends and legislative changes. It is unlikely that future losses and loss adjustment expenses will develop exactly as projected. The Property and Casualty Group continually refines reserves as experience develops and new information becomes known. The Property and Casualty Group reflects adjustments to reserves in the results of operations in the periods in which the estimates are changed. With the exception of reserves relating to certain workers’ compensation cases, which have been discounted at 2.5% in 2003 and 2002, loss reserves are not discounted.

     Adverse development of losses from prior accident years results in higher calendar year loss ratios and reduced calendar year underwriting results. To the extent prior year reserve deficiencies are indicative of deteriorating underlying loss trends and are material, the Property and Casualty Group’s pricing of affected lines of business would be increased to the extent permitted by state departments of insurance. Management also reviews trends in loss developments in order to determine if adjustments, such as reserve strengthening, are appropriate. Any adjustments considered necessary are reflected in current results of operations.

     In 2003, the Company addressed loss trends by controlling exposure growth, improving underwriting risk selection, instituting programs to control loss severity and obtaining additional premium on risks through rate increases. Pricing actions have been taken since 2001 to increase premiums charged to Property and Casualty Group policyholders. The Property and Casualty Group has implemented more rigorous underwriting practices, the criteria under which policyholders are selected or renewed and premium rates are determined. Restricting underwriting practices will affect the number of new policyholders eligible for coverage with the Property and Casualty Group as well as the number eligible to renew and the terms of renewal. Taken together, pricing actions and restricting underwriting practices are designed to improve the overall underwriting result of the Property and Casualty Group. These actions will also reduce the growth rate of the Property and Casualty Group’s new and renewal premium and could adversely affect policy retention rates currently experienced by the Property and Casualty Group. To the extent the premium growth rate of the Property and Casualty Group direct written premiums is impacted by these actions, the growth in the Company’s management fee revenue will be proportionately affected. See “Management’s Discussion and Analysis” in the Annual Report for further discussion of the underwriting initiatives implemented in the current year.

     For a reconciliation of beginning and ending property and casualty unpaid losses and loss adjustment expense reserves for each of the last three years, see Note 10 of the “Notes to Consolidated Financial Statements” contained in the Annual Report.

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     The following table sets forth the development of the Company’s property and casualty subsidiaries’ reserves for unpaid losses and loss adjustment expenses from 1994 through 2003.  

Property and Casualty Subsidiaries of Erie Indemnity Company

Reserves for Unpaid Losses and Loss Adjustment Expenses

                                                                                   
      At December 31,
     
(amounts in millions)   2003   2002   2001   2000   1999   1998   1997   1996   1995   1994
     
 
 
 
 
 
 
 
 
 
Net liability for unpaid losses and loss adjustment expense (“LAE”)
  $ 157.7     $ 139.1     $ 118.7     $ 102.3     $ 95.0     $ 91.4     $ 89.5     $ 84.9     $ 79.0     $ 68.9  
 
   
     
                         
Net liability re-estimated as of:
                                                                               
 
One year later
            138.8       126.9       110.4       103.0       91.3       88.9       87.2       78.4       65.7  
 
           
                         
 
Two years later
                    122.7       114.9       103.9       93.2       85.3       86.6       79.4       65.3  
 
                   
                 
 
Three years later
                            111.0       107.1       94.1       87.6       83.4       80.2       68.6  
 
                           
         
 
Four years later
                                    103.4       97.2       87.5       84.4       78.2       69.4  
 
                                   
 
 
Five years later
                                            93.7       90.1       84.5       78.9       68.2  
 
                                           
                                 
 
Six years later
                                                    87.1       86.2       79.8       68.8  
 
                                                   
                         
 
Seven years later
                                                            83.6       80.0       69.7  
 
                                                           
                 
 
Eight years later
                                                                    77.4       69.8  
 
                                                                   
         
 
Nine years later
                                                                            67.1  
 
                                                                           
 
Cumulative (deficiency) redundancy
            0.3       (4.0 )     (8.7 )     (8.4 )     (2.3 )     2.4       1.3       1.6       1.8  
 
           
     
     
     
     
     
     
     
     
 
Net liability for unpaid losses and LAE
  $ 157.7     $ 139.1     $ 118.7     $ 102.3     $ 95.0     $ 91.4     $ 89.5     $ 84.9     $ 79.0     $ 68.9  
Reinsurance recoverable on unpaid losses
    687.8       577.9       438.6       375.6       337.9       334.8       323.9       301.5       278.3       275.9  
 
   
     
     
     
     
     
     
     
     
     
 
Gross liability for unpaid losses and LAE
  $ 845.5     $ 717.0     $ 557.3     $ 477.9     $ 432.9     $ 426.2     $ 413.4     $ 386.4     $ 357.3     $ 344.8  
 
   
     
     
     
     
     
     
     
     
     
 
Gross re-estimated liability as of:
                                                                               
 
One year later
          $ 712.3     $ 627.8     $ 500.4     $ 463.2     $ 414.3     $ 410.6     $ 394.2     $ 351.0     $ 327.3  
 
           
                         
 
Two years later
                    620.8       548.2       464.9       429.0       398.4       398.2       362.3       332.7  
 
                   
                 
 
Three years later
                            538.5       497.9       426.9       406.0       388.0       373.0       351.6  
 
                           
         
 
Four years later
                                    493.4       449.8       402.4       391.3       367.7       364.0  
 
                                   
 
 
Five years later
                                            448.1       424.6       389.3       370.8       361.8  
 
                                           
                                 
 
Six years later
                                                    425.6       408.0       368.6       365.0  
 
                                                   
                         
 
Seven years later
                                                            411.7       385.6       363.0  
 
                                                           
                 
 
Eight years later
                                                                    389.5       379.3  
 
                                                                   
         
 
Nine years later
                                                                            385.9  
 
 
                                                                           
 
Cumulative (deficiency) redundancy
            4.7       (63.5 )     (60.6 )     (60.5 )     (21.9 )     (12.2 )     (25.3 )     (32.2 )     (41.1 )
 
           
     
     
     
     
     
     
     
     
 

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Reserves for Unpaid Losses and Loss Adjustment Expenses
(Continued)

                                                                                   
      Through December 31,
     
(amounts in millions)   2003   2002   2001   2000   1999   1998   1997   1996   1995   1994
   
 
 
 
 
 
 
 
 
 
Cumulative amount of net liability paid through:
                                                                               
 
One year later
          $ 50.5     $ 47.3     $ 41.2     $ 38.9     $ 33.6     $ 31.3     $ 32.6     $ 29.3     $ 22.1  
 
           
                         
 
Two years later
                    72.9       64.9       59.2       52.4       48.3       48.7       44.7       36.2  
 
                   
                 
 
Three years later
                            78.5       73.5       63.9       59.2       57.8       53.9       44.7  
 
                           
         
 
Four years later
                                    80.8       71.3       65.5       63.5       59.4       49.8  
 
                                   
 
 
Five years later
                                            74.9       70.0       67.4       62.5       53.2  
 
                                           
                                 
 
Six years later
                                                    72.1       70.1       64.8       55.0  
 
                                                   
                         
 
Seven years later
                                                            71.2       66.3       56.5  
 
                                                           
                 
 
Eight years later
                                                                    66.9       57.7  
 
                                                                   
         
 
Nine years later
                                                                            58.0  
 
                                                                           
 
Cumulative amount of gross liability paid through:
                                                                               
 
One year later
          $ 217.0     $ 194.3     $ 174.4     $ 158.9     $ 145.4     $ 136.9     $ 141.3     $ 131.9     $ 134.0  
 
           
                         
 
Two years later
                    302.1       270.9       244.9       228.2       211.5       212.2       199.2       199.9  
 
                   
                 
 
Three years later
                            326.1       297.6       274.9       256.8       250.0       235.7       233.4  
 
                           
         
 
Four years later
                                    326.9       300.9       280.5       271.6       256.0       253.4  
 
                                   
 
 
Five years later
                                            315.8       295.9       285.9       267.7       265.0  
 
                                           
                                 
 
Six years later
                                                    306.0       295.0       276.1       272.3  
 
                                                   
                         
 
Seven years later
                                                            302.3       280.9       277.6  
 
                                                           
                 
 
Eight years later
                                                                    286.5       281.2  
 
                                                                   
         
 
Nine years later
                                                                            285.8  
 
                                                                           
 

     Additional information with respect to the reserve activity of the Company’s property and casualty subsidiaries may be found at Note 10 of the “Notes to Consolidated Financial Statements” contained in the Annual Report.

     The top line shows the estimated liability that was recorded at the end of each of the indicated years for all current and prior year unpaid losses and loss expenses. The upper portion of the table shows re-estimations of the original recorded reserve as of the end of each successive year. The estimate is increased or decreased as payments are made and more information becomes known about the development of remaining unpaid claims. The lower portion of the table shows the cumulative amount paid in succeeding years for losses incurred prior to the Statement of Financial Position date. The cumulative deficiency or redundancy represents the aggregate amount by which original estimates of reserves as of that year-end have changed in subsequent years. The deficiency in reserves means that the reserves established in prior years were less than actual losses and loss adjustment expenses or were reevaluated at more than the originally reserved amount.

     The Property and Casualty Group does not discount reserves except for workers’ compensation reserves which are discounted on a non-tabular basis. The workers’ compensation reserves are discounted at a risk-adjusted 2.5% interest rate as permitted by the Insurance Department of the Commonwealth of Pennsylvania. The discount is based upon the Property and Casualty Group’s historical workers’ compensation

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payout pattern. The Company’s unpaid losses and loss adjustment expenses reserve, as a result of this discounting, was reduced by $3.3 million and $2.7 million at December 31, 2003 and 2002, respectively.

     During 2003 the Property and Casualty Group experienced continued increases in claims severity and increased catastrophe losses principally due to Hurricane Isabel. The Company’s share of catastrophe losses was $10.0 million in 2003 compared to $7.1 million in 2002. Offsetting these increases to losses was much lower adverse development on prior accident years in 2003 compared to 2002. See “Insurance Underwriting Operations” in the Management’s Discussion and Analysis contained in the Annual Report.

     The 2002 unpaid losses and loss adjustment expenses reserve of $717.0 million includes an adjustment to strengthen loss reserves made during the fourth quarter of 2002. The Property and Casualty Group increased losses and loss adjustment expense reserves by $184.1 million, of which the Company’s 5.5% share amounted to $10.1 million. During 2002, the Property and Casualty Group experienced continued adverse development of the loss reserves for prior accident years, principally in certain private passenger and commercial automobile coverages.

     The 2001 unpaid losses and loss adjustment expenses reserve of $557.3 million includes the Property and Casualty Group’s share of estimated incurred losses from the unaffiliated reinsurance business stemming from the September 11th attack on the World Trade Center. The portion of World Trade Center losses recorded by the Company’s property and casualty subsidiaries after giving effect to recoveries from the excess of loss agreement with the Exchange was $5.8 million, or $.06 per share, after taxes. The Property and Casualty Group is exposed to both direct and reinsurance losses arising from possible future terrorist actions.

Government Regulation

     The Company is subject to the corporate governance standards set forth in the recently enacted Sarbanes-Oxley Act of 2002 and other recent changes to the federal securities laws, as well as any rules or regulations that may be promulgated by the Securities and Exchange Commission or the Nasdaq Stock Market SM . Compliance with these standards, rules and regulations, as well as with accelerated filing requirements that have recently been enacted, impose additional administrative costs and burdens on the Company.

     The Sarbanes-Oxley Act of 2002 (Act) was designed to better protect investors by improving the accuracy and reliability of public company disclosures. Some requirements of the Act were effective immediately while others became effective throughout 2003 and into 2004. Management believes it has the appropriate processes in place both within the Company and with the Board of Directors to ensure timely compliance with the requirements. New internal control evaluation and reporting requirements introduced by the Act will become effective in 2004.

     The Property and Casualty Group is subject to supervision and regulation in the states in which it transacts business. The primary purpose of such supervision and regulation is the protection of policyholders. The extent of such regulation varies, but generally derives from state statutes which delegate regulatory, supervisory and administrative authority to state insurance departments. Accordingly, the authority of the state insurance departments includes the establishment of standards of solvency that must be met and maintained by insurers, the licensing to do business of insurers and agents, the nature of the limitations on investments, the approval of premium rates for property and casualty insurance, the provisions that insurers must make for current losses and future liabilities, the deposit of securities for the benefit of policyholders, the approval of policy forms, notice requirements for the cancellation of policies and the approval of certain changes in control. In addition, many states have enacted variations of competitive rate-making laws that allow insurers to set certain premium rates for certain classes of insurance without having to obtain the prior approval of the state

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insurance department. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to the financial condition of insurance companies.

     The Property and Casualty Group may be required, under the solvency or guaranty laws of the various states in which it is licensed, to pay assessments to fund policyholder losses or liabilities of insolvent insurance companies. Depending on state law, insurers can be assessed an amount that is generally equal to between 1% and 2% of premiums written for the relevant lines of insurance in that state each year to pay the claims of an insolvent insurer. Certain states permit these assessments, or a portion thereof, to be recorded as an offset to future premium taxes. The members of the Property and Casualty Group have made accruals for their portion of assessments related to such insolvencies based upon the most current information furnished by the guaranty associations. Reference is made to the Critical Accounting Estimates section of the “Management’s Discussion and Analysis” contained in the Annual Report for the year ended December 31, 2003 for a complete discussion of the liability for guaranty funds.

     The Property and Casualty Group is also required to participate in various involuntary insurance programs for automobile insurance, as well as other property and casualty lines, in states in which such companies operate. These involuntary programs provide various insurance coverages to individuals or other entities that otherwise are unable to purchase such coverage in the voluntary market. These programs include joint underwriting associations, assigned risk plans, fair access to insurance requirements (“FAIR”) plans, reinsurance facilities and windstorm plans. Legislation establishing these programs generally provides for participation in proportion to voluntary writings of related lines of business in that state. Generally, state law requires participation in such programs as a condition to doing business in that state. The loss ratio on insurance written under involuntary programs has traditionally been greater than the loss ratio on insurance in the voluntary market. Involuntary programs generated underwriting losses for the Property and Casualty Group of $30.2 million and $2.7 million in 2003 and 2002, compared to an underwriting profit of $4.1 million in 2001.

     Most states have enacted legislation that regulates insurance holding company systems. Each insurance company in the holding company system is required to register with the insurance supervisory authority of its state of domicile and furnish information regarding the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. Pursuant to these laws, the respective insurance departments may examine the Company and the Property and Casualty Group at any time, require disclosure of material transactions with the insurers and the Company as an insurance holding company and require prior approval of certain transactions between the Company and the Property and Casualty Group.

     All transactions within the holding company system affecting the insurers the Company manages are filed with the applicable insurance departments and must be fair and reasonable. Approval of the applicable insurance commissioner is required prior to the consummation of transactions affecting the control of an insurer. In some states, the acquisition of 10% or more of the outstanding common stock of an insurer or its holding company is presumed to be a change in control.

Financial Regulation

     The Company is subject to the filing requirements of the Securities and Exchange Commission (SEC). The financial information in these filings are prepared in accordance with generally accepted accounting principles (GAAP) and SEC guidelines. The Company’s property and casualty insurance subsidiaries are required to file financial statements prepared using Statutory Accounting Principles (SAP) with state regulatory authorities. The adjustments necessary to reconcile the Company’s property and casualty

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insurance subsidiaries’ net income and shareholders’ equity prepared in accordance with Statutory Accounting Principles (SAP) to net income and shareholders’ equity prepared in accordance with GAAP are as follows:

 
                         
    Net Income
   
    Year Ended
    December 31,
   
    2003   2002   2001
   
 
 
            (in thousands)
SAP amounts
  $ 539     ($ 10,679 )   ($ 4,929 )
Adjustments:
                       
Deferred policy acquisition costs
    ( 4,952 )     4,695       3,816  
Deferred income taxes
    4,481       664       1,392  
Salvage and subrogation
    1,567       833       312  
Incurred premium adjustment
    ( 2,003 )     ( 3,270 )     ( 1,816 )
Other
    96       (104 )     83  
 
   
     
     
 
GAAP amounts
  ($ 272 )   ($ 7,861 )   $ 1,142  
 
   
     
     
 
 
                         
    Shareholders’ Equity
   
    As of December 31,
   
    2003   2002   2001
   
 
 
            (in thousands)        
SAP amounts
  $ 134,399     $ 82,549     $ 92,128  
Adjustments:
                       
Deferred policy acquisition costs
    16,761       21,713       17,018  
Difference between GAAP and SAP deferred income taxes
    3,611       (2,337 )     (354 )
Salvage and subrogation
    6,061       4,493       3,661  
Incurred premium adjustment
    (19,291 )     (17,288 )     (14,018 )
Unrealized gains net of deferred taxes
    12,072       9,602       4,722  
Other
    307       249       223  
 
   
     
     
 
GAAP amounts
  $ 153,920     $ 98,981     $ 103,380  
 
   
     
     
 

     The 2003 reconciling item between the SAP and GAAP net income amounts for deferred policy acquisition costs resulted from a fourth quarter 2003 charge recorded by the Company to reduce its deferred acquisition cost asset. This charge relates to acquisition costs that were previously deferred at the full amount of the management fee, which included an intercompany profit component. The capitalized acquisition costs were adjusted to reflect only the underlying policy acquisition costs to the Company. See further discussion in Note 3, “Significant Accounting Policies,” included in the Annual Report.

     The increase in shareholders’ equity on a statutory basis in 2003 was the result of the Company making a $50 million capital contribution to its wholly-owned property/casualty insurance subsidiary, Erie Insurance Company. The capital was used to strengthen the surplus of Erie Insurance Company and to bring its premium to surplus leverage ratio in line with the other members of the Property and Casualty Group.

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     Pennsylvania regulations limit the amount of dividends EFL can pay its shareholders and limit the amount of dividends the Company’s property and casualty insurance subsidiaries the Erie Insurance Company and the Erie Insurance Property and Casualty Company can pay to the Company. New York state regulates the amount of dividends the Erie Insurance Company of New York can pay to the Erie Insurance Company. The limitations are fully described and reference is made herein to Note 15 of the “Notes to Consolidated Financial Statements” contained in the Annual Report for the year ended December 31, 2003, incorporated by reference.

     The NAIC has adopted risk-based capital (“RBC”) standards that require insurance companies to calculate and, report statutory capital and surplus needs based on a formula measuring underwriting, investment and other business risks inherent in an individual company’s operations. These RBC standards have not affected the operation of the Company’s property and casualty insurance subsidiaries and affiliates because each of them has statutory capital and surplus in excess of RBC requirements.

Website access to Company Reports

The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K , and all amendments to those reports are available free of charge on the Company’s website at www.erieinsurance.com as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.

Also copies of the Company’s annual report will be made available, free of charge, upon written request.

“Safe Harbor” Statement Under the Private Securities Litigation Reform Act of 1995: Certain forward-looking statements contained herein involve risks and uncertainties. These statements include certain discussions relating to management fee revenue, cost of management operations, underwriting, premium and investment income volume, business strategies, profitability and business relationships and the Company’s other business activities during 2003 and beyond. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential” and similar expressions. These forward-looking statements reflect the Company’s current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties that may cause results to differ materially from those anticipated in those statements. Many of the factors that will determine future events or achievements are beyond our ability to control or predict.

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Item 2. Properties

     The member companies of the Erie Insurance Group (the Company and its subsidiaries, the Exchange and its subsidiary and EFL) share a corporate home office complex in Erie, Pennsylvania, which is comprised of 489,710 square feet. The home office complex is owned by the Exchange. The Company is charged rent expense for the related square footage it occupies.

     The Company also operates 23 field offices, including the Erie branch office, in 11 states. Eighteen of these offices provide both agency support and claims services and are referred to as “Branch Offices”, while the remaining five provide only claims services and are considered “Claims Offices”. The Company owns three of its field offices. Three other field offices are owned by the Exchange and leased to the Company. The rent expense incurred by the Company for both the home office complex and the field offices leased from the Exchange totaled $11.8 million in 2003.

     One field office is owned by EFL and leased to the Company. The rent expense for the field office leased from EFL was $.3 million in 2003.

     The remaining 16 field offices are leased from various unaffiliated parties. In addition to these field offices, the Company leases a warehouse facility from an unaffiliated party. During 2003, the Company entered into a lease for a building in the vicinity of the home office complex. This additional space will be used to house certain home office employees to be relocated to this space in 2004. Total lease payments to external parties amounted to $2.5 million in 2003. Lease commitments for these properties expire periodically through 2008.

     The total operating expense, including rent expense, for all office space occupied by the Company in 2003 was $20.7 million. This amount was reduced by allocations to the Property and Casualty Group of $12.9 million for claims operations. The net amount after allocations is reflected in the cost of management operations.

 

Item 3. Legal Proceedings

     Information concerning the legal proceedings of the Company is incorporated by reference to the section “Legal Proceedings” in the Company’s definitive Proxy Statement with respect to the Company’s Annual Meeting of Shareholders to be held on April 27, 2004 to be filed with the Securities and Exchange Commission within 120 days of December 31, 2003 (the “Proxy Statement”).

 

Item 4. Submission of Matters to a Vote of Security Holders

     No matters were submitted to a vote of security holders during the fourth quarter of 2003.

Executive Officers of the Registrant

     Information with respect to executive officers of the Company is incorporated by reference to the information set forth in Item 10 in Part III of this Annual Report on Form 10-K.

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PART II

Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Repurchases of Equity Securities

     Reference is made to “Market Price of and Dividends on Common Stock and Related Shareholder Matters” in the Annual Report for the year ended December 31, 2003, incorporated herein by reference, for information regarding the high and low sales prices for the Company’s stock and additional information regarding such stock of the Company.

     During the year ended December 31, 2003, the Company did not repurchase any of its Class A Common Stock or Class B Common Stock.

 

Item 6. Selected Consolidated Financial Data

     Reference is made to “Selected Consolidated Financial Data” in the Annual Report for the year ended December 31, 2003, incorporated herein by reference. Reference is also made to the contractual obligation table in the Liquidity section of the Management’s Discussion and Analysis in the Annual Report for the year ended December 31, 2003, incorporated herein by reference.

 

Item 7. Management’s Discussion and Analysis of Financial Condition and
Results of Operations

     Reference is made to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report for the year ended December 31, 2003, incorporated herein by reference.

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Item 7A. Quantitative and Qualitative Disclosure about Market Risk

     Reference is made to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report for the year ended December 31, 2003, incorporated herein by reference.

 

Item 8. Financial Statements and Supplementary Data

     Reference is made to the “Consolidated Financial Statements” and the “Quarterly Results of Operations” contained in the “Notes to Consolidated Financial Statements” in the Annual Report for the year ended December 31, 2003, incorporated herein by reference.

 

Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosures

     As previously reported in the Registrant’s Form 10-K annual report for the year ended December 31, 2002 that was filed with the Commission on March 27, 2003, the Company appointed Ernst & Young, LLP as the Company’s independent auditors for 2003. Malin, Bergquist & Company, LLP were the Company’s independent auditors for 2002.

 

Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

     As of December 31, 2003, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and its Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange act). Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of December 31, 2003 are effective for gathering, analyzing and disclosing the information the Company is required to disclose in the reports it files under the Securities Exchange Act of 1934, within the time periods specified in the Security and Exchange Commission’s rules and forms.

Changes in Internal Control over Financial Reporting

There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect disclosure controls subsequent to the date of this evaluation.

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PART III

Item 10. Directors and Executive Officers of the Registrant

The information with respect to directors, audit committee, and audit committee financial experts of the Company and Section 16(a) beneficial ownership reporting compliance, is incorporated herein by reference to the Company’s definitive Proxy Statement relating to the Company’s Annual Meeting of Shareholders to be held on April 27, 2004 to be filed with the Securities and Exchange Commission within 120 days of December 31, 2003 in response to this item.

The Company has adopted a code of conduct that applies to all of its directors, officers (including its chief executive officer, chief financial officer, chief accounting officer, controller and any person performing similar functions) and employees. The Company has filed a copy of this Code of Conduct as Exhibit 14 to this Form 10–K. The Company has also made the Code of Conduct available on its website at http://www.erieinsurance.com.

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     Certain information as to the executive officers of the Company is as follows:

 
         
    Age   Principal Occupation for Past
    as of   Five Years and Positions with
Name   12/31/03   Erie Insurance Group

 
 
President & Chief
Executive Officer
       
         
Jeffrey A. Ludrof   44   President and Chief Executive Officer of the Company, Erie Family Life Insurance Company (EFL), Erie Insurance Company, Flagship City Insurance Company (Flagship), Erie Insurance Company of New York (Erie NY), and Erie Insurance Property and Casualty Company (Erie PC) since May 8, 2002. Executive Vice President–Insurance Operations of the Company, Erie Insurance Co., Flagship, Erie P&C, and Erie NY 1999–May 8, 2002; Senior Vice President of the Company 1994–1999.
         
Executive Vice Presidents        
         
Jan R. Van Gorder, Esq   56   Senior Executive Vice President, Secretary and General Counsel of the Company, EFL and Erie Insurance Co. since 1990, and of Flagship and Erie P&C since 1992 and 1993, respectively, and of Erie NY since 1994; Senior Vice President, Secretary and General Counsel of the Company, EFL and Erie Insurance Co. for more than five years prior thereto; Director, the Company, EFL, Erie Insurance Co., Erie NY, Flagship and Erie P&C.
         
John J. Brinling, Jr.   56   Executive Vice President of Erie Family Life Insurance Company since December 1990. Division Officer 1984–Present; Director, Erie NY.
         
Philip A. Garcia   47   Executive Vice President and Chief Financial Officer since 1997; Senior Vice President and Controller 1993–1997. Director, the Erie NY, Flagship and Erie P&C.
         
Michael J. Krahe   50   Executive Vice President–Human Development and Leadership since January 2003; Senior Vice President 1999–December 2002; Vice President 1994–1999.
         
Thomas B. Morgan   40   Executive Vice President–Insurance Operations since January 2003; Senior Vice President October 2001– December 2003; Assistant Vice President and Branch Manager 1997–October 2001; Independent Insurance Agent 1988–1997; Director, Erie NY, Erie P&C and Flagship.
Senior Vice Presidents        
Douglas F. Ziegler   53   Senior Vice President, Treasurer and Chief Investment Officer since 1993.

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Item 11. Executive Compensation

     The answer to this item is incorporated by reference to the Company’s definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on April 27, 2004, except for the Performance Graph, which has not been incorporated herein by reference.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     The information with respect to security ownership of certain beneficial owners and management and securities authorized for issuance under equity compensation plans, is incorporated by reference to the Company’s definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on April 27, 2004 to be filed with the Securities and Exchange Commission within 120 days of December 31, 2003.

     As of February 20, 2004, there were approximately 1,114 beneficial shareholders of record of the Company’s Class A non-voting common stock and 26 beneficial shareholders of record of the Company’s Class B voting common stock.

 

Item 13. Certain Relationships and Related Transactions

     The Company operates predominantly as a provider of sales, underwriting and policy issuance services to the Exchange. Since the formation of the Company and the Exchange in 1925, the Company has served as the attorney-in-fact for the policyholders of the Exchange. The Company’s earnings are largely generated from fees based on the direct written premium of the Exchange in addition to the direct written premium of the other members of the Property and Casualty Group. Also, the Company’s property and casualty insurance subsidiaries participate in the underwriting results of the Exchange via the pooling arrangement. As the Company’s operations are interrelated with the operations of the Exchange, the Company’s results of operations are largely dependent on the success of the Exchange. Reference is made to Note 13 of the “Notes to Consolidated Financial Statements” in the Annual Report for the year ended December 31, 2003, incorporated herein by reference for a complete discussion of the financial results of the Exchange.

     Reference is made to Note 11 of the “Notes to Consolidated Financial Statements” in the Annual Report for the year ended December 31, 2003, incorporated herein by reference, for a complete discussion of related party transactions.

     Information with respect to certain relationships with Company directors is incorporated by reference to the Company’s definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on April 27, 2004 to be filed with the Securities and Exchange Commission within 120 days of December 31, 2003.

 

Item 14. Principal Accountant Fees and Services

     The information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on April 27, 2004, to be filed with the Securities and Exchange Commission within 120 days of December 31, 2003.

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Part IV

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

     (a)  Financial statements, financial statement schedules and exhibits filed:

  (1)   Consolidated Financial Statements
 
           
      Page*
     
Erie Indemnity Company and Subsidiaries:
       
 
Independent Auditors’ Report on the Consolidated Financial Statements
    34  
 
Consolidated Statements of Operations for the three years ended December 31, 2003, 2002 and 2001
    35  
 
Consolidated Statements of Financial Position as of December 31, 2003 and 2002
    36  
 
Consolidated Statements of Cash Flows for the three years ended December 31, 2003, 2002 and 2001
    37  
 
Consolidated Statements of Shareholders’ Equity for the three years ended December 31, 2003, 2002 and 2001
    38  
 
Notes to Consolidated Financial Statements
    39  

  (2)   Financial Statement Schedules
           
      Page
     
Erie Indemnity Company and Subsidiaries:
       
Report of Independent Auditors – 2002 and 2001
    26  
Schedule I. Summary of Investments – Other than Investments in Related Parties
    27  
Schedule IV. Reinsurance
    28  
Schedule VI. Supplemental Information Concerning Property/Casualty Insurance Operations
    29  

All other schedules have been omitted since they are not required, not applicable or the information is included in the financial statements or notes thereto.

*     Refers to the respective page of Erie Indemnity Company’s 2003 Annual Report to Shareholders. The “Consolidated Financial Statements” and “Notes to Consolidated Financial Statements and Auditors’ Report” thereon on pages 34 to 63 are incorporated by reference. With the exception of the portions of such Annual Report specifically incorporated by reference in this Item and Items 1, 5, 6, 7, 7a, 8 and 13, such Annual Report shall not be deemed filed as part of this Form 10-K Report or otherwise subject to the liabilities of Section 18 of the Securities Exchange Act of 1934.

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  (3)   Exhibits

          See Exhibit Index on page 31 hereof.

     (b)  Reports on Form 8-K:

    On October 15, 2003, the Company filed a report on Form 8-K, reporting under Item 5, that the Property and Casualty Group had received loss notifications from more than 17,000 policyholders as a result of Hurricane Isabel and subsequent severe wind and rain storms. Total losses from these events were estimated to be $74 million for the Group. Also, wind and hail storms that struck Pennsylvania in July resulted in losses of approximately $20 million. These losses did not have a material impact on third quarter 2003 financial results of the Company due to an aggregate excess-of-loss reinsurance agreement the Company has in effect with the Erie Insurance Exchange.
 
    On October 29, 2003, the Company filed a report on Form 8-K, reporting under Item 12, the Company’s results for the third quarter of 2003. The results were discussed for the quarter and year to date, based on the three segments, management operations, insurance underwriting operations and investment operations. The Company’s Consolidated Statements of Operations, Consolidated Statements of Operations Segment Basis, Consolidated Statements of Financial Position, Segment Information and Selected Financial Data of Erie Insurance Exchange were included in the filing.
 
    On December 10, 2003 the Company filed a report on Form 8-K, reporting under Item 5, that at the regular meeting of the Board of Directors of the Company, the Board approved an increase in shareholders’ dividends. The Board also set the management fee rate charged to the Erie Insurance Exchange for 2004. The Board also reauthorized a stock repurchase program under which the Company may repurchase up to $250 million of its outstanding Class A common stock through December 31, 2006.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

     
Date: March 2, 2004   ERIE INDEMNITY COMPANY
(Registrant)
Principal Officers

/s/ Jeffrey A. Ludrof


Jeffrey A. Ludrof, President and CEO

/s/ Jan R. Van Gorder


Jan R. Van Gorder, Executive Vice President, Secretary & General Counsel

/s/ Philip A. Garcia


Philip A. Garcia, Executive Vice President & CFO

/s/ Timothy G. NeCastro

Timothy G. NeCastro, Senior Vice President & Controller

Board of Directors

     
/s/ Kaj Ahlmann   /s/ C. Scott Hartz

 
Kaj Ahlmann   C. Scott Hartz
     
/s/ John T. Baily   /s/ F. William Hirt

 
John T. Baily   F. William Hirt
     
/s/ Samuel P. Black, III   /s/ Samuel P. Katz

 
Samuel P. Black, III   Samuel P. Katz
     
/s/ J. Ralph Borneman, Jr.   /s/ Claude C. Lilly, III

 
J. Ralph Borneman, Jr.   Claude C. Lilly, III
     
/s/ Wilson C. Cooney   /s/ Jeffrey A. Ludrof

 
Wilson C. Cooney   Jeffrey A. Ludrof
     
/s/ Patricia Garrison-Corbin   /s/ Jan R. Van Gorder

 
Patricia Garrison-Corbin   Jan R. Van Gorder
     
/s/ John R. Graham   /s/ Robert C. Wilburn

 
John R. Graham   Robert C. Wilburn
     
/s/ Susan Hirt Hagen    

   
Susan Hirt Hagen    

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INDEPENDENT AUDITORS’ REPORT

To The Board of Directors and Shareholders
Erie Indemnity Company

We have audited the Consolidated Statements of Financial Position of Erie Indemnity Company and subsidiaries (Company) as of December 31, 2002 and the related Consolidated Statements of Operations, Shareholders’ Equity and Cash Flows for each of the two years in the period ended December 31, 2002. In connection with our audits of the financial statements, we also have audited the 2002 and 2001 financial statement schedules. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Erie Indemnity Company and subsidiaries as of December 31, 2002, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related 2002 and 2001 financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

/s/ Malin, Bergquist & Company, LLP


Malin, Bergquist & Company, LLP

Erie, Pennsylvania
February 7, 2003

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SCHEDULE I - SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES

December 31, 2003

                               
                          Amount at which
                          Shown in the
          Cost or           Consolidated
          Amortized   Fair   Statements of
Type of Investment   Cost   Value   Financial Position

 
 
 
(In Thousands)
                       
Available-for-sale securities:
                       
Fixed maturities:
                       
 
U.S. treasuries & government agencies
  $ 11,912     $ 12,189     $ 12,189  
 
States & political subdivisions
    69,330       72,272       72,272  
 
Special revenue
    95,418       99,471       99,471  
 
Public utilities
    62,966       67,766       67,766  
 
U.S. industrial & miscellaneous
    372,705       393,088       393,088  
 
Mortgage backed securities
    66,385       66,903       66,903  
 
Asset backed securities
    16,754       16,684       16,684  
 
Foreign
    106,313       115,680       115,680  
 
Redeemable preferred stock
    32,866       35,308       35,308  
Equity securities:
                       
 
Common stock:
                       
     
U.S. banks, trusts & insurance companies
    1,020       4,000       4,000  
     
U.S. industrial & miscellaneous
    13,843       34,764       34,764  
     
Foreign
    1,077       1,687       1,687  
 
Non-redeemable preferred stock:
                       
     
Public utilities
    29,767       32,222       32,222  
     
U.S. banks, trusts & insurance companies
    41,882       46,506       46,506  
     
U.S. industrial & miscellaneous
    52,517       56,668       56,668  
     
Foreign
    12,232       13,556       13,556  
 
   
     
     
 
 
Total fixed maturities and equity securities
  $ 986,987     $ 1,068,764     $ 1,068,764  
 
   
     
     
 
Real estate mortgage loans
  $ 5,182     $ 5,182     $ 5,182  
Limited partnerships
    105,617       111,218       111,218  
 
   
     
     
 
   
Total investments
  $ 1,097,786     $ 1,185,164     $ 1,185,164  
 
 
   
     
     
 

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SCHEDULE IV - REINSURANCE

                                         
                                    Percentage
            Ceded to   Assumed           of Amount
            Other   From Other   Net   Assumed
(In thousands)   Direct   Companies   Companies   Amount   to Net

 
 
 
 
 
December 31, 2003
                                       
Premiums for the year
                                       
Property and Liability Insurance
  $ 644,286     $ 654,841     $ 202,147     $ 191,592       105.5 %
 
   
     
     
     
     
 
December 31, 2002
                                       
Premiums for the year
                                       
Property and Liability Insurance
  $ 531,479     $ 541,888     $ 174,367     $ 163,958       106.3 %
 
   
     
     
     
     
 
December 31, 2001
                                       
Premiums for the year
                                       
Property and Liability Insurance
  $ 432,307     $ 439,698     $ 145,039     $ 137,648       105.4 %
 
   
     
     
     
     
 

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SCHEDULE VI — SUPPLEMENTAL INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS

                                     
        Deferred                        
        Policy   Reserves for   Discount, if        
        Acquisition   Unpaid Loss & LAE   any deducted   Unearned
        Costs   Expenses   from reserves*   Premiums
       
 
 
 
(In Thousands)
                               
   
@ 12/31/03
                               
Consolidated P&C Entities
  $ 16,761     $ 845,536     $ 3,303     $ 449,606  
Unconsolidated P&C Entities
    0       0       0       0  
Proportionate share of registrant & subsidiaries
    0       0       0       0  
 
   
     
     
     
 
 
Total
  $ 16,761     $ 845,536     $ 3,303     $ 449,606  
 
   
     
     
     
 
   
@ 12/31/02
                               
Consolidated P&C Entities
  $ 21,713     $ 717,015     $ 2,655     $ 393,091  
Unconsolidated P&C Entities
    0       0       0       0  
Proportionate share of registrant & subsidiaries
    0       0       0       0  
 
   
     
     
     
 
 
Total
  $ 21,713     $ 717,015     $ 2,655     $ 393,091  
 
   
     
     
     
 
   
@ 12/31/01
                               
Consolidated P&C Entities
  $ 17,018     $ 557,278     $ 2,390     $ 311,969  
Unconsolidated P&C Entities
    0       0       0       0  
Proportionate share of registrant & subsidiaries
    0       0       0       0  
 
   
     
     
     
 
 
Total
  $ 17,018     $ 557,278     $ 2,390     $ 311,969  
 
   
     
     
     
 


*   Workers’ compensation case and incurred but not reported (IBNR) loss and loss adjustment reserves were discounted at 2.5% for all years presented.

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SCHEDULE VI — SUPPLEMENTAL INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS (CONTINUED)

                                                             
                        Loss and Loss Adjustment Expense   Amortization                
                Net   Incurred   Related to   of Deferred   Net        
        Earned   Investment   (1)   (2)   Policy   Loss & LAE   Premiums
        Premiums   Income   Current Year   Prior Years   Acquisition Costs   Paid   Written
       
 
 
 
 
 
 
(In Thousands)
                                                       
 
@ 12/31/03
                                                     
Consolidated P&C Entities
  $
191,592
    $ 23,398     $ 154,816     ($ 1,832 )   $ 38,647     $ 134,365     $ 204,694  
Unconsolidated P&C Entities
   
0
      0       0       0       0       0       0  
Proportionate share of registrant & subsidiaries
   
0
      0       0       0       0       0       0  
 
   
     
     
     
     
     
     
 
 
Total
  $
191,592
    $ 23,398     $ 154,816     ($ 1,832 )   $ 38,647     $ 134,365     $ 204,694  
 
   
     
     
     
     
     
     
 
 
@ 12/31/02
                                                     
Consolidated P&C Entities
  $
163,958
    $ 13,289     $ 133,787     $ 5,438     $ 29,928     $ 118,800     $ 181,013  
Unconsolidated P&C Entities
   
0
      0       0       0       0       0       0  
Proportionate share of registrant & subsidiaries
   
0
      0       0       0       0       0       0  
 
   
     
     
     
     
     
     
 
 
Total
  $
163,958
    $ 13,289     $ 133,787     $ 5,438     $ 29,928     $ 118,800     $ 181,013  
 
   
     
     
     
     
     
     
 
 
@ 12/31/01
                                                     
Consolidated P&C Entities
  $
137,648
    $ 17,071     $ 111,258     $ 5,943     $ 24,276     $ 100,840     $ 146,936  
Unconsolidated P&C Entities
   
0
      0       0       0       0       0       0  
Proportionate share of registrant & subsidiaries
   
0
      0       0       0       0       0       0  
 
   
     
     
     
     
     
     
 
 
Total
  $
137,648
    $ 17,071     $ 111,258     $ 5,943     $ 24,276     $ 100,840     $ 146,936  
 
   
     
     
     
     
     
     
 

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EXHIBIT INDEX

(Pursuant to Item 601 of Regulation S-K)

             
        Sequentially
Exhibit       Numbered
Number   Description of Exhibit   Page

 
 
3.1*   Articles of Incorporation of Registrant
     
3.2**   Amended and Restated By-laws of Registrant
     
3.3##   Amended and Restated By-laws of Registrant dated March 9, 1999
     
3.4@   Amended and Restated By-laws of Registrant effective September 9, 2002
     
3.5$   Amended and Restated By-laws of Registrant Section 2.07(a) effective September 9, 2003
     
4A*   Form of Registrant’s Class A Common Stock certificate
     
4B*   Form of Registrant’s Class B Common Stock certificate
     
10.1***   Retirement Plan for Employees of Erie Insurance Group, effective as of December 31, 1989
     
10.2***   Restatement of Supplemental Retirement Plan for Certain Members of the Erie Insurance Group Retirement Plan for Employees, effective as of January 1, 1990
     
10.3***   Deferred Compensation Plan of Registrant
     
10.4***   Retirement Plan for Outside Directors of Registrant, effective as of January 1, 1991
     
10.5***   Employee Savings Plan of Erie Insurance Group, effective as of April 1, 1992
     
10.6***   Amendment to Employee Savings Plan of Erie Insurance Group
     
10.7***   Supplemental 401(k) Plan of Erie Insurance Group effective as of January 1, 1994
     
10.8***   Service Agreement dated January 1, 1989 between Registrant and Erie Insurance Company
     
10.9***   Service Agreement dated June 21, 1993 between Registrant and Erie Insurance Property & Casualty Company
     

31


Table of Contents

             
        Sequentially
Exhibit       Numbered
Number   Description of Exhibit   Page

 
 
10.10***   Service Agreement dated June 21, 1993 between Registrant and Flagship City Insurance Company
     
10.11***   Reinsurance Pooling Agreement dated January 1, 1992 between Erie Insurance Company and Erie Insurance Exchange
     
10.12***   Form of Subscriber’s Agreement whereby policyholders of Erie Insurance Exchange appoint Registrant as their Attorney-in-Fact
     
10.13*   Stock Redemption Plan of Registrant dated December 14, 1989
     
10.14*   Stock Purchase Agreement dated December 20, 1991, between Registrant and Erie Insurance Exchange relating to the capital stock of Erie Insurance Company
     
10.15**   Property Catastrophe Excess of Loss Reinsurance Agreement dated January 1, 1994 between Erie Insurance Exchange and Erie Insurance Co.
     
10.16****   Stock Redemption Plan of Registrant restated as of December 12, 1995
     
10.17****   Property Catastrophe Excess of Loss Reinsurance Agreement dated January 1, 1995 between Erie Insurance Exchange and Erie Insurance Company of New York
     
10.18****   Service Agreement dated January 1, 1995 between Registrant and Erie Insurance Company of New York
     
10.19*****   Consulting Agreement for Investing Services dated January 2, 1996 between Erie Indemnity Company and John M. Petersen
     
10.20*****   Agreement dated April 29, 1994 between Erie Indemnity Company and Thomas M. Sider
     
10.21******   Aggregate Excess of Loss Reinsurance Agreement effective January 1, 1997 between Erie Insurance Exchange, by and through its Attorney-in-Fact, Erie Indemnity Company and Erie Insurance Company and its wholly-owned subsidiary Erie Insurance Company of New York
     
10.22#   1997 Annual Incentive Plan of Erie Indemnity Company

32


Table of Contents

             
        Sequentially
Exhibit       Numbered
Number   Description of Exhibit   Page

 
 
10.23#   Erie Indemnity Company Long-Term Incentive Plan
     
10.24#   Employment Agreement dated December 16, 1997 by and between Erie Indemnity Company and Stephen A. Milne
     
10.25#   Employment Agreement dated December 16, 1997 by and between Erie Indemnity Company and Jan R. Van Gorder
     
10.26#   Employment Agreement dated December 16, 1997 by and between Erie Indemnity Company and Philip A. Garcia
     
10.27#   Employment Agreement effective December 16, 1997 by and between Erie Indemnity Company and John J. Brinling, Jr.
     
10.28###   Employment Agreement effective June 30, 1999 by and between Erie Indemnity Company and Jeffrey A. Ludrof
     
10.29###   Employment Agreement effective December 15, 1999 By and between Erie Indemnity Company and Douglas F. Ziegler
     
10.30###   Addendum to Employment Agreement effective December 15, 1999 by and between Erie Indemnity Company and Stephen A. Milne
     
10.31###   Addendum to Employment Agreement effective December 15, 1999 by and between Erie Indemnity Company and Jan R. Van Gorder
     
10.32###   Addendum to Employment Agreement effective December 15, 1999 by and between Erie Indemnity Company and Philip A. Garcia
     
10.33###   Addendum to Employment Agreement effective December 15, 1999 by and between Erie Indemnity Company and John J. Brinling, Jr.
     
10.34###   Addendum to Employment Agreement effective December 15, 1999 by and between Erie Indemnity Company and Jeffrey A. Ludrof
     
10.35&   Addendum to Employment Agreement effective December 15, 2000 by and between Erie Indemnity Company and Stephen A. Milne
     
10.36&   Addendum to Employment Agreement effective December 15, 2000 by and between Erie Indemnity Company and Jan R. Van Gorder

33


Table of Contents

             
        Sequentially
Exhibit       Numbered
Number   Description of Exhibit   Page

 
 
10.37&   Addendum to Employment Agreement effective December 15, 2000 by and between Erie Indemnity Company and Philip A. Garcia
     
10.38&   Addendum to Employment Agreement effective December 15, 2000 by and between Erie Indemnity Company and John J. Brinling, Jr.
     
10.39&   Addendum to Employment Agreement effective December 15, 2000 by and between Erie Indemnity Company and Jeffrey A. Ludrof
     
10.40&   Addendum to Employment Agreement effective December 15, 2000 by and between Erie Indemnity Company and Douglas F. Ziegler
     
10.41&&   Cost Sharing Agreement for Information Technology Development dated March 14, 2001 between Registrant and member companies of the Erie Insurance Group
     
10.42&&&   Addendum to Employment Agreement effective December 12, 2001 by and between Erie Indemnity Company and Stephen A. Milne
     
10.43&&&   Addendum to Employment Agreement effective December 12, 2001 by and between Erie Indemnity Company and Jan R. Van Gorder
     
10.44&&&   Addendum to Employment Agreement effective December 12, 2001 by and between Erie Indemnity Company and Philip A. Garcia
     
10.45&&&   Addendum to Employment Agreement effective December 12, 2001 by and between Erie Indemnity Company and John J. Brinling, Jr.
     
10.46&&&   Addendum to Employment Agreement effective December 12, 2001 by and between Erie Indemnity Company and Jeffrey A. Ludrof
     
10.47&&&   Addendum to Employment Agreement effective December 12, 2001 by and between Erie Indemnity Company and Douglas F. Ziegler
     
10.48&&&   Summary of termination benefits provided under the Employment Agreement effective January 18, 2002 by and and between Erie Indemnity Company and Stephen A. Milne
     
10.49@   Amended and Restated Service Agreement between Registrant and Erie Insurance Company effective January 1, 1992

34


Table of Contents

             
        Sequentially
Exhibit       Numbered
Number   Description of Exhibit   Page

 
 
10.50@   Amended and Restated Supplemental Retirement Plan for Certain Members of the Erie Insurance Group Retirement Plan for Employees, effective December 31, 1995
     
10.51@   Amended and Restated Reinsurance Pooling Agreement effective January 1, 1995 between Erie Insurance Company and its wholly-owned subsidiary Erie Insurance Company of New York and Erie Insurance Exchange
     
10.52@   Amended and Restated Aggregate Excess of Loss Reinsurance Contract effective January 1, 1998 between Erie Insurance Exchange, by and through its Attorney-in-Fact, Erie Indemnity Company and Erie Insurance Company and its wholly-owned subsidiary Erie Insurance Company of New York
     
10.53@   Amended and Restated Retirement Plan for Employees of Erie Insurance Group, effective December 31, 2000
     
10.54@   Amended and Restated Deferred Compensation Plan from Outside Directors of Registrant, effective January 1, 2001
     
10.55@   Amended and Restated Employee Savings Plan of Erie Insurance Group, effective January 1, 2001
     
10.56@   First Amendment and Restatement to Employee Savings Plan of Erie Insurance Group effective January 1, 2001
     
10.57@   2001 Annual Incentive Plan of Erie Indemnity Company
     
10.58@   Amended and Restated Deferred Compensation Plan for Outside Directors of Registrant effective April 30, 2002
     
10.59@   Employment Agreement effective May 9, 2002 by and between Erie Indemnity Company and Jeffrey A. Ludrof
     
10.60@   Form of Subscriber’s Agreement whereby policyholders of Erie Insurance Exchange Appoint Registrant as their Attorney-in-Fact
     
10.61@@   Employment Agreement effective December 15, 2002 by and between Erie Indemnity Company and Michael J. Krahe
     
10.62@@   Employment Agreement effective December 15, 2002 by and between Erie Indemnity Company and Thomas B. Morgan

35


Table of Contents

             
        Sequentially
Exhibit       Numbered
Number   Description of Exhibit   Page

 
 
10.63@@   Addendum to Employment Agreement effective December 12, 2002 by and between Erie Indemnity Company and John J. Brinling, Jr.
     
10.64@@   Addendum to Employment Agreement effective December 12, 2002 by and between Erie Indemnity Company and Philip A. Garcia
     
10.65@@   Addendum to Employment Agreement effective December 12, 2002 by and between Erie Indemnity Company and Jan R. Van Gorder
     
10.66@@   Addendum to Employment Agreement effective December 12, 2002 by and between Erie Indemnity Company and Douglas F. Ziegler
     
10.67@@@   Addendum to Aggregate Excess of Loss Reinsurance Contract effective January 1, 2003 between Erie Insurance Exchange, by and through its Attorney-in-Fact, Erie Indemnity Company and Erie Insurance Company and its wholly-owned subsidiary Erie Insurance Company of New York
     
10.68   Addendum to Aggregate Excess of Loss Reinsurance Contract effective January 1, 2004 between Erie Insurance Exchange, by and through its Attorney-in-Fact, Erie Indemnity Company and Erie Insurance Company and its wholly-owned subsidiary Erie Insurance Company of New York   39
     
10.69   Addendum to Employment Agreement effective December 12, 2003 by and between Erie Indemnity Company and John J. Brinling, Jr.   41
     
10.70   Addendum to Employment Agreement effective December 12, 2003 by and between Erie Indemnity Company and Thomas B. Morgan   42
     
10.71   Addendum to Employment Agreement effective December 12, 2003 by and between Erie Indemnity Company and Michael J. Krahe   43
     
10.72   Addendum to Employment Agreement effective December 12, 2003 by and between Erie Indemnity Company and Jeffrey A. Ludrof   44
     
10.73   Addendum to Employment Agreement effective December 12, 2003 by and between Erie Indemnity Company and Philip A. Garcia   45
     
10.74   Addendum to Employment Agreement effective December 12, 2003 by and between Erie Indemnity Company and Jan R. Van Gorder   46

36


Table of Contents

         
        Sequentially
Exhibit       Numbered
Number   Description of Exhibit   Page

 
 
10.75   Addendum to Employment Agreement effective December 12, 2003 by and between Erie Indemnity Company and Douglas F. Ziegler   47
         
10.76   Insurance bonus agreement effective December 23, 2003 by and between Erie Indemnity Company and Jeffrey A. Ludrof   48
         
10.77   Insurance bonus agreement effective December 23, 2003 by and between Erie Indemnity Company and Jeffrey A. Ludrof   51
         
10.78   Insurance bonus agreement effective December 23, 2003 by and between Erie Indemnity Company and John J. Brinling, Jr.   54
         
10.79   Insurance bonus agreement effective December 23, 2003 by and between Erie Indemnity Company and Jan R. Van Gorder   57
         
10.80   Insurance bonus agreement effective December 23, 2003 by and between Erie Indemnity Company and Michael J. Krahe   60
         
10.81   Insurance bonus agreement effective December 23, 2003 by and between Erie Indemnity Company and Philip A. Garcia   62
         
10.82   Insurance bonus agreement effective December 23, 2003 by and between Erie Indemnity Company and Thomas B. Morgan   65
         
13   2003 Annual Report to Shareholders. Reference is made to the Annual Report furnished to the Commission, herewith   67
         
14   Code of Conduct   120
         
16@@   Letter re Change in Certifying Accountant    
         
21   Subsidiaries of Registrant   131
         
23   Independent Auditors' Consent and Report on Schedules   132
         
31.1   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes - Oxley Act of 2002   133
         
31.2   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes - Oxley Act of 2002   134
         
32   Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002   135
         
99.1##   Report of the Special Committee to the Board of Directors    
         
99.4@   First Amendment to Second Restated Agreement of H.O. Hirt Trust effective December 22, 1980    
     

37


Table of Contents

 
     
     
*   Such exhibit is incorporated by reference to the like numbered exhibit in Registrant’s Form 10 Registration Statement Number
0-24000 filed with the Securities and Exchange Commission on May 2, 1994.
     
**   Such exhibit is incorporated by reference to the like numbered exhibit in Registrant’s Form 10/A Registration Statement Number 0-24000 filed with the Securities and Exchange Commission on August 3, 1994.
     
***   Such exhibit is incorporated by reference to the like titled but renumbered exhibit in Registrant’s Form 10 Registration Statement Number 0-24000 filed with the Securities and Exchange Commission on May 2, 1994.
     
****   Such exhibit is incorporated by reference to the like titled exhibit in the Registrant’s Form 10-K annual report for the year ended December 31, 1995 that was filed with the Commission on March 25, 1996.
     
*****   Such exhibit is incorporated by reference to the like titled exhibit in the Registrant’s Form 10-K/A amended annual report for the year ended December 31, 1995 that was filed with the Commission on April 25, 1996.
     
******   Such exhibit is incorporated by reference to the like titled exhibit in the Registrant’s Form 10-K annual report for the year ended December 31, 1996 that was filed with the Commission on March 21, 1997.
     
#   Such exhibit is incorporated by reference to the like titled exhibit in the Registrant’s Form 10-K annual report for the year ended December 31, 1997 that was filed with the Commission on March 25, 1998.
     
##   Such exhibit is incorporated by reference to the like titled exhibit in the Registrant’s Form 10-K annual report for the year ended December 31, 1998 that was filed with the Commission on March 30, 1999.
     
###   Such exhibit is incorporated by reference to the like titled exhibit in the Registrant’s Form 10-K annual report for the year ended December 31, 1999 that was filed with the Commission on March 23, 2000.
     
&   Such exhibit is incorporated by reference to the like titled exhibit in the Registrant’s Form 10-K annual report for the year ended December 31, 2000 that was filed with the Commission on March 23, 2001.
     
&&   Such exhibit is incorporated by reference to the like titled exhibit in the Registrant’s Form 10-Q quarterly report for the quarter ended June 30, 2001 that was filed with the Commission on July 17, 2001.
     
&&&   Such exhibit is incorporated by reference to the like titled exhibit in the Registrant’s Form 10-K annual report for the year ended December 31, 2001 that was filed with the Commission on March 12, 2002.
     
@   Such exhibit is incorporated by reference to the like titled exhibit in the Registrant’s Form 10-Q/A quarterly report for the quarter ended September 30, 2002 that was filed with the Commission on January 27, 2003.
     
@@   Such exhibit is incorporated by reference to the like titled exhibit in the Registrant’s Form 10-K annual report for the year ended December 31, 2002 that was filed with the Commission on March 27, 2003.
     
@@@   Such exhibit is incorporated by reference to the like titled exhibit in the Registrant’s Form 10-Q quarterly report for the quarter ended March 31, 2003 that was filed with the Commission on April 24, 2003.
     
$   Such exhibit is incorporated by reference to the like titled exhibit in the Registrant’s Form 10-Q quarterly report for the quarter ended September 30, 2003 that was filed with the Commission on October 29, 2003.

38


 
 
 

Exhibit 10.68

ERIE INSURANCE COMPANY and
ERIE INSURANCE COMPANY OF NEW YORK
Erie, Pennsylvania

AGGREGATE EXCESS OF LOSS REINSURANCE

ADDENDUM NO. 3

Amendment to the REINSURANCE CONTRACT made the first day of January, 1998, between ERIE INSURANCE EXCHANGE, by and through its Attorney-in-Fact, ERIE INDEMNITY COMPANY, of Erie, Pennsylvania, (hereafter called the “REINSURER”), and ERIE INSURANCE COMPANY and its wholly owned subsidiary ERIE INSURANCE COMPANY OF NEW YORK, both of Erie, Pennsylvania (herein referred to collectively (or individually as the context requires) as the “COMPANY”)

It is understood and agreed that, effective January 1, 2004, this Contract is amended by the deletion of Article 12 and by substitution of the following revised Article 12:

ARTICLE 12 – Premium

The premium for this reinsurance shall be 1.70% of the subject Net Premiums earned by the COMPANY during any Annual Period this Reinsurance Contract remains in force, and shall be subject to a minimum premium of $2,992,000 for each Annual Period.

The COMPANY shall pay to the REINSURER a deposit premium of $3,366,000 for each Annual Period which shall be payable in equal installments of $1,683,000 each on the first days of January and July during the period this Reinsurance Contract remains in force. Final adjustment of the premium for each Annual Period hereunder shall be made as soon as may be reasonably practicable after expiration of that Annual Period.

39


 

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their duly authorized representatives.

In Erie, Pennsylvania, this 28th day of January, 2004.

                 
            ERIE INSURANCE COMPANY
    ATTEST:      
    /s/ Sheila Hirsch   /s/ Jan R. Van Gorder
   
 
      Sheila Hirsch     Jan R. Van Gorder
      Executive Secretary     Senior Executive Vice President
              Secretary & General Counsel
                 
            ERIE INSURANCE COMPANY
            OF NEW YORK
                 
    ATTEST:      
    /s/ Cori Coccarelli   /s/ Philip A. Garcia
   
 
      Cori Coccarelli     Philip A. Garcia
      Executive Secretary     Executive Vice President and
              Chief Financial Officer
                 
            ERIE INSURANCE EXCHANGE, by
             ERIE INDEMNITY COMPANY,
            Attorney-in-Fact
                 
    ATTEST:        
    /s/ Pamela D. Carullo   /s/ Michael S. Zavasky
   
 
      Pamela D. Carullo     Michael S. Zavasky
      Administrative Assistant     Senior Vice President

40

 
 
 

Exhibit 10.69

ADDENDUM TO EMPLOYMENT AGREEMENT

     This Addendum (the “Addendum”) is made effective as of the 12th day of December, 2003 and is intended to amend a certain Employment Agreement (the “Agreement”) by and between Erie Indemnity Company and John J. Brinling, Jr. effective as of December 16, 1997.

     WHEREAS, the Company has determined that it is in the best interest of the Company and its Shareholders to secure the continued employment of the Executive in accordance with the terms of the Agreement; and

     WHEREAS, the Board of Directors of the Company has previously considered and agreed to extend the term of the Agreement from its original term; and

     WHEREAS, the Board of Directors of the Company at its meeting of December 9, 2003 has again agreed to extend the term of the Agreement for a period of one (1) additional year as contained herein; and

     WHEREAS, the Executive is agreeable to the extension of the Agreement.

     NOW, THEREFORE, intending to be legally bound hereby, the parties agree as follows:

     1.     Paragraph 1 of the Agreement with respect to the Term is hereby amended by extending the Term to expire on December 15, 2005.

     2.     All other terms and conditions of the Agreement remain in full force and effect.

                 
    ATTEST:   ERIE INDEMNITY COMPANY
                 
    /s/ Jan R. Van Gorder By:   /s/ F. William Hirt
   
   
      Jan R. Van Gorder       F. William Hirt
      Secretary       Chairman of the Board
                 
    WITNESS:        
    /s/ Julie Krasinski     /s/ John J. Brinling, Jr.
   
   
      Julie Krasinski       John J. Brinling, Jr.
      Executive Secretary       5691 Culpepper Drive
                Erie, PA 16506

41

 
 
 

Exhibit 10.70

ADDENDUM TO EMPLOYMENT AGREEMENT

     This Addendum (the “Addendum”) is made effective as of the 12th day of December, 2003 and is intended to amend a certain Employment Agreement (the “Agreement”) by and between Erie Indemnity Company and Thomas B. Morgan effective as of December 15, 2002.

     WHEREAS, the Company has determined that it is in the best interest of the Company and its Shareholders to secure the continued employment of the Executive in accordance with the terms of the Agreement; and

     WHEREAS, the Board of Directors of the Company at its meeting of December 9, 2003 has again agreed to extend the term of the Agreement for a period of one (1) additional year as contained herein; and

     WHEREAS, the Executive is agreeable to the extension of the Agreement.

     NOW, THEREFORE, intending to be legally bound hereby, the parties agree as follows:

     1.     Paragraph 1 of the Agreement with respect to the Term is hereby amended by extending the Term to expire on December 15, 2005.

     2.     All other terms and conditions of the Agreement remain in full force and effect.

                 
    ATTEST:   ERIE INDEMNITY COMPANY
                 
    /s/   Jan R. Van Gorder   By:   /s/   F. William Hirt
   
   
      Jan R. Van Gorder       F. William Hirt
      Secretary       Chairman of the Board
                 
    WITNESS:        
                 
    /s/   Jeffrey A. Ludrof     /s/   Thomas B. Morgan
   
   
      Jeffrey A. Ludfrof       Thomas B. Morgan
      President and Chief Executive Officer       6378 Echo Hill Lane
                Fairview, PA 16415

42

 
 
 

Exhibit 10.71

ADDENDUM TO EMPLOYMENT AGREEMENT

     This Addendum (the “Addendum”) is made effective as of the 12th day of December, 2003 and is intended to amend a certain Employment Agreement (the “Agreement”) by and between Erie Indemnity Company and Michael J. Krahe effective as of December 15, 2002.

     WHEREAS, the Company has determined that it is in the best interest of the Company and its Shareholders to secure the continued employment of the Executive in accordance with the terms of the Agreement; and

     WHEREAS, the Board of Directors of the Company at its meeting of December 9, 2003 has again agreed to extend the term of the Agreement for a period of one (1) additional year as contained herein; and

     WHEREAS, the Executive is agreeable to the extension of the Agreement.

     NOW, THEREFORE, intending to be legally bound hereby, the parties agree as follows:

     1.     Paragraph 1 of the Agreement with respect to the Term is hereby amended by extending the Term to expire on December 15, 2005.

     2.     All other terms and conditions of the Agreement remain in full force and effect.

                     
    ATTEST:       ERIE INDEMNITY COMPANY
                     
    /s/   Jan R. Van Gorder       By:   /s/   F. William Hirt
   
       
        Jan R. Van Gorder           F. William Hirt
        Secretary           Chairman of the Board
                     
    WITNESS:            
                     
    /s/   Kathleen E. Skelton         /s/ Michael J. Krahe
   
       
        Kathleen E. Skelton           Michael J. Krahe
        Executive Secretary           4516 Cedarwood Ct.
                    Erie, PA 16506

43

 
 
 

Exhibit 10.72

ADDENDUM TO EMPLOYMENT AGREEMENT

     This Addendum (the “Addendum”) is made effective as of the 12th day of December, 2003 and is intended to amend a certain Employment Agreement (the “Agreement”) by and between Erie Indemnity Company and Jeffrey A. Ludrof effective as of May 9, 2002.

     WHEREAS, the Company has determined that it is in the best interest of the Company and its Shareholders to secure the continued employment of the Executive in accordance with the terms of the Agreement; and

     WHEREAS, the Board of Directors of the Company at its meeting of December 9, 2003 has again agreed to extend the term of the Agreement for an additional period of time as contained herein; and

     WHEREAS, the Executive is agreeable to the extension of the Agreement.

     NOW, THEREFORE, intending to be legally bound hereby, the parties agree as follows:

     1.     Paragraph 1 of the Agreement with respect to the Term is hereby amended by extending the Term to expire on December 15, 2007.

     2.     All other terms and conditions of the Agreement remain in full force and effect.

                 
    ATTEST:   ERIE INDEMNITY COMPANY
                 
    /s/   Jan R. Van Gorder   By:   /s/   F. William Hirt
   
   
        Jan R. Van Gorder       F. William Hirt
        Secretary       Chairman of the Board
                 
        WITNESS:        
                 
    /s/   Sheila M. Hirsch     /s/   Jeffrey A. Ludrof
   
   
        Sheila M. Hirsch       Jeffrey A. Ludrof
        Executive Secretary       5700 Stoneridge Drive
                Fairview, PA 16415

44

 
 
 

Exhibit 10.73

ADDENDUM TO EMPLOYMENT AGREEMENT

     This Addendum (the “Addendum”) is made effective as of the 12th day of December, 2003 and is intended to amend a certain Employment Agreement (the “Agreement”) by and between Erie Indemnity Company and Philip A. Garcia effective as of December 16, 1997.

     WHEREAS, the Company has determined that it is in the best interest of the Company and its Shareholders to secure the continued employment of the Executive in accordance with the terms of the Agreement; and

     WHEREAS, the Board of Directors of the Company has previously considered and agreed to extend the term of the Agreement from its original term; and

     WHEREAS, the Board of Directors of the Company at its meeting of December 9, 2003 has again agreed to extend the term of the Agreement for a period of one (1) additional year as contained herein; and

     WHEREAS, the Executive is agreeable to the extension of the Agreement.

     NOW, THEREFORE, intending to be legally bound hereby, the parties agree as follows:

     1.     Paragraph 1 of the Agreement with respect to the Term is hereby amended by extending the Term to expire on December 15, 2005.

     2.     All other terms and conditions of the Agreement remain in full force and effect.

                 
    ATTEST:   ERIE INDEMNITY COMPANY
                 
    /s/   Jan R. Van Gorder   By:   /s/   F. William Hirt
   
   
        Jan R. Van Gorder       F. William Hirt
        Secretary       Chairman of the Board
                 
        WITNESS:        
                 
    /s/   Cori Coccarelli     /s/   Philip A. Garcia
   
   
        Cori Coccarelli       Philip A. Garcia
        Executive Secretary       786 Stockbridge Drive
                Erie, PA 16505

45

 
 
 

Exhibit 10.74

ADDENDUM TO EMPLOYMENT AGREEMENT

     This Addendum (the “Addendum”) is made effective as of the 12th day of December, 2003 and is intended to amend a certain Employment Agreement (the “Agreement”) by and between Erie Indemnity Company and Jan R. Van Gorder effective as of December 16, 1997.

     WHEREAS, the Company has determined that it is in the best interest of the Company and its Shareholders to secure the continued employment of the Executive in accordance with the terms of the Agreement; and

     WHEREAS, the Board of Directors of the Company has previously considered and agreed to extend the term of the Agreement from its original term; and

     WHEREAS, the Board of Directors of the Company at its meeting of December 9, 2003 has again agreed to extend the term of the Agreement for a period of one (1) additional year as contained herein; and

     WHEREAS, the Executive is agreeable to the extension of the Agreement.

     NOW, THEREFORE, intending to be legally bound hereby, the parties agree as follows:

     1.     Paragraph 1 of the Agreement with respect to the Term is hereby amended by extending the Term to expire on December 15, 2005.

     2.     All other terms and conditions of the Agreement remain in full force and effect.

                 
    ATTEST:   ERIE INDEMNITY COMPANY
                 
    /s/   Jeffrey A. Ludrof   By:   /s/   F. William Hirt
   
   
        Jeffrey A. Ludrof       F. William Hirt
        President & CEO       Chairman of the Board
                 
    WITNESS:        
                 
    /s/   Sheila M. Hirsch     /s/   Jan R. Van Gorder
   
   
        Sheila M. Hirsch       Jan R. Van Gorder
        Executive Secretary       6796 Manchester Beach Rd.
                Fairview, PA 16415

46

 
 
 

Exhibit 10.75

ADDENDUM TO EMPLOYMENT AGREEMENT

     This Addendum (the “Addendum”) is made effective as of the 12th day of December, 2003 and is intended to amend a certain Employment Agreement (the “Agreement”) by and between Erie Indemnity Company and Douglas F. Ziegler effective as of December 15, 1999.

     WHEREAS, the Company has determined that it is in the best interest of the Company and its Shareholders to secure the continued employment of the Executive in accordance with the terms of the Agreement; and

     WHEREAS, the Board of Directors of the Company at its meeting of December 9, 2003 has again agreed to extend the term of the Agreement for a period of one (1) additional year as contained herein; and

     WHEREAS, the Executive is agreeable to the extension of the Agreement.

     NOW, THEREFORE, intending to be legally bound hereby, the parties agree as follows:

     1.     Paragraph 1 of the Agreement with respect to the Term is hereby amended by extending the Term to expire on December 15, 2005.

     2.     All other terms and conditions of the Agreement remain in full force and effect.

                 
    ATTEST:   ERIE INDEMNITY COMPANY
                 
    /s/   Jan R. Van Gorder   By:   /s/   F. William Hirt
   
   
        Jan R. Van Gorder       F. William Hirt
        Secretary       Chairman of the Board
                 
    WITNESS:        
                 
                 
    /s/   Cori Coccarelli     /s/ Douglas F. Ziegler
   
   
        Cori Coccarelli       Douglas F. Ziegler
        Executive Secretary       378 Ridgeview Drive
                Erie, PA 16505

47

 
 
 

Exhibit 10.76

INSURANCE BONUS AGREEMENT

This Agreement (“Agreement”) made this 23rd day of December, 2003 by and between Erie Indemnity Company, a Pennsylvania business corporation (the “Employer”), and Jeffrey A. Ludrof (the “Executive”).

WHEREAS, The Company and the Executive had previously entered into a Split Dollar Insurance Agreement, a copy of which is attached to this Agreement; and

WHEREAS, under the terms of the Split Dollar Insurance Agreement, the parties may mutually agree to terminate such contract; and

WHEREAS, the Employer and the Executive believe it is in their mutual interests to terminate the Split Dollar Agreement because of specific but separate provisions of the Sarbanes-Oxley Act of 2002 with respect to the prohibition of loans to officers or directors of a public company, and U. S. Department of Treasury regulations (published September 17, 2003) with respect to the taxation of split dollar arrangements; and

WHEREAS, based on consideration of the Sarbanes-Oxley Act and Department of Treasury regulations, it was the recommendation of the Executive Compensation and Development Committee of Erie Indemnity Company’s Board of Directors to terminate the Split Dollar Agreement and replace it with this Insurance Bonus Agreement, which recommendation was accepted and approved by the Board of Directors of Erie Indemnity Company at its meeting of December 9, 2003; and

NOW, THEREFORE, intending to be legally bound hereby, the Employer and the Executive agree as follows:

  1.   The Split Dollar Agreement as attached to this policy is hereby mutually agreed to be terminated effective upon the execution of this Agreement. The life insurance policy issued with respect to the Split Dollar Agreement shall remain in full force and effect, and the Executive shall remain the owner of such policy. Any premium loans due and owing to the Employer by the Executive shall be paid in full from the accumulated cash value in the policy as soon as practicable after the execution of this Agreement by the parties.

48


 

  2.   The Employer agrees to pay all premiums on life insurance Policy No. 15-145-189 insuring Executive’s life issued by the Northwestern Mutual Life Insurance Company of Milwaukee, Wisconsin necessary to pay up the policy such that no further premium would be required under current dividend assumptions which contemplate that the policy would be paid up fifteen (15) years after its issuance date; provided, that in the event the Employee remains continuously employed with the Employer for at least fifteen (15) years from the date of the policy issuance, dividends at that point in time should be sufficient to pay all future premiums; and no further premium payments would be required by the Employer. In the event that dividends are not sufficient to pay future premium at the end of the fifteen (15) year period, then the Employer shall continue making such premium payments as are necessary to continue the policy in force so long as Employee remains employed with Employer. No contributions toward the payment of premiums by the Executive are required.
 
  3.   The Executive will execute an endorsement on the policy restricting the Executive’s right to (a) surrender the policy for its cash value, (b) obtain a policy loan from the insurance company, (c) assign the policy as collateral, (d) change the ownership of the policy by endorsement or assignment, except for a change in ownership to a trust or similar entity for estate tax planning purposes for the benefit of Executive, his heirs or assigns, or (e) change insured. Such endorsement shall remain in effect for the benefit of the Employer so long as the Executive remains continuously employed with Employer for fifteen (15) years from the date of policy issuance at which time the Company shall execute a release of such endorsement. If employment is terminated, the Executive shall have all rights under the policy without restriction and the Company shall execute a release of such endorsement.
 
  4.   The Employer shall not be entitled to receive any benefits under the policy.
 
  5.   The Executive shall recognize the premium paid hereunder as additional compensation for federal income tax purposes.
 
  6.   The Employer shall, in addition to the premium payment, annually increase the Executive’s normal compensation by an amount determined by the following formula: P/1-X where P equals premium paid by the Employer on the policy pursuant to this Agreement and X equals the Executive’s marginal Federal income tax bracket for such year plus the tax rate for any of the following that may be applicable:
 
  i.   Pennsylvania income tax;
 
  ii.   Employee portion of Pennsylvania unemployment tax;
 
  iii.   Local income tax;
 
  iv.   Employee portion of FICA OASDI; and
 
  v.   Employee portion of FICA Medicare.

49


 

  7.   This Agreement is being delivered and is intended to be performed in Pennsylvania and shall be construed and enforced in accordance with the laws of Pennsylvania.
 
  8.   This Agreement is the entire understanding among the parties and may be altered, amended or revoked only by subsequent written instrument executed by all parties.

WITNESS WHEREOF the parties have executed this Agreement this 23rd day of December, 2003.

         
    By:   /s/ Philip A. Garcia
       
(Corporate Seal)       Philip A. Garcia, Executive Vice President
         
    Attest:   /s/ Jan R. Van Gorder
       
        Jan R. Van Gorder, Secretary
         
        /s/ Jeffrey A. Ludrof
       
        Employee

50

 
 
 

Exhibit 10.77

INSURANCE BONUS AGREEMENT

This Agreement (“Agreement”) made this 23rd day of December, 2003 by and between Erie Indemnity Company, a Pennsylvania business corporation (the “Employer”), and Jeffrey A. Ludrof (the “Executive”).

WHEREAS, The Company and the Executive had previously entered into a Split Dollar Insurance Agreement, a copy of which is attached to this Agreement; and

WHEREAS, under the terms of the Split Dollar Insurance Agreement, the parties may mutually agree to terminate such contract; and

WHEREAS, the Employer and the Executive believe it is in their mutual interests to terminate the Split Dollar Agreement because of specific but separate provisions of the Sarbanes-Oxley Act of 2002 with respect to the prohibition of loans to officers or directors of a public company, and U. S. Department of Treasury regulations (published September 17, 2003) with respect to the taxation of split dollar arrangements; and

WHEREAS, based on consideration of the Sarbanes-Oxley Act and Department of Treasury regulations, it was the recommendation of the Executive Compensation and Development Committee of Erie Indemnity Company’s Board of Directors to terminate the Split Dollar Agreement and replace it with this Insurance Bonus Agreement, which recommendation was accepted and approved by the Board of Directors of Erie Indemnity Company at its meeting of December 9, 2003; and

NOW, THEREFORE, intending to be legally bound hereby, the Employer and the Executive agree as follows:

  1.   The Split Dollar Agreement as attached to this policy is hereby mutually agreed to be terminated effective upon the execution of this Agreement. The life insurance policy issued with respect to the Split Dollar Agreement shall remain in full force and effect, and the Executive shall remain the owner of such policy. Any premium loans due and owing to the Employer by the Executive shall be paid in full from the accumulated cash value in the policy as soon as practicable after the execution of this Agreement by the parties.

51


 

  2.   The Employer agrees to pay all premiums on life insurance Policy No. 16-176-764 insuring Executive’s life issued by the Northwestern Mutual Life Insurance Company of Milwaukee, Wisconsin necessary to pay up the policy such that no further premium would be required under current dividend assumptions which contemplate that the policy would be paid up twelve (12) years after its issuance date; provided, that in the event the Employee remains continuously employed with the Employer for at least twelve (12) years from the date of the policy issuance, dividends at that point in time should be sufficient to pay all future premiums; and no further premium payments would be required by the Employer. In the event that dividends are not sufficient to pay future premium at the end of the twelve (12) year period, then the Employer shall continue making such premium payments as are necessary to continue the policy in force so long as Employee remains employed with Employer. No contributions toward the payment of premiums by the Executive are required.
 
  3.   The Executive will execute an endorsement on the policy restricting the Executive’s right to (a) surrender the policy for its cash value, (b) obtain a policy loan from the insurance company, (c) assign the policy as collateral, (d) change the ownership of the policy by endorsement or assignment, except for a change in ownership to a trust or similar entity for estate tax planning purposes for the benefit of Executive, his heirs or assigns, or (e) change insured. Such endorsement shall remain in effect for the benefit of the Employer so long as the Executive remains continuously employed with Employer for twelve (12) years from the date of policy issuance at which time the Company shall execute a release of such endorsement. If employment is terminated, the Executive shall have all rights under the policy without restriction and the Company shall execute a release of such endorsement.
 
  4.   The Employer shall not be entitled to receive any benefits under the policy.
 
  5.   The Executive shall recognize the premium paid hereunder as additional compensation for federal income tax purposes.
 
  6.   The Employer shall, in addition to the premium payment, annually increase the Executive’s normal compensation by an amount determined by the following formula: P/1-X where P equals premium paid by the Employer on the policy pursuant to this Agreement and X equals the Executive’s marginal Federal income tax bracket for such year plus the tax rate for any of the following that may be applicable:

  i.   Pennsylvania income tax;
 
  ii.   Employee portion of Pennsylvania unemployment tax;
 
  iii.   Local income tax;
 
  iv.   Employee portion of FICA OASDI; and
 
  v.   Employee portion of FICA Medicare.

52


 

  7.   This Agreement is being delivered and is intended to be performed in Pennsylvania and shall be construed and enforced in accordance with the laws of Pennsylvania.
 
  8.   This Agreement is the entire understanding among the parties and may be altered, amended or revoked only by subsequent written instrument executed by all parties.

WITNESS WHEREOF the parties have executed this Agreement this 23rd day of December, 2003.

         
    By:   /s/ Philip A. Garcia
       
(Corporate Seal)        Philip A. Garcia, Executive Vice President
         
    Attest:   /s/ Jan R. Van Gorder
       
          Jan R. Van Gorder, Secretary
         
        /s/ Jeffrey A. Ludrof
       
        Employee

53

 
 
 

Exhibit 10.78

INSURANCE BONUS AGREEMENT

This Agreement (“Agreement”) made this 23rd day of December, 2003 by and between Erie Indemnity Company, a Pennsylvania business corporation (the “Employer”), and John J. Brinling, Jr. (the “Executive”).

WHEREAS, The Company and the Executive had previously entered into a Split Dollar Insurance Agreement, a copy of which is attached to this Agreement; and

WHEREAS, under the terms of the Split Dollar Insurance Agreement, the parties may mutually agree to terminate such contract; and

WHEREAS, the Employer and the Executive believe it is in their mutual interests to terminate the Split Dollar Agreement because of specific but separate provisions of the Sarbanes-Oxley Act of 2002 with respect to the prohibition of loans to officers or directors of a public company, and U. S. Department of Treasury regulations (published September 17, 2003) with respect to the taxation of split dollar arrangements; and

WHEREAS, based on consideration of the Sarbanes-Oxley Act and Department of Treasury regulations, it was the recommendation of the Executive Compensation and Development Committee of Erie Indemnity Company’s Board of Directors to terminate the Split Dollar Agreement and replace it with this Insurance Bonus Agreement, which recommendation was accepted and approved by the Board of Directors of Erie Indemnity Company at its meeting of December 9, 2003; and

NOW, THEREFORE, intending to be legally bound hereby, the Employer and the Executive agree as follows:

  1.   The Split Dollar Agreement as attached to this policy is hereby mutually agreed to be terminated effective upon the execution of this Agreement. The life insurance policy issued with respect to the Split Dollar Agreement shall remain in full force and effect, and the Executive shall remain the owner of such policy. Any premium loans due and owing to the Employer by the Executive shall be paid in full from the accumulated cash value in the policy as soon as practicable after the execution of this Agreement by the parties.

54


 

  2.   The Employer agrees to pay all premiums on life insurance Policy No. 12-342-669 insuring Executive’s life issued by the Northwestern Mutual Life Insurance Company of Milwaukee, Wisconsin necessary to pay up the policy such that no further premium would be required under current dividend assumptions which contemplate that the policy would be paid up nineteen (19) years after its issuance date; provided, that in the event the Employee remains continuously employed with the Employer for at least nineteen (19) years from the date of the policy issuance, dividends at that point in time should be sufficient to pay all future premiums; and no further premium payments would be required by the Employer. In the event that dividends are not sufficient to pay future premium at the end of the nineteen (19) year period, then the Employer shall continue making such premium payments as are necessary to continue the policy in force so long as Employee remains employed with Employer. No contributions toward the payment of premiums by the Executive are required.
 
  3.   The Executive will execute an endorsement on the policy restricting the Executive’s right to (a) surrender the policy for its cash value, (b) obtain a policy loan from the insurance company, (c) assign the policy as collateral, (d) change the ownership of the policy by endorsement or assignment, except for a change in ownership to a trust or similar entity for estate tax planning purposes for the benefit of Executive, his heirs or assigns, or (e) change insured. Such endorsement shall remain in effect for the benefit of the Employer so long as the Executive remains continuously employed with Employer for nineteen (19) years from the date of policy issuance at which time the Company shall execute a release of such endorsement. If employment is terminated, the Executive shall have all rights under the policy without restriction and the Company shall execute a release of such endorsement.
 
  4.   The Employer shall not be entitled to receive any benefits under the policy.
 
  5.   The Executive shall recognize the premium paid hereunder as additional compensation for federal income tax purposes.
 
  6.   The Employer shall, in addition to the premium payment, annually increase the Executive’s normal compensation by an amount determined by the following formula: P/1-X where P equals premium paid by the Employer on the policy pursuant to this Agreement and X equals the Executive’s marginal Federal income tax bracket for such year plus the tax rate for any of the following that may be applicable:

  i.   Pennsylvania income tax;
 
  ii.   Employee portion of Pennsylvania unemployment tax;
 
  iii.   Local income tax;
 
  iv.   Employee portion of FICA OASDI; and
 
  v.   Employee portion of FICA Medicare.

55


 

  7.   This Agreement is being delivered and is intended to be performed in Pennsylvania and shall be construed and enforced in accordance with the laws of Pennsylvania.
 
  8.   This Agreement is the entire understanding among the parties and may be altered, amended or revoked only by subsequent written instrument executed by all parties.

WITNESS WHEREOF the parties have executed this Agreement this 23rd day of December, 2003.

         
    By:   /s/ Jeffrey A. Ludrof
       
(Corporate Seal)          Jeffrey A. Ludrof, President and CEO
         
    Attest:   /s/ Jan R. Van Gorder
       
           Jan R. Van Gorder, Secretary
         
        /s/ John J. Brinling, Jr.
       
           Employee

56

 
 
 

Exhibit 10.79

INSURANCE BONUS AGREEMENT

This Agreement (“Agreement”) made this 23rd day of December, 2003 by and between Erie Indemnity Company, a Pennsylvania business corporation (the “Employer”), and Jan R. Van Gorder (the “Executive”).

WHEREAS, The Company and the Executive had previously entered into a Split Dollar Insurance Agreement, a copy of which is attached to this Agreement; and

WHEREAS, under the terms of the Split Dollar Insurance Agreement, the parties may mutually agree to terminate such contract; and

WHEREAS, the Employer and the Executive believe it is in their mutual interests to terminate the Split Dollar Agreement because of specific but separate provisions of the Sarbanes-Oxley Act of 2002 with respect to the prohibition of loans to officers or directors of a public company, and U. S. Department of Treasury regulations (published September 17, 2003) with respect to the taxation of split dollar arrangements; and

WHEREAS, based on consideration of the Sarbanes-Oxley Act and Department of Treasury regulations, it was the recommendation of the Executive Compensation and Development Committee of Erie Indemnity Company’s Board of Directors to terminate the Split Dollar Agreement and replace it with this Insurance Bonus Agreement, which recommendation was accepted and approved by the Board of Directors of Erie Indemnity Company at its meeting of December 9, 2003; and

NOW, THEREFORE, intending to be legally bound hereby, the Employer and the Executive agree as follows:

  1.   The Split Dollar Agreement as attached to this policy is hereby mutually agreed to be terminated effective upon the execution of this Agreement. The life insurance policy issued with respect to the Split Dollar Agreement shall remain in full force and effect, and the Executive shall remain the owner of such policy. Any premium loans due and owing to the Employer by the Executive shall be paid in full from the accumulated cash value in the policy as soon as practicable after the execution of this Agreement by the parties.

57


 

  2.   The Employer agrees to pay all premiums on life insurance Policy No. 11-426-488 insuring Executive’s life issued by the Northwestern Mutual Life Insurance Company of Milwaukee, Wisconsin necessary to pay up the policy such that no further premium would be required under current dividend assumptions which contemplate that the policy would be paid up twenty-two (22) years after its issuance date; provided, that in the event the Employee remains continuously employed with the Employer for at least twenty-two (22) years from the date of the policy issuance, dividends at that point in time should be sufficient to pay all future premiums; and no further premium payments would be required by the Employer. In the event that dividends are not sufficient to pay future premium at the end of the twenty-two (22) year period, then the Employer shall continue making such premium payments as are necessary to continue the policy in force so long as Employee remains employed with Employer. No contributions toward the payment of premiums by the Executive are required.
 
  3.   The Executive will execute an endorsement on the policy restricting the Executive’s right to (a) surrender the policy for its cash value, (b) obtain a policy loan from the insurance company, (c) assign the policy as collateral, (d) change the ownership of the policy by endorsement or assignment, except for a change in ownership to a trust or similar entity for estate tax planning purposes for the benefit of Executive, his heirs or assigns, or (e) change insured. Such endorsement shall remain in effect for the benefit of the Employer so long as the Executive remains continuously employed with Employer for twenty-two (22) years from the date of policy issuance at which time the Company shall execute a release of such endorsement. If employment is terminated, the Executive shall have all rights under the policy without restriction and the Company shall execute a release of such endorsement.
 
  4.   The Employer shall not be entitled to receive any benefits under the policy.
 
  5.   The Executive shall recognize the premium paid hereunder as additional compensation for federal income tax purposes.
 
  6.   The Employer shall, in addition to the premium payment, annually increase the Executive’s normal compensation by an amount determined by the following formula: P/1-X where P equals premium paid by the Employer on the policy pursuant to this Agreement and X equals the Executive’s marginal Federal income tax bracket for such year plus the tax rate for any of the following that may be applicable:

  i.   Pennsylvania income tax;
 
  ii.   Employee portion of Pennsylvania unemployment tax;
 
  iii.   Local income tax;
 
  iv.   Employee portion of FICA OASDI; and
 
  v.   Employee portion of FICA Medicare.

58


 

  7.   This Agreement is being delivered and is intended to be performed in Pennsylvania and shall be construed and enforced in accordance with the laws of Pennsylvania.
 
  8.   This Agreement is the entire understanding among the parties and may be altered, amended or revoked only by subsequent written instrument executed by all parties.

WITNESS WHEREOF the parties have executed this Agreement this 23rd day of December, 2003.

         
    By:   /s/ Jeffrey A. Ludrof
       
(Corporate Seal)          Jeffrey A. Ludrof, President and CEO
         
    Attest:   /s/ Philip A. Garcia
       
          Philip A. Garcia, Executive Vice President
         
        /s/ Jan R. Van Gorder
       
          Employee

59

 
 
 

Exhibit 10.80

INSURANCE BONUS AGREEMENT

Erie Indemnity Company, a Pennsylvania business corporation (the “Employer”), and Michael J. Krahe (the “Executive”) intending to be legally bound hereby agree as follows:

  1.   The Employer agrees to pay all premiums on life insurance Policy No. 16 352 040 insuring Executive’s life issued by the Northwestern Mutual Life Insurance Company of Milwaukee, Wisconsin, and owned by Executive as long as Executive remains employed by the Employer. No contributions toward the payment of premiums by the Executive are required.
 
  2.   The Executive will execute an endorsement on the policy restricting the Executive’s right to (a) surrender the policy for its cash value, (b) obtain a policy loan from the insurance company, (c) assign the policy as collateral, (d) change the ownership of the policy by endorsement or assignment, or (e) change insured. The Employer shall not be entitled to receive any benefits under the policy.
 
      Employer shall release the endorsement after fifteen (15) years have passed if Executive was continuously employed by the Employer throughout that time. If Executive’s employment is terminated for any reason by either party during that fifteen (15) year period, the Employer is under no obligation to release the endorsement. However, if employment is terminated prior to that time, the Executive retains the right to convert the policy to a plan of paid up insurance.
 
  3.   The Executive will recognize the premium paid hereunder as additional compensation for federal income tax purposes.
 
  4.   The Employer shall, in addition to the premium payment, annually increase the Executive’s normal compensation by an amount determined by the following formula: P/1-X where P equals premium paid by the Employer on the policy pursuant to this Agreement and X equals the Executive’s marginal Federal income tax bracket for such year plus the tax rate for any of the following that may be applicable:

  (a)   Pennsylvania income tax;
 
  (b)   Employee portion of Pennsylvania unemployment tax;
 
  (c)   Local income tax;
 
  (d)   Employee portion of FICA OASDI; and
 
  (e)   Employee portion of FICA Medicare.

  5.   This Agreement is being delivered and is intended to be performed in Pennsylvania and shall be construed and enforced in accordance with the laws of Pennsylvania.

60


 

  6.   This Agreement is the entire understanding among the parties and may be altered, amended or revoked only by subsequent written instrument executed by all parties.

WITNESS WHEREOF the parties have executed this Agreement this 23rd day of December, 2003.

         
    By:   /s/ Douglas F. Ziegler
       
(Corporate Seal)       Douglas F. Ziegler, Senior Vice President
         
    Attest:   /s/ Jan R. Van Gorder
       
         Jan R. Van Gorder, Secretary
         
        /s/ Michael J. Krahe
       
         Employee

61

 
 
 

Exhibit 10.81

INSURANCE BONUS AGREEMENT

This Agreement (“Agreement”) made this 23rd day of December, 2003 by and between Erie Indemnity Company, a Pennsylvania business corporation (the “Employer”), and Philip A. Garcia (the “Executive”).

WHEREAS, The Company and the Executive had previously entered into a Split Dollar Insurance Agreement, a copy of which is attached to this Agreement; and

WHEREAS, under the terms of the Split Dollar Insurance Agreement, the parties may mutually agree to terminate such contract; and

WHEREAS, the Employer and the Executive believe it is in their mutual interests to terminate the Split Dollar Agreement because of specific but separate provisions of the Sarbanes-Oxley Act of 2002 with respect to the prohibition of loans to officers or directors of a public company, and U. S. Department of Treasury regulations (published September 17, 2003) with respect to the taxation of split dollar arrangements; and

WHEREAS, based on consideration of the Sarbanes-Oxley Act and Department of Treasury regulations, it was the recommendation of the Executive Compensation and Development Committee of Erie Indemnity Company’s Board of Directors to terminate the Split Dollar Agreement and replace it with this Insurance Bonus Agreement, which recommendation was accepted and approved by the Board of Directors of Erie Indemnity Company at its meeting of December 9, 2003; and

NOW, THEREFORE, intending to be legally bound hereby, the Employer and the Executive agree as follows:

  1.   The Split Dollar Agreement as attached to this policy is hereby mutually agreed to be terminated effective upon the execution of this Agreement. The life insurance policy issued with respect to the Split Dollar Agreement shall remain in full force and effect, and the Executive shall remain the owner of such policy. Any premium loans due and owing to the Employer by the Executive shall be paid in full from the accumulated cash value in the policy as soon as practicable after the execution of this Agreement by the parties.

62


 

  2.   The Employer agrees to pay all premiums on life insurance Policy No. 14-515-647 insuring Executive’s life issued by the Northwestern Mutual Life Insurance Company of Milwaukee, Wisconsin necessary to pay up the policy such that no further premium would be required under current dividend assumptions which contemplate that the policy would be paid up fifteen (15) years after its issuance date; provided, that in the event the Employee remains continuously employed with the Employer for at least fifteen (15) years from the date of the policy issuance, dividends at that point in time should be sufficient to pay all future premiums; and no further premium payments would be required by the Employer. In the event that dividends are not sufficient to pay future premium at the end of the fifteen (15) year period, then the Employer shall continue making such premium payments as are necessary to continue the policy in force so long as Employee remains employed with Employer. No contributions toward the payment of premiums by the Executive are required.
 
  3.   The Executive will execute an endorsement on the policy restricting the Executive’s right to (a) surrender the policy for its cash value, (b) obtain a policy loan from the insurance company, (c) assign the policy as collateral, (d) change the ownership of the policy by endorsement or assignment, except for a change in ownership to a trust or similar entity for estate tax planning purposes for the benefit of Executive, his heirs or assigns, or (e) change insured. Such endorsement shall remain in effect for the benefit of the Employer so long as the Executive remains continuously employed with Employer for fifteen (15) years from the date of policy issuance at which time the Company shall execute a release of such endorsement. If employment is terminated, the Executive shall have all rights under the policy without restriction and the Company shall execute a release of such endorsement.
 
  4.   The Employer shall not be entitled to receive any benefits under the policy.
 
  5.   The Executive shall recognize the premium paid hereunder as additional compensation for federal income tax purposes.
 
  6.   The Employer shall, in addition to the premium payment, annually increase the Executive’s normal compensation by an amount determined by the following formula: P/1-X where P equals premium paid by the Employer on the policy pursuant to this Agreement and X equals the Executive’s marginal Federal income tax bracket for such year plus the tax rate for any of the following that may be applicable:

  i.   Pennsylvania income tax;
 
  ii.   Employee portion of Pennsylvania unemployment tax;
 
  iii.   Local income tax;
 
  iv.   Employee portion of FICA OASDI; and
 
  v.   Employee portion of FICA Medicare.

  7.   This Agreement is being delivered and is intended to be performed in Pennsylvania and shall be construed and enforced in accordance with the laws of Pennsylvania.

63


 

  8.   This Agreement is the entire understanding among the parties and may be altered, amended or revoked only by subsequent written instrument executed by all parties.

WITNESS WHEREOF the parties have executed this Agreement this 23rd day of December, 2003.

         
    By:   /s/ Jeffrey A. Ludrof
       
(Corporate Seal)         Jeffrey A. Ludrof, President and CEO
         
    Attest:   /s/ Jan R. Van Gorder
       
          Jan R. Van Gorder, Secretary
         
        /s/ Philip A. Garcia
       
          Employee

64

 
 
 

Exhibit 10.82

INSURANCE BONUS AGREEMENT

Erie Indemnity Company, a Pennsylvania business corporation (the “Employer”), and Thomas B. Morgan (the “Executive”) intending to be legally bound hereby agree as follows:

  1.   The Employer agrees to pay all premiums on life insurance Policy No. 16-343-631 insuring Executive’s life issued by the Northwestern Mutual Life Insurance Company of Milwaukee, Wisconsin, and owned by Executive as long as Executive remains employed by the Employer. No contributions toward the payment of premiums by the Executive are required.
 
  2.   The Executive will execute an endorsement on the policy restricting the Executive’s right to (a) surrender the policy for its cash value, (b) obtain a policy loan from the insurance company, (c) assign the policy as collateral, (d) change the ownership of the policy by endorsement or assignment, or (e) change insured. The Employer shall not be entitled to receive any benefits under the policy.
 
      Employer shall release the endorsement after fifteen (15) years have passed if Executive was continuously employed by the Employer throughout that time. If Executive’s employment is terminated for any reason by either party during that fifteen (15) year period, the Employer is under no obligation to release the endorsement. However, if employment is terminated prior to that time, the Executive retains the right to convert the policy to a plan of paid up insurance.
 
  3.   The Executive will recognize the premium paid hereunder as additional compensation for federal income tax purposes.
 
  4.   The Employer shall, in addition to the premium payment, annually increase the Executive’s normal compensation by an amount determined by the following formula: P/1-X where P equals premium paid by the Employer on the policy pursuant to this Agreement and X equals the Executive’s marginal Federal income tax bracket for such year plus the tax rate for any of the following that may be applicable:

  i.   Pennsylvania income tax;
 
  ii.   Employee portion of Pennsylvania unemployment tax;
 
  iii.   Local income tax;
 
  iv.   Employee portion of FICA OASDI; and
 
  v.   Employee portion of FICA Medicare.

65


 

  5.   This Agreement is being delivered and is intended to be performed in Pennsylvania and shall be construed and enforced in accordance with the laws of Pennsylvania.
 
  6.   This Agreement is the entire understanding among the parties and may be altered, amended or revoked only by subsequent written instrument executed by all parties.

WITNESS WHEREOF the parties have executed this Agreement this 23rd day of December, 2003.

         
    By:   /s/ Douglas F. Ziegler
       
(Corporate Seal)       Douglas F. Ziegler, Senior Vice President
         
    Attest:   /s/ Jan R. Van Gorder
       
        J. R. Van Gorder, Secretary
         
        /s/ Thomas B. Morgan
       
        Employee

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(EXHIBIT 13)

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(LOGO) Management’s Discussion & Analysis of Financial Condition & Results of Operations

The following discussion and analysis should be read in conjunction with the audited financial statements and related notes found on pages 39 to 63 as they contain important information helpful in evaluating the Company’s operating results and financial condition. The discussions below also focus heavily on the Company’s three primary segments: management operations, insurance underwriting operations and investment operations. Thus, the financial results presented throughout Management’s Discussion & Analysis herein are those which management uses internally to monitor and evaluate results, and are a supplemental presentation of the Company’s Consolidated Statements of Operations.

Introduction

Erie Indemnity Company (Company) operates predominantly as a provider of management services to the Erie Insurance Exchange (Exchange). 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 a reciprocal insurance exchange signs a subscriber’s agreement that contains an appointment of an attorney-in-fact. The Company has served since 1925 as the attorney-in-fact for the policyholders of the Exchange. As attorney-in-fact, the Company is required to perform certain services relating to the sales, underwriting and issuance of policies on behalf of the Exchange. The Company also operates as a property/casualty insurer through its three insurance subsidiaries.

The Exchange and its property/casualty subsidiary and the Company’s three property/casualty subsidiaries (collectively, the “Property and Casualty Group”) write personal and commercial lines property/casualty coverages exclusively through independent agents and pool their underwriting results. The financial position or results of operations of the Exchange are not consolidated with those of the Company.

For its services as attorney-in-fact, the Company charges a management fee calculated as a percentage, not to exceed 25%, of the direct written premiums of the Property and Casualty Group. Management fees accounted for approximately 74.4% of the Company’s total revenues for 2003. During 2003, 70.2% of the direct premiums written by the Property and Casualty Group were personal lines, while 29.8% were commercial lines. The Company also owns 21.6% of the common stock of Erie Family Life Insurance Company, an affiliated life insurance company, of which the Exchange owns 53.5% and public shareholders, including certain of the Company’s directors, own 24.9%. The Company, together with the Property and Casualty Group and EFL, collectively operate as the “Erie Insurance Group.”

The Company’s earnings are largely generated by fees based on direct written premiums of the Property and Casualty

(ORGANIZATIONAL CHART)

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Group, the principal member of which is the Exchange. The Company therefore has a direct incentive to protect the financial condition of the Exchange. The members of the Property & Casualty Group pool their underwriting results and share participation in the pool. Under the pooling agreement, the Exchange assumes 94.5% of the pool. Accordingly the underwriting risk of the Property and Casualty Group’s business is largely borne by the Exchange, which had $2.4 billion and $2.1 billion of statutory surplus at December 31,2003 and 2002, respectively. Through the pool, the Company’s property/casualty subsidiaries currently assume 5.5% of the Property and Casualty Group’s underwriting results, and, therefore, the Company has an additional direct incentive to manage the overall underwriting business as effectively as possible.

The Property and Casualty Group seeks to insure standard and preferred risks primarily in private passenger automobile, homeowners and small commercial lines, including workers’ compensation. The Property and Casualty Group’s sole distribution channel is its independent agency force, which consists of over 1,700 independent agencies comprised of nearly 7,200 licensed representatives in 11 Midwestern, Mid-Atlantic and Southeastern states (Illinois, Indiana, Maryland, New York, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and Wisconsin) and the District of Columbia. The independent agents play a significant role as underwriters and are major contributors to the Property and Casualty Group’s success.

Overview

During 2003, the Company generated net income of $199.7 million compared to $172.1 million in 2002. Gross margins from management operations decreased to 28.0% in 2003 from 30.3%, principally due to the reduced management fee rate revenues. The two determining factors of management fee revenue are the management fee rate charged by the Company and the direct written premiums of the Property and Casualty Group.

  The management fee rate was 24.0% in 2003 compared to 25.0% in 2002. The lower rate was the primary reason for the reduction in management fee revenue. The management fee rate has been lowered to 23.5% beginning January 1,2004.
 
  In 2003, the direct written premiums of the Property and Casualty Group increased 16.6% in comparison to a 24.0% increase in 2002. This reduction in growth in direct written premiums resulted from actions taken by the Company to improve the underwriting profitability of the Property and Casualty Group. The Company’s emphasis on underwriting profitability initiatives will continue in 2004, which may result in continued declines in the direct written premium and policy growth rates. Offsetting the decline in the policy growth rate are anticipated increases in the average premium per policy in 2004, primarily as a result of rate increases.

While premium volumes and growth rates are major factors in the short-term profitability of the Company, a long-term driver of the Company’s results is the underwriting profitability of the Property and Casualty Group. Underwriting profitability enhances surplus strength, enabling the Property and Casualty Group to continue growing by offering competitive products.

Although the Company assumes only 5.5% of the underwriting results of the Property and Casualty Group, the underwriting profitability of the Exchange, which assumes 94.5% of the Property and Casualty Group results, is critical to the Company. The Exchange is the Company’s only customer for risk management services and the Exchange’s financial condition and profitability are crucial to the long-term growth and profitability of the Company.

The Property and Casualty Group generated underwriting losses of $403.7 million, $653.5 million and $517.3 million in 2003, 2002 and 2001 respectively. The Company’s property/ casualty insurance subsidiaries’share of underwriting results represents their 5.5% share of the Property and Casualty Group’s results adjusted for recoveries under an excess-of-loss reinsurance agreement with the Exchange. The Company’s property/casualty insurance subsidiaries generated underwriting losses of $24.9 million in 2003 compared to $27.1 million in 2002 and $20.5 million in 2001.

During 2003, the Company took measures to refine its focus on underwriting profitability in response to unacceptable underwriting results. Company management devoted substantive resources to improve underwriting profitability in 2003, concentrating on initiatives that will help to produce combined ratios more in line with historical results. These initiatives, which will continue in 2004, are described in the insurance underwriting operations section.

During 2003, income from unaffiliated investments of the Company increased to $66.7 million from $40.5 million with the change arising largely from realized gains of $10.4 million,in 2003, compared to realized losses of $11.2 million in 2002. The realized losses in 2002 resulted principally from impairment charges on fixed income and equity securities, primarily in the energy and communications segments, of $25.4 million. Impairment charges on fixed income and equity securities in 2003 totaled $6.0 million. The 2001 income from unaffiliated investments was $18.0 million, reflecting impairment charges on equity securities and other realized losses totaling $29.1 million.

Equity in earnings of Erie Family Life Insurance Company (EFL), net of tax, increased to $6.9 million in 2003, from $1.6 million in 2002 and $0.7 million in 2001. The improved net income of EFL in 2003 primarily resulted from improved investment results due to significantly lower impairment charges recognized in 2003 compared to 2002 and improved spreads on interest-sensitive products marketed by EFL.

The topics addressed in this overview are discussed in more detail in the sections that follow.

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Transactions and agreements with related parties

Board oversight

The Company’s Board of Directors (Board) oversees intercompany transactions. In its capacity as the Board for the attorney-in-fact, the Board has a fiduciary duty to protect the interests of the policyholders of the Exchange in addition to its fiduciary duty to protect the interests of the Company’s shareholders. Certain conflicting interests are inherent in these separate fiduciary duties such as: (1) the Company’s Board of Directors sets the management fee rate paid by the Exchange to the Company and (2) the Company’s Board of Directors determines the participation percentages of the intercompany pooling agreement. As a consequence, the Company’s Board of Directors must make decisions or take actions that are not solely in the interest of the Company’s shareholders.

If the Board of Directors determines that the Exchange’s surplus requires strengthening, it could decide to reduce the management fee rate or change the Company’s property/casualty insurance subsidiaries’ intercompany pooling participation percentages. The Board of Directors could also require, under such circumstances, that the Company provide capital to the Exchange, although there is no legal obligation to do so.

The Directors of the Company are also the Directors for Erie Family Life Insurance Company.

Intercompany cost allocation

Company management makes judgments affecting the financial condition of the Erie Insurance Group companies, including the allocation of shared costs between the companies. Management must determine that allocations are consistently made in accordance with intercompany agreements, the attorney-in-fact agreements with the policyholders of the Exchange and applicable insurance laws and regulations.

Intercompany agreements

Erie Insurance Property and Casualty Company, Flagship City Insurance Company, Erie Insurance Company and Erie Insurance Company of New York participate in an intercompany reinsurance pooling agreement with the Exchange. Under the pooling agreement, all insurance business of the Property and Casualty Group is pooled. 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.

To reduce its potential exposure to catastrophe losses and variations in long-term underwriting results, the Company’s property/casualty insurance subsidiaries have in effect an all-lines aggregate excess-of-loss reinsurance agreement with the Exchange. This reinsurance treaty is excluded from the intercompany pooling agreement and limits the amount of sustained ultimate net losses in any applicable accident year for the Erie Insurance Company and Erie Insurance Company of New York.

Company management sets the parameters for this excess-of-loss reinsurance agreement in effect between the Exchange and the Company’s property/casualty insurance subsidiaries. Factors evaluated by Company management include the premium amount to be received by the Exchange from the Company’s insurance subsidiaries, the loss level at which the excess agreement becomes effective and the portion of ultimate net loss to be retained by each of the companies.

During 2001, the Erie Insurance Group undertook a series of information technology initiatives to develop eCommerce capabilities. In connection with this program, the Company and the Property and Casualty Group entered into a Cost-Sharing Agreement for Information Technology Development (“Agreement”). The Agreement describes how member companies of the Erie Insurance Group will share certain costs to be incurred for the development of new Internet-enabled property/casualty policy administration and customer relationship management systems. Costs are shared under the Agreement in the same proportion as the underwriting results of the Property and Casualty Group are shared.

Also included as part of this eCommerce program are information technology hardware and infrastructure expenditures that are not subject to the Agreement. The Company’s share of these eCommerce program costs are included in the cost of management operations in the Company’s Consolidated Statements of Operations.

The Exchange leases certain office facilities to the Company on a year-to-year basis. Rents are determined considering returns on invested capital and building operating and overhead costs. Rental costs of shared facilities are allocated based on square footage occupied.

While allocation of costs under these various agreements requires management judgment and interpretation, such allocations are performed using a consistent methodology, which, in management’s opinion, adheres to the terms and intentions of the underlying agreements.

Intercompany receivables

A concentration of credit risk results from the pooling agreement with the Exchange and from management services performed by the Company for the Exchange. Credit risks related to the receivables from the Exchange are evaluated periodically by Company management. The Exchange has an A.M. Best rating of A+ (Superior) and is considered to have a superior credit rating. The receivable from the Exchange related to reinsurance recoverable and ceded unearned premiums amounted to $785.1 million and $649.0 million at December 31, 2003 and 2002, respectively, or 28.5% and 27.5% of assets, respectively. This receivable relates primarily to unpaid losses ceded to the Exchange as

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part of the pooling agreement between the Exchange and the Company’s property/casualty insurance subsidiaries. Reinsurance contracts do not relieve the Company from its primary obligations to policyholders. The Company collects its reinsurance recoverable amount generally within 30 days of actual settlement of losses.

The Company also has a receivable from the Exchange for management fees and for services performed for administration of the Exchange’s unaffiliated assumed reinsurance business as well as costs paid by the Company on behalf of the Exchange. The Company pays certain costs for, and is reimbursed by, EFL as well. Since the Company’s inception, it has collected these amounts due from the Exchange and EFL in a timely manner (generally within 120 days). The receivable from the Exchange and EFL for all fees, costs and reimbursements equaled 7.2% and 7.6% of total Company assets as of December 31, 2003 and 2002, respectively.

The aggregate of the receivables from the Exchange and EFL at December 31, 2003 and 2002, equaled $984.1 million and $829.0 million, respectively, or 35.7% and 35.2%, respectively, of the Company’s total assets. No interest is charged or received on these intercompany balances due to the timely settlement terms and nature of the items.

Critical accounting estimates

The Company makes estimates and assumptions that have a significant effect on amounts and disclosures reported in the financial statements. The most significant estimates relate to valuation of investments, reserves for property/casualty insurance unpaid losses and loss adjustment expenses and employee benefit obligations. While management believes its estimates are appropriate, the ultimate amounts may differ from the estimates provided. The estimates and the estimating methods used are reviewed continually and any adjustments considered necessary are reflected in current earnings.

Investment valuation

Management makes estimates concerning the valuation of all investments and the recognition of declines in value of these investments. When the decline in value of an investment is considered by management to be other-than-temporary, the investment is written down to its market value. For all investments except limited partnerships, the impairment charge is included as a realized loss in the Consolidated Statements of Operations. For limited partnerships, the impairment charge is included as a component of equity in losses or earnings of limited partnerships in the Consolidated Statements of Operations. All investments are monitored individually for other-than-temporary declines in value. Management makes judgments about when there are other-than-temporary declines in its investments. If an individual security has, in management’s opinion, depreciated significantly in value and has been in such unrealized loss position for an extended time period, management presumes there has been an other-than-temporary decline in value. In making valuation judgements, management considers the significance of the amount and the time frame in which fair value is below cost; financial condition of the issuer;a significant drop in ratings by Standard & Poor’s or Moody’s or other reputable rating agency; specific events that occurred affecting an investment;and specific industry or geographic events.

Investments in fixed maturity and marketable equity securities are presented at estimated fair value, which generally represents quoted market prices. Investments in limited partnerships are recorded using the equity method, which approximates the Company’s proportionate share of the partnership’s reported net equity. There is increased risk in valuation of limited partnerships because of their illiquid nature and the lack of quoted market prices. The recorded value of limited partnerships includes the valuation of investments held by these partnerships, which include U.S. and foreign private equity, real estate and fixed income investments. These valuations are determined by the general partner, and their reasonableness is reviewed by the Company. Generally, limited partnership market values are derived from audited and unaudited financial statements from these partnerships and other information provided by the general partner.

Property/casualty insurance liabilities

Reserves for property/casualty insurance unpaid losses and loss adjustment expenses include estimates of a variety of factors such as medical inflation trends, regulatory and judicial rulings, legal settlements, property replacements and repair cost trends, and losses for assumed reinsurance activities. In recent years, certain of these component costs, such as medical inflation trends and legal settlements, have experienced significant volatility and resulted in increased loss severity trends and incurred amounts higher than original estimates. Management has factored these changes in these underlying factors into its projected severity trends used to develop the Company’s loss and loss adjustment expense reserves. Due to the nature of these liabilities, actual results ultimately could vary significantly from the amounts recorded.

In establishing loss and loss adjustment expense reserves, management uses its best judgment to predict trends in the factors described in the preceeding paragraph which will affect the ultimate payments required to settle claims. Estimates of medical cost inflation, mortality and trends in the judicial environment are factors which have a significant influence on management’s estimate of the claims severity trend which underlies the loss and loss adjustment expense reserves.

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While precise prediction of factors underlying loss and loss adjustment expense reserves is not possible, management continually monitors trends and adjusts its reserve estimates promptly when changes in trends are believed by management to be pervasive and not temporary.

Employee benefit obligations

The Company’s pension and other postretirement benefit obligations are developed from actuarial estimates. The Company uses an outside actuarial firm to develop these estimates. Inherent in these estimates are key assumptions about inflation, investment returns, mortality, turnover, medical costs and discount rates. Changes in the Company’s pension and other postretirement benefit obligations may occur in the future due to variances in actual results from the key assumptions made by Company management. The Company’s pension plan for employees is the largest and only funded benefit plan of the Company. Discount rates and long-term rate-of-return assumptions are reviewed annually by Company management and the external actuarial firm in determining the pension liabilities for this plan. At December 31, 2003, the fair market value of the pension assets totaled $181.7 million, which continues to exceed the accumulated benefit obligation of $118.3 million at that date. Lower discount rate assumptions and actual return on assets resulted in an increase in FAS 87 (“Employers’ Accounting for Pensions”) pension expense of $1.9 million during 2003 compared to 2002. The Company anticipates FAS 87 pension expense for the employees’ pension plan for the year ended December 31, 2004, will increase by $2.8 million based upon a lower discount rate assumption of 6.00% for the plan in 2004.

Results of operations summary

 
                         
    Years ended December 31
    (dollars in thousands,
    except per share data)
    2003   2002   2001
   
 
 
Income from management operations
  $ 253,251     $ 241,984     $ 184,568  
Underwriting loss
    (24,941 )     (27,132 )     (20,463 )
Net revenue from investment operations
    74,172       42,281       18,771  
 
   
     
     
 
Income before income taxes
  $ 302,482     $ 257,133     $ 182,876  
 
   
     
     
 
Net income
  $ 199,725     $ 172,126     $ 122,261  
 
   
     
     
 
Net income per share
  $ 2.81     $ 2.42     $ 1.71  
 
   
     
     
 

Consolidated net income increased 16.0% in 2003 to $199.7 million from $172.1 million in 2002. The slower growth in management operations was the result of a lower management fee rate of 24.0% in 2003 compared to 25.0% in 2002, despite the 16.6% increase in direct written premiums of the Property and Casualty Group. Losses generated from the insurance underwriting operations improved to $24.9 million in 2003 compared to losses of $27.1 million in 2002. The Company’s share of catastrophe losses, as defined by the Property and Casualty Group, were higher in 2003, totaling $10.0 million, or $.09 per share, after taxes. Despite historically high catastrophe losses, insurance underwriting results for 2003 improved, as 2002 included a charge of $10.1 million for adverse development of prior-year loss and loss adjustment expense reserves. Insurance underwriting operations were also affected in 2003 by a reduction in the deferred acquisition costs asset of $7.6 million. Net revenue from investment operations improved to $74.2 million in 2003 from $42.3 million in 2002. This was primarily due to net realized gains in 2003 of $10.4 million compared to net realized losses of $11.2 million in 2002. Impairment charges of $25.4 million in 2002 were responsible for the 2002 net realized losses. Earnings from the Company’s equity investment in EFL, net of tax, increased to $6.9 million in 2003 from $1.6 million in 2002. Income tax expense increased by $3.2 million for an adjustment to deferred taxes on the Company’s equity of EFL in excess of the Company’s basis. As a consequence, the effective tax rate in 2003 was 34.7% versus 33.2% in 2002.

Consolidated net income increased 40.8% in 2002 to $172.1 million from $122.3 million in 2001. The increase in net income in 2002 was primarily driven by a 22.2% increase in management fee revenues. The increase in management fee revenue was a result of the 24.0% growth in direct written premiums of the Property and Casualty Group. Underwriting losses in 2002 were impacted negatively by adverse development in personal and commercial automobile, particularly uninsured motorist and underinsured motorist, as well as fourth quarter reserve increases to strengthen the Property and Casualty Group’s reserve position in light of loss development trends. Increased loss severity was the primary factor for increasing reserves in 2002. When compared to 2001, the Company’s share of catastrophe losses, as defined by the Property and Casualty Group, were higher in 2002, totaling $7.1 million, or $.06 per share, after taxes. Net revenue from investment operations improved in 2002 compared to 2001 primarily as a result of a $17.9 million decrease in net realized losses.

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(LOGO) Management fee revenue by state and line of business

                                                         For the year ended December 31, 2003 (dollars in thousands)
 
                                                         
    Private   Commercial           Commercial   Workers’   All other lines        
State   passenger auto   auto   Homeowners   multi-peril   compensation   of business   Total

 
 
 
 
 
 
 
District of Columbia
  $ 854     $ 121     $ 465     $ 742     $ 894     $ 252     $ 3,328  
Illinois
    8,214       2,116       3,859       3,394       3,574       1,127       22,284  
Indiana
    18,565       2,364       9,864       3,958       2,402       1,889       39,042  
Maryland
    54,531       9,227       18,645       9,023       10,446       4,201       106,073  
New York
    16,753       3,269       4,341       5,047       2,787       1,355       33,552  
North Carolina
    19,028       5,911       11,201       6,788       5,532       3,307       51,767  
Ohio
    37,570       7,182       15,368       13,657             3,951       77,728  
Pennsylvania
    230,995       30,530       61,356       36,360       38,411       13,024       410,676  
Tennessee
    5,570       2,036       2,751       3,232       2,367       891       16,847  
Virginia
    29,146       7,367       12,395       9,217       10,338       3,564       72,027  
West Virginia
    25,712       3,424       6,580       3,929             1,393       41,038  
Wisconsin
    3,290       475       1,372       1,023       383       475       7,018  
 
   
     
     
     
     
     
     
 
Total
  $ 450,228     $ 74,022     $ 148,197     $ 96,370     $ 77,134     $ 35,429     $ 881,380  
 
   
     
     
     
     
     
     
 

This table is gross of an allowance for management fees returned on mid-term cancellations and the intersegment elimination of management fee revenue.

Analysis of business segments

Management operations

 
                         
    Years ended December 31
    (dollars in thousands)
    2003   2002   2001
   
 
 
Management fee revenue
  $ 878,380     $ 775,700     $ 634,966  
Service agreement revenue
    27,127       23,729       27,247  
 
   
     
     
 
Total revenue from management operations
    905,507       799,429       662,213  
Cost of management operations
    652,256       557,445       477,645  
 
   
     
     
 
Income from management operations
  $ 253,251     $ 241,984     $ 184,568  
 
   
     
     
 
Gross margins
    28.0 %     30.3 %     27.9 %
Management fee rate
    24 %     25 %     25 %
 
   
     
     
 

Management fees represented 75.4% of the Company’s total revenues for 2003 and 77.3% and 77.6% of the Company’s total revenues for 2002 and 2001, respectively. The management fee rate set by the Company’s Board of Directors and the volume of direct written premiums of the Property and Casualty Group determine the level of management fees. Changes in the management fee rate affect the Company’s revenue and net income significantly. The rate was set at 24.0% for 2003 and 25.0% for 2002 and 2001. The Company’s Board of Directors reduced the management fee rate to 23.5% beginning January 1, 2004. If the management fee rate had been 23.5% in 2003, 2002 and 2001, management fee revenue would have been reduced by $18.4 million, $47.3 million and $38.1 million, respectively. Net income per share after taxes would have been reduced by $.17, $.43 and $.35 for 2003, 2002 and 2001, respectively.

Management fees are returned to the Exchange when policyholders cancel their insurance coverage and unearned premiums are refunded to them. An estimated allowance for management fees returned on mid-term cancellations was first established in the fourth quarter of 2002. This allowance recognizes the management fee anticipated to be returned to the Exchange based on historical mid-term cancellation rates. The allowance was $14.9 million and $11.9 million at December 31, 2003 and 2002, respectively. Future adjustments to the allowance, which will be reflected in operations, will be affected by future premium levels and changes in the midterm cancellation rate. The cash flows of the Company are unaffected by the recording of the allowance.

Management fee revenue derived from the direct and affiliated assumed premiums of the Exchange, before consideration of the allowance for mid-term cancellations, rose 11.9% to $881.4 million in 2003 from $787.6 million in 2002. The direct and affiliated assumed premiums of the Exchange grew by 16.6% in 2003 to $3.7 billion from $3.2 billion in 2002, and grew by 24.0% in 2002 from $2.5 billion in 2001.

Growth in the direct and affiliated assumed written premiums of the Exchange is reflective of rate increases achieved in various lines of business and a continued favorable policy

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retention rate.The slower premium growth in 2003 compared to 2002 is due to the Company’s focus on underwriting profitability through increased emphasis on controlling exposure growth and improving underwriting risk selection.

Increases in average premium per policy and continued favorable policy retention rates were contributing factors in premium growth.The average premium per policy increased 9.3% to $981 in 2003 from $898 in 2002. For personal auto (which accounted for 50.9% of the direct written premiums of the Property and Casualty Group), the average premium per policy increased 7.7% to $1,122 in 2003 from $1,042 in 2002. For commercial lines, the average premium per policy increased 9.5% to $2,326 in 2003 from $2,124 in 2002.

Policy retention decreased to a 12-month moving average of 90.2% in 2003 from 91.2% in 2002 and 90.9% in 2001. Personal lines policy retention rates decreased to 90.5% in 2003 from 91.5% in 2002. Commercial lines policy retention rates declined to 87.3% in 2003 from 88.2% in 2002. Policies in force increased 6.7% to 3.7 million policies in 2003, from 3.5 million policies in 2002,and 12.8% in 2002, from 3.1 million in 2001.

New business premiums written in 2003 began to show the impact of the increased emphasis on underwriting profitability, particularly the AWARE program and other underwriting profitability initiatives. Strong growth in new business premiums written in 2002 was influenced by an incentive promotion for ERIE agencies.Total new business premium written declined 13.7% to $501.9 million in 2003 from $581.5 million in 2002. Personal lines new business premiums written declined 8.6% to $333.3 million in 2003, while commercial lines new premium decreased 22.3% to $168.4 million in 2003.

Improved pricing in recent years for commercial and personal insurance allowed the Property and Casualty Group to more adequately price its products while maintaining its competitive position in the insurance marketplace. In 2003, more significant rate increases were sought to offset growing loss costs in certain lines. Rate increases accounted for $208.4 million in additional premium for the Property and Casualty Group in 2003, compared to $122.2 million in 2002. Premium increases anticipated due to pricing actions approved through December 31,2003, could amount to approximately $254.1 million in additional premium for the Property and Casualty Group in 2004.The majority of the 2004 rate increases are in private passenger automobile, totaling $96.2 million,and homeowners, totaling $80.0 million. Additional rate increases are planned or filed but not yet approved. Further rate actions contemplated or awaiting approval could increase 2004 premiums by an additional $66.2 million.

Service agreement revenue includes service charges the Company collects from policyholders for providing extended payment terms on policies written by the Property and Casualty Group. Such service charges amounted to $19.9 million, $10.9 million and $16.0 million in 2003,2002 and 2001, respectively. During the third quarter of 2002, the Company determined service charges were being recognized on future billing installments at the time a policy was issued instead of at the time each billing was rendered.The Company recorded a one-time adjustment to reduce service charge income by $7.9 million in the third quarter of 2002.

Also included in service agreement revenue is service income received from the Exchange as compensation for the management and administration of voluntary assumed reinsurance from nonaffiliated insurers.The Company received a service fee of 6.0% of nonaffiliated assumed reinsurance premiums in 2003 and 7.0% in 2002 and 2001. These fees totaled $7.2 million, $12.8 million and $11.2 million on net voluntary nonaffiliated assumed reinsurance premiums of $119.8 million, $183.2 million and $160.7 million for 2003,2002 and 2001, respectively.The decrease in 2003 service fee income directly correlates with the decision by management to exit the nonaffiliated assumed reinsurance business effective December 31,2003. A modest amount of reinsurance business will be recorded in 2004 from several treaties that expire through June 2004.The service fee income will decrease accordingly, and cease entirely after June 2004.

The cost of management operations rose 17.0% to $652.3 million in 2003,from $557.4 million in 2002,and 16.7% in 2002, from $477.6 million in 2001. Commissions to independent agents, which are the largest component of the cost of management operations, include scheduled commissions earned by independent agents on premiums written,as well as agent contingency awards and promotional incentives for agents. Commission costs rose 19.2% to $474.8 million in 2003, from $398.3 million in 2002, and 23.3% in 2002, from $323.1 million in 2001.

Scheduled commissions, which include normal and accelerated commissions, increased 19.2% to $450.4 million in 2003, from $377.7 million in 2002.The level of commissions is directly related to the change in direct written premiums of the Property and Casualty Group, which increased 16.6% in 2003, and to the mix of business written.

Accelerated commissions are offered to newly recruited agents in addition to normal commission schedules. Accelerated commissions above normal scheduled rate commissions increased 7.4% to $9.8 million in 2003, from $9.1 million in 2002.This increase was driven by the new agencies that were appointed in the beginning of 2003 before new agent appointments were suspended.

Commission rates will be reduced for certain new and renewal business in commercial lines effective January 1,2005.The new commission rates will align agent compensation with Company product line costs. Management believes the new rates are competitive with those of other insurers.

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Agent contingency awards are based upon underwriting profitability of the direct business written within the Property and Casualty Group by the independent agency. The estimate for the contingency award is modeled on a monthly basis using the two prior years’ actual underwriting data by agency combined with the current year-to-date actual data. The provision for agent contingency awards totaled $24.0 million, $18.0 million and $15.7 million in 2003,2002 and 2001, respectively.

Changes were made to the agent contingency award program effective January 1,2004. The changes to the program place more emphasis on underwriting profitability and quality growth in agency property and casualty premiums.

Promotional incentive expenses were $0.4 million and $2.4 million in 2003 and 2002, respectively. These costs related entirely to a 2002 sales incentive contest for the Company’s independent agents.

The cost of management operations, excluding commission costs, increased 11.5% in 2003 to $177.5 million, from $159.1 million in 2002 due primarily to increases in personnel related costs. The Company’s personnel and benefit related costs increased 13.4% to $102.8 million in 2003, from $90.7 million in 2002, and decreased 3.9% in 2002, from $94.4 million in 2001.

Personnel costs, principally salaries, increased 7.8%, or $5.7 million, in 2003 compared to 2002. This increase was the result of a 5.8% increase in staffing levels as well as pay rate increases. A portion of the higher personnel costs in 2001 as compared to 2002 resulted from recognition of the severance benefit related to the retirement of the Company’s president and chief executive officer in January 2002. The Company recorded a severance charge in the fourth quarter of 2001 of $10.7 million.

Total employee benefit costs increased 46.7% in 2003 driven by increases in health and retirement plan benefit costs. Health plan benefit costs rose 29.3% to $12.6 million in 2003, from $9.8 million in 2002. Health plan benefit costs grew due to increased plan enrollment and increases in medical costs within the various plans offered by the Company. The Company self insures its health plans. Retirement plan benefit costs increased 89% to $6.7 million in 2003 from $3.5 million in 2002. The majority of this increase was due to an increase in participants as well as changes in plan assumptions. The assumed discount rate used to calculate 2003 FAS 87 pension expense was 6.75% compared to 7.00% used to calculate 2002 expense. Retirement plan benefit expenses are expected to increase approximately $3.1 million for all retirement plans in 2004, as the assumed discount rate used to calculate pension costs will decrease from the 6.75% in 2003 to 6.00% for 2004.

Certain eCommerce program expenditures for information technology hardware and infrastructure changes are included in the cost of management operations in the Company’s Consolidated Statements of Operations. These costs totaled $0.5 million in 2003, $2.6 million in 2002 and $1.6 million in 2001. (See additional discussion of this program under “Insurance Underwriting Operations” and “Factors That May Affect Future Results.”)

Insurance underwriting operations

 
                                 
    Years ended December 31
    (dollars in thousands)
    2003   2002   2001        
   
 
 
       
Premiums earned
  $ 191,592     $ 163,958     $ 137,648  
 
   
     
     
 
Losses and loss adjustment expenses incurred
    152,984       139,225       117,201  
Policy acquisition and other underwriting expenses
    63,549       51,865       40,910  
 
   
     
     
 
Total losses and expenses
    216,533       191,090       158,111  
 
   
     
     
 
Underwriting loss
  $ (24,941 )   $ (27,132 )   $ (20,463 )
 
   
     
     
 
GAAP combined ratio
    113.0       116.5       114.9  
 
   
     
     
 

The GAAP combined ratio represents the ratio of losses, loss adjustment, acquisition and other underwriting expenses incurred to premiums earned. The GAAP combined ratios of the Company are different than the results of the Property and Casualty Group due to certain GAAP adjustments and the effects of the excess-of-loss reinsurance agreement between the Company’s property/casualty subsidiaries and the Exchange. The statutory combined ratio for the Property and Casualty Group was 109.5 for 2003, compared to 118.5 during 2002 and 118.4 during 2001.

The Company’s insurance subsidiaries’ share of the Property and Casualty Group’s direct business generated underwriting losses of $24.0 million, $32.8 million and $14.9 million in 2003, 2002 and 2001, respectively. The 2003 underwriting losses on direct business resulted primarily from continued rapid increases in current claims severity and increased catastrophe losses. Claims severity rose in 2003 in certain lines of business at rates much higher than general inflation. While loss reserves continued to grow in 2003, this growth was a reflection of increases in exposure, not continued deterioration in prior year reserves. Reserve strengthening completed in 2002 and 2001 appears to have been adequate.

The statutory combined ratio of the direct business of the Property and Casualty Group was 109.8, 119.3 and 110.9 in 2003, 2002 and 2001, respectively. Catastrophe losses contributed 5.2 points, 4.3 points and 1.1 points to the 2003, 2002 and 2001 direct business statutory combined ratio, respectively. In 2003, modest adverse development on loss reserves of prior accident years contributed .1 point to the direct business statutory combined ratio, whereas adverse development on loss reserves of prior accident years contributed 7.3 points to the 2002 statutory combined ratio.

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Increased losses were experienced in 2002 primarily due to adverse development of the loss reserves for prior accident years, principally in certain private passenger and commercial automobile coverages. During the fourth quarter of 2002, the Property and Casualty Group increased loss and loss adjustment reserves by $184.1 million, of which the Company’s 5.5% share amounted to $10.1 million. The Company’s share of this reserve strengthening related to the following lines of business: $7.6 million in private passenger automobile, $1.1 million in commercial automobile, $0.6 million in homeowners and $0.8 million in other personal and commercial lines. About half of the reserve strengthening related to prior accident years.

Strengthening of private passenger and commercial automobile loss reserves in 2002 was based on loss and loss adjustment expense indications for increased reserves in uninsured motorist and underinsured motorist (UM/UIM) of $4.9 million, massive injury of $1.1 million and the balance for bodily injury. The actual loss development of UM/UIM exceeded established reserves for prior periods due to unfavorable precedents set by court decisions and evolving arbitration systems. The estimated ultimate losses related to massive injury coverages increased due to a change in the assumed inflation level from 4.5% to 5.0%,as well as a refinement to the estimation process. Increased loss severity drove the increase to bodily injury reserves.

Some of the rate increases taken by the Property and Casualty Group were realized in 2003, which contributed to the improved statutory combined ratio on the direct business. The impact of the underwriting profitability initiatives implemented in 2003 are expected to continue to be realized into 2004.

The underwriting profitability initiatives implemented in 2003 addressed loss trends by controlling exposure growth, improving underwriting risk selection, instituting programs to control loss severity and obtaining additional premium on risks through rate increases. In recent years, rate increases were filed by the Property and Casualty Group for certain lines of business in various states to offset the growing loss costs in those lines of business. The Property and Casualty Group writes one-year policies; therefore, rate increases take 24 months to be reflected fully in earned premiums as it takes 12 months to implement rate increases to all policyholders and 12 months more to earn fully the increased premiums.

During the fourth quarter of 2003, the Company recorded a charge to reduce its deferred acquisition cost asset (DAC). Prior to the fourth quarter 2003, the Company recorded as DAC the management fee paid to the Company by its wholly-owned property/casualty insurance subsidiaries through their assumed share of the intercompany reinsurance pool. These costs were being deferred at the full amount of the management fee, which included an intercompany profit component. During the fourth quarter 2003, the DAC asset was adjusted to reflect only the underlying policy acquisition costs to the Company of the 5.5% pooled business. The adjustment of the DAC asset resulted in a one-time, non-cash charge to net income of $.07 per share.

Catastrophes are an inherent risk of the property/casualty insurance business and can have a material impact on the Company’s insurance underwriting results. In addressing this risk, the Company employs what it believes are reasonable underwriting standards and monitors its exposure by geographic region. Additionally, the Company’s property/casualty insurance subsidiaries’all-lines excess-of-loss reinsurance agreement with the Exchange should substantially mitigate the effect of catastrophe losses on the Company’s financial position. During 2003,2002 and 2001, the Company’s share of catastrophe losses, as defined by the Property and Casualty Group, amounted to $10.0 million, $7.1 million and $1.6 million, respectively. The 2003 catastrophe losses were largely driven by Hurricane Isabel, which affected the states of North Carolina, Maryland,Virginia, Pennsylvania and the District of Columbia. Catastrophe losses in 2003 contributed 5.2 points to the combined ratio compared to 4.3 points in 2002 and 1.1 points in 2001.

The Company’s property/casualty insurance subsidiaries’ reinsurance business includes its share of the Property and Casualty Group’s unaffiliated voluntary and involuntary assumed business, its share of the Property and Casualty Group’s unaffiliated ceded business and reinsurance ceded under the excess-of-loss agreement with the Exchange. The Company’s share of the unaffiliated voluntary assumed reinsurance business generated an underwriting gain of $1.6 million in 2003 compared to underwriting losses of $0.6 million and $11.8 million recorded in 2002 and 2001, respectively. During 2003, the Company announced plans that the Exchange would exit the voluntary assumed reinsurance business as of December 31,2003, to allow the Property and Casualty Group to focus on its core business and lessen its underwriting exposure.

During 2003,2002 and 2001, the Company’s property/ casualty insurance subsidiaries recorded $6.5 million, $8.8 million and $7.2 million, respectively, in reinsurance recoveries under the excess-of-loss reinsurance agreement with the Exchange. No cash payments have been made between the companies in 2003,2002, or 2001 for these recoveries as the contract states the reimbursement is made when the claims are paid. The contract also states that any unpaid loss recoverables will be commuted 60 months after that annual period expires. The total recoverable reduces the Company’s loss and loss adjustment expenses on the Consolidated Statements of Operations.

The annual premium paid to the Exchange for this agreement totaled $2.5 million in 2003, $2.1 million in 2002 and $1.5 million in 2001.

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Recoveries by accident year are as follows:

(dollars in thousands)

 
                                                 
    Accident Year    
Calendar  
  Total
Year   2003   2002   2001   2000   1999   Recoveries

 
 
 
 
 
 
2003
  $ 6,012     $ (1,969 )   $ 2,645     $ (57 )   $ (170 )   $ 6,461  
2002
            2,002       2,176       2,213       2,424       8,815  
2001
                    6,506       0       735       7,241  

During 2003, the $6.0 million recoveries in the 2003 accident year included the loss recoveries from the impact of Hurricane Isabel. During 2002, actual loss development patterns of prior reserve estimates revealed higher loss amounts than previously recorded. Re-estimations of prior accident year reserves, as well as the estimate for accident year 2002, were increased after incorporating this new information. During 2001, the $6.5 million related to the 2001 accident year included the losses related to the World Trade Center.

Also included in the Company’s policy acquisition and other underwriting expenses is the property/casualty insurance subsidiaries’share of costs related to the eCommerce initiative. Costs associated with the eCommerce initiative totaled $2.5 million, $3.9 million and $1.3 million for 2003, 2002 and 2001, respectively. These costs relate to application development expenses associated with the eCommerce initiative covered under an intercompany technology cost-sharing agreement (“Agreement”). The Agreement provides that the application development costs and the related enabling technology costs, such as technical infrastructure and architectural tools, will be shared among the Property and Casualty Group in a manner consistent with the sharing of property/casualty underwriting results under the existing intercompany pooling agreement. Since the amounts are pooled within the Exchange and ceded to members of the pooling agreement at their participation levels, the Company, by way of its insurance subsidiaries, incurs a 5.5 percent share of these costs. These technology costs are included in the policy acquisition and other underwriting expenses in the Company’s Consolidated Statements of Operations.

Investment operations

 
                         
    Years ended December 31
    (dollars in thousands)
    2003   2001   2002
   
 
 
Net investment income
  $ 58,298     $ 55,440     $ 49,884  
Net realized gains (losses) on investments
    10,445       (11,237 )     (29,146 )
Equity in earnings of EFL
    7,429       1,732       773  
Equity in losses of limited partnerships
    (2,000 )     (3,654 )     (2,740 )
 
   
     
     
 
Net revenue from investment operations
  $ 74,172     $ 42,281     $ 18,771  
 
   
     
     
 

The increase in net revenue from investment operations in 2003 is primarily due to net realized gains of $10.4 million in 2003, compared to net realized losses of $11.2 million in 2002, as well as increased earnings from the Company’s equity investment in EFL. In 2003, net realized gains included $6.0 million in losses from impairment charges related primarily to bonds in the finance and retail segments and to equity securities in the energy segment. Of the $6.0 million, $3.7 million related to equity securities and $2.3 million related to fixed maturities. Impairment charges totaled $25.4 million in 2002, were comprised of $20.6 million and $4.8 million related to fixed maturities and equity securities, respectively. The increase in net revenue from investment operations in 2002 from 2001 is primarily due to the $11.2 million in net realized losses recorded in 2002 compared to $29.1 million in net realized losses recorded in 2001. The $29.1 million of net realized losses in 2001 was in part due to a proactive year-end tax-motivated selling strategy.

Net investment income increased 5.2% in 2003 and 11.1% in 2002. Included in net investment income are primarily interest and dividends on the Company’s fixed maturity and equity security portfolios. Increases in investments in taxable bonds contributed to the growth in net investment income in 2003 and 2002. Declines in overall market yields caused lower growth in 2003 investment income compared to 2002.

The Company’s performance of its fixed maturities and equity securities compared to selected market indices is presented below.

Pre-tax annualized returns

 
         
    Two years ended December 31, 2003
   
Fixed maturities—corporate
    8.40 %
Fixed maturities—municipal
    5.92 (1)
Preferred stock
    9.81 (1)
Common stock
    (2.24 )
Benchmark indices:
       
Lehman Brothers Global
       
Aggregate Bond Index—Unhedged
    14.50 %(2)
Lehman Brothers Global
       
Aggregate Bond Index—Hedged
    5.75  
S&P 500 Composite Index
    0.12  

(1)   Returns on municipal fixed maturities and preferred stocks have tax-equivalent yields of 8.74% and 10.81%, respectively.
(2)   Unhedged global bond index return includes the effects of currency fluctuations.

Limited partnership earnings pertain to investments in U.S. and foreign private equity, real estate and mezzanine debt partnerships. Private equity and mezzanine debt limited partnerships incurred realized losses of $5.4 million in 2003 compared to losses of $8.0 million in 2002. Included in the partnerships’ realized losses are impairment charges of $5.0 million and $6.9 million in 2003 and 2002, respectively. Real

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estate limited partnerships reflected earnings of $3.3 million in 2003 compared to $4.4 million in 2002.

The Company’s 21.6% ownership of EFL is accounted for under the equity method of accounting. The Company’s 2003 earnings from its investment in EFL, before income taxes, increased $5.7 million from 2002. The increased earnings from the Company’s investment in EFL in 2003 are related to a reduction in the realized losses on EFL’s investments in 2003 compared to 2002 and higher interest spreads on the Company’s interest-sensitive products.

Financial condition

Investments

The Company’s investment strategy takes a long-term perspective emphasizing investment quality, diversification and superior investment returns. Investments are managed on a total return approach that focuses on current income and capital appreciation. The Company’s investment strategy also provides for liquidity to meet the short- and long-term commitments of the Company. At December 31,2003 and 2002, the Company’s investment portfolio of investment-grade bonds, common stock, investment-grade preferred stock and cash and cash equivalents represents 39.6% and 41.1%, respectively, of total assets. These investments provide the liquidity the Company requires to meet the demands on its funds.

Distribution of investments

 
                                 
    Carrying value at December 31
    (dollars in thousands)
    2003   %   2002   %
   
 
 
 
Fixed maturities
  $ 879,361       74     $ 708,068       71  
Equity securities:
                               
Preferred stock
    148,952       13       157,563       16  
Common stock
    40,451       3       36,515       3  
Limited partnerships
    111,218       9       91,046       9  
Real estate mortgage loans
    5,182       1       5,567       1  
 
   
     
     
     
 
Total investments
  $ 1,185,164       100 %   $ 998,759       100 %
 
   
     
     
     
 

The Company continually reviews the investment portfolio to evaluate positions that might incur other-than-temporary declines in value. For all investment holdings,general economic conditions and/or conditions specifically affecting the underlying issuer or its industry, including downgrades by the major rating agencies, are considered in evaluating impairment in value. In addition to specific factors, other factors considered in the Company’s review of investment valuation are the length of time the market value is below cost and the amount the market value is below cost.

There is a presumption of impairment for common equity securities and equity limited partnerships when the decline is, in management’s opinion, significant and of an extended duration. The Company considers market conditions, industry characteristics and the fundamental operating results of the issuer to determine if sufficient objective evidence exists to refute the presumption of impairment. When the presumption of impairment is confirmed, the Company will recognize an impairment charge to operations. Common stock impairments are included in realized losses in the Consolidated Statements of Operations. For limited partnerships, the impairment charge is included as a component of equity in losses or earnings of limited partnerships in the Consolidated Statements of Operations.

For fixed maturity and preferred stock investments, the Company individually analyzes all positions with emphasis on those that have, in management’s opinion,declined significantly below cost. The Company considers market conditions, industry characteristics and the fundamental operating results of the issuer to determine if the decline is due to changes in interest rates,changes relating to a decline in credit quality, or other issues affecting the investment. A charge is recorded in the Consolidated Statements of Operations for positions that have experienced other-than-temporary impairments due to credit quality or other factors, or for which it is not the intent of the Company to hold the position until recovery has occurred.

Fixed maturities

Under its investment strategy, the Company maintains a fixed maturities portfolio that is of high quality and well-diversified within each market sector. This investment strategy also achieves a balanced maturity schedule in order to moderate investment income in the event of interest rate declines in a year in which a large amount of securities could be redeemed or mature. The fixed maturities portfolio is managed with the goal of achieving reasonable returns while limiting exposure to risk.

Diversification of fixed maturities

Carrying value at December 31, 2003

(PIE CHART)

The Company’s fixed maturity investments include 95.3% of high-quality, marketable bonds and redeemable preferred stock, all of which were rated at investment-grade levels (above Ba1/BB+) at December 31, 2003. Included in this investment-grade category are $314.1 million, or 35.7%, of the highest quality bonds and redeemable preferred stock rated Aaa/AAA or Aa/AA or bonds issued by the United States government. Generally, the fixed maturities in the Company’s portfolio are rated by external rating agencies.

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If not externally rated, they are rated by the Company on a basis consistent with that used by the rating agencies. Management classifies all fixed maturities as available-for-sale securities,allowing the Company to meet its liquidity needs and provide greater flexibility for its investment managers to appropriately respond to changes in market conditions or strategic direction.

Quality* of fixed maturities

Carrying value at December 31,2003

Securities classified as available-for-sale are carried at market value with unrealized gains and losses net of deferred taxes included in shareholders’equity. At December 31,2003, the net unrealized gain on fixed maturities, net of deferred taxes, amounted to $29.1 million,compared to $20.9 million at December 31,2002.

Equity securities

The Company’s equity securities consist of common stock and nonredeemable preferred stock. Investment characteristics of common stock and nonredeemable preferred stock differ substantially from one another. The Company’s nonredeemable preferred stock portfolio provides a source of highly predictable current income that is competitive with investment-grade bonds. Nonredeemable preferred stocks generally provide for fixed rates of return that, while not guaranteed, resemble fixed income securities and are paid before common stock dividends. Common stock provides capital appreciation potential within the portfolio. Common stock investments inherently provide no assurance of producing income because dividends are not guaranteed.

Diversification of equity securities

Carrying value at December 31,2003

At December 31,2003, equity securities represented 16.0% of total invested assets.

The Company’s equity securities are carried on the Consolidated Statements of Financial Position at market value. At December 31,2003, the net unrealized gain on equity securities, net of deferred taxes, amounted to $24.1 million, compared to $12.0 million at December 31,2002.

Limited partnership investments

The Company’s limited partnership investments include U.S. and foreign private equity, real estate and mezzanine debt investments. During 2003, limited partnership investments increased $20.2 million to $111.2 million. Mezzanine debt and real estate limited partnerships, which comprise 49.5% of the total limited partnerships, produce a predictable earnings stream while private equity limited partnerships, which comprise 50.5% of the total limited partnerships, tend to provide a less predictable earnings stream but the potential for greater long-term returns.

Distribution of limited partnership investments

 
                 
    Carrying value at December 31
    (dollars in thousands)
    2003   2002
   
 
Private equity
  $ 56,207     $ 48,307  
Real estate
    39,341       28,510  
Mezzanine debt
    15,670       14,229  
 
   
     
 
 
  $ 111,218     $ 91,046  
 
   
     
 

Liabilities

Property/casualty loss reserves

Loss reserves are established to account for the estimated ultimate costs of loss and loss adjustment expenses for claims that have been reported but not yet settled and claims that have been incurred but not reported. The estimated loss reserve for reported claims is based primarily upon a case-by-case evaluation of the type of risk involved and knowledge of the circumstances surrounding each claim and the insurance policy provisions relating to the type of loss. Estimates of bulk reserves for unreported claims and loss settlement expenses are determined on the basis of historical information by line of insurance as adjusted to current conditions. Loss reserves are set at full-expected cost, except for loss reserves for workers’compensation, which have been discounted at 2.5% in 2003 and 2002. Inflation is implicitly provided for in the reserving function through analysis of costs, trends and reviews of historical reserving results.

Adverse development of losses from prior accident years results in higher calendar year loss ratios and reduced calendar year underwriting results. To the extent prior year reserve deficiencies are indicative of deteriorating underlying loss trends and are material, the Property and Casualty Group’s pricing of affected lines of business would be increased to the extent permitted by state departments of insurance. Management also reviews trends in loss developments

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in order to determine if adjustments, such as reserve strengthening, are appropriate. Any adjustments considered necessary are reflected in current results of operations.

At December 31, 2003, the Property and Casualty Group’s estimated total loss exposure related to the events of September 11th remained at $150 million. During the first quarter of 2003, the Company updated its comprehensive review of reinsurance claims related to the World Trade Center attack. At December 31, 2003, paid claims and case reserves on reported claims total $83.8 million with an additional exposure to adverse development of $47.7 million if every claim ultimately develops into the full layer limit loss. These estimates are based on the September 11th attack being considered one event. If the attack comes to be considered two events, the Company anticipates an additional loss of approximately $22 million. Based on this review, the Company believes the $150 million total loss estimate should be sufficient to absorb the potential development that may occur from the first and/or second event. The Company’s property/casualty insurance subsidiaries share of losses related to the World Trade Center attack amounted to $5.8 million in 2001 net of recoveries under the excess-of-loss reinsurance agreement with the Exchange. No losses were recognized by the Company’s property/casualty insurance subsidiaries in 2003 or 2002 related to the World Trade Center attack.

Impact of inflation

Property/casualty insurance premiums are established before losses and loss adjustment expenses, and the extent to which inflation may impact such expenses are known. Consequently, in establishing premium rates, the Company attempts to anticipate the potential impact of inflation.

Quantitative and qualitative disclosures about market risk

The Company is exposed to potential loss from various market risks, including changes in interest rates, equity prices, foreign currency exchange rate risk and credit risk.

Interest rate risk

The Company’s exposure to interest rates is concentrated in the fixed maturities portfolio. The fixed maturities portfolio comprises 74.2% and 70.9% of invested assets at December 31,2003 and 2002, respectively. The Company does not hedge its exposure to interest rate risk since it has the capacity and intention to hold the fixed maturity positions until maturity. The Company calculates the duration and convexity of the fixed maturities portfolio each month to measure the price sensitivity of the portfolio to interest rate changes. Duration measures the relative sensitivity of the fair value of an investment to changes in interest rates. Convexity measures the rate of change of duration with respect to changes in interest rates. These factors are analyzed monthly to ensure that both the duration and convexity remain in the targeted ranges established by management.

Principal cash flows and related weighted-average interest rates by expected maturity dates for financial instruments sensitive to interest rates are as follows:

 
                   
      As of December 31,2003
      (dollars in thousands)
      Principal   Weighted-average
      cash flows   interest rate
     
 
Fixed maturities, including notes from EFL:
               
 
2004
  $ 52,088       5.5 %
 
2005
    55,968       5.4  
 
2006
    68,408       4.7  
 
2007
    71,150       4.9  
 
2008
    89,957       5.1  
 
Thereafter
    537,078       6.0  
 
   
     
 
 
Total
  $ 874,649          
 
   
         
 
Market value
  $ 919,361          
 
   
         
 
                   
      As of December 31,2002
      (dollars in thousands)
      Principal   Weighted-average
      cash flows   interest rate
     
 
Fixed maturities, including note from EFL:
               
 
2003
  $ 69,622       6.3 %
 
2004
    49,195       6.9  
 
2005
    55,322       6.3  
 
2006
    37,390       6.3  
 
2007
    64,000       5.4  
 
Thereafter
    425,331       6.8  
 
   
     
 
 
Total
  $ 700,860          
 
   
         
 
Market value
  $ 723,068          
 
   
         

Actual cash flows may differ from those stated as a result of calls, prepayments or defaults.

A sensitivity analysis is used to measure the potential loss in future earnings, fair values or cash flows of market sensitive instruments resulting from one or more selected hypothetical changes in interest rates and other market rates or prices over a selected period. In the Company’s sensitivity analysis model, a hypothetical change in market rates is selected that is expected to reflect reasonably possible changes in those rates. The following pro forma information is presented assuming a 100 basis point increase in interest rates at December 31 of each year and reflects the estimated effect on the fair value of the Company’s fixed maturity investment portfolio. The Company used the modified duration of its fixed maturity investment portfolio to model the pro forma effect of a change in interest rates at December 31,2003 and 2002.

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Fixed maturities interest rate sensitivity analysis 100 basis point rise in interest rates

 
                 
    As of December 31
    (dollars in thousands)
    2003   2002
   
 
Current market value
  $ 919,361     $ 723,068  
Change in market value (1)
    (40,160 )     (29,682 )
 
   
     
 
Pro forma market value
  $ 879,201     $ 693,386  
 
   
     
 
Modified duration (2)
    4.4       4.1  
 
   
     
 

(1)   The change in market value is calculated by taking the negative of the product obtained by multiplying (i) modified duration by (ii) change in interest rates by (iii) market value of the portfolio.
 
(2)   Modified duration is a measure of a portfolio’s sensitivity to changes in interest rates. It is interpreted as the approximate percentage change in the market value of a portfolio for a certain basis point change in interest rates.

Equity price risk

The Company’s portfolio of marketable equity securities, which is carried on the Consolidated Statements of Financial Position at estimated fair value, has exposure to price risk, the risk of potential loss in estimated fair value resulting from an adverse change in prices. The Company does not hedge its exposure to equity price risk inherent in its equity investments. The Company’s objective is to earn competitive relative returns by investing in a diverse portfolio of high-quality, liquid securities. Portfolio holdings are diversified across industries and among exchange traded mid- to large-cap stocks. The Company measures risk by comparing the performance of the marketable equity portfolio to benchmark returns such as the S&P 500.

The Company’s portfolio of limited partnership investments has exposure to market risks, primarily relating to the financial performance of the various entities in which they invested. The limited partnership portfolio comprises 9.4% and 9.1% of invested assets at December 31, 2003 and 2002, respectively. These investments consist primarily of equity investments in small- and medium-sized companies and in real estate. The Company achieves diversification within the limited partnership portfolio by investing in approximately 62 partnerships that have approximately 1,350 distinct investments. The Company reviews at least quarterly the limited partnership investments by sector, geography and vintage year. These limited partnership investments are diversified to avoid concentration in a particular industry or geographic area. The Company performs extensive research prior to investment in these partnerships.

Foreign currency risk

The Company has foreign currency risk in the limited partnership portfolio. The limited partnership portfolio includes approximately $16.2 million of partnerships that are denominated in Euros. The Company also is exposed to foreign currency risk through commitments to Euro-denominated partnerships of approximately $11.3 million. The foreign currency risk in the partnerships denominated in Euros and the foreign currency risk in the commitments due in Euros are partially offsetting. This risk is not hedged, although the Euro rate is monitored daily and the Company may decide to hedge all or some of the partnership-related foreign currency risk at some time in the future.

Credit risk

The Company’s objective is to earn competitive returns by investing in a diversified portfolio of securities. The Company’s portfolios of fixed maturity securities, nonredeemable preferred stock, mortgage loans and, to a lesser extent, short-term investments are subject to credit risk. This risk is defined as the potential loss in market value resulting from adverse changes in the borrower’s ability to repay the debt. The Company manages this risk by performing up front underwriting analysis and ongoing reviews of credit quality by position and for the fixed maturity portfolio in total. The Company does not hedge credit risk inherent in its fixed maturity investments.

The Company is also exposed to a concentration of credit risk with the Exchange. See the previous section, “Transactions and Agreements with Related Parties”, for further discussion of this risk.

Liquidity and capital resources

Liquidity is a measure of an entity’s ability to secure enough cash to meet its contractual obligations and operating needs. The Company’s major sources of funds from operations are the net cash flow generated from management operations, the net cash flow from Erie Insurance Company’s and Erie Insurance Company of New York’s 5.5% participation in the underwriting results of the reinsurance pool with the Exchange,and investment income from affiliated and nonaffiliated investments. With respect to the management fee, funds are received generally from the Exchange on a premiums-collected basis. The Company has a receivable from the Exchange and affiliates related to the management fee receivable from premiums written, but not yet collected, as well as the management fee receivable on premiums collected in the current month. The Company pays nearly all general and administrative expenses on behalf of the Exchange and other affiliated companies. The Exchange generally reimburses the Company for these expenses on a paid basis each month.

Management fee and other cash settlements due at December 31 from the Exchange were $195.6 million and $177.2 million in 2003 and 2002, respectively. A receivable from EFL for cash settlements totaled $3.4 million at December 31,2003, compared to $2.8 million at December 31, 2002. The receivable due from the Exchange for reinsurance recoverable from unpaid loss and loss adjustment expenses and unearned premium balances ceded to the intercompany reinsurance pool rose 21.0% to $785.1 million,from $649.0 million at December 31,2003 and 2002, respectively. These increases are the result of corresponding increases in direct loss reserves, loss adjustment expense reserves and unearned

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premium reserves of the Company’s property/casualty insurance subsidiaries that are ceded to the Exchange under the intercompany pooling agreement. The increase in the property/casualty insurance subsidiaries reserves ceded to the Exchange is a result of a corresponding increase in direct premium written by the Company’s property/casualty insurance subsidiaries. The increase in the property/casualty insurance subsidiaries’direct written premium was 15.1% and 26.7% for the years ended December 31,2003 and 2002, respectively. Total receivables from the Exchange represented 12.2% of the Exchange’s assets at December 31,2003, and 11.8% at December 31,2002. Cash outflows are variable because of the fluctuations in settlement dates for liabilities for unpaid losses and because of the potential for large losses, either individually or in aggregate.

The Company has certain obligations and commitments to make future payments under various contracts. As of December 31,2003, the aggregate obligations were:

 
                                 
    Payments Due By Period
   
            Less than   1-3   3-5
(dollars in thousands)   Total   1 year   years   years

 
 
 
 
Limited partnership commitments
  $ 86,774     $ 14,089     $ 60,789     $ 11,896  
Operating leases—other
    15,373       5,182       9,415       776  
Operating leases—real estate
    8,448       2,617       5,187       644  
Operating leases—computer
    5,379       3,982       1,397        
Financing arrangements
    1,784       724       1,060        
eCommerce Program consulting arrangements
    1,519       1,519              
 
   
     
     
     
 
Total
  $ 119,277     $ 28,113     $ 77,848     $ 13,316  
 
   
     
     
     
 

The limited partnership commitments included in the table above will be funded as required for capital contributions at any time prior to the agreement expiration date. The commitment amounts are presented using the expiration date as the factor by which to age when the amounts are due. At December 31,2003, the total commitment to fund limited partnerships that invest in private equity securities is $49.3 million, real estate activities $20.2 million and mezzanine debt of $17.3 million. The Company expects to have sufficient cash flows from operations to meet these partnership commitments.

The other operating leases include various computer software and licenses. Of the total $15.4 million obligation, approximately $9.2 million will be reimbursed to the Company from its affiliates. The Company has operating leases for 16 of its 23 field offices that are operated in the states in which the Property and Casualty Group does business. Of the total $8.4 million obligation, approximately $5.8 million will be reimbursed to the Company from its affiliates. Of the $5.4 million obligation related to the operating leases for computer equipment which were entered into in conjunction with the eCommerce initiative, approximately $3.2 million will be reimbursed to the Company from its affiliates.

The financing arrangements are related to software licenses and printing equipment. Payments are due periodically and the respective items will be owned at the end of the agreements. Of the total $1.8 million, approximately $1.0 million will be reimbursed to the Company from its affiliates.

Not included in the table above are the obligations for the Company’s unfunded benefit plans including the Supplemental Employee Retirement Plan (SERP) for its executive and senior management, the directors’retirement plan and the post retirement health care plan. The recorded accumulated benefit obligations for these plans at December 31,2003, is $22.2 million. The Company expects to have sufficient cash flows from operations to meet the future benefit payments as they become due.

There are no off-balance sheet obligations related to the variable interest the Company has in the Exchange. Any liabilities between the Exchange and the Company are recorded in the Consolidated Statements of Financial Position of the Company. The Company has no other material off-balance sheet obligations or guarantees.

The Company generates sufficient net positive cash flow from its operations to fund its commitments and build its investment portfolio, thereby increasing future investment returns. The Company maintains a high degree of liquidity in its investment portfolio in the form of readily marketable fixed maturities, equity securities and short-term investments. Net cash flows provided by operating activities for the years ended December 31,2003,2002 and 2001, were $225.4 million, $187.6 million and $148.6 million, respectively.

Cash flows provided by operating activities may be impacted in 2004 by the reduction of the management fee rate from the 2003 rate of 24.0% to 23.5% and the discontinuance of the assumed voluntary reinsurance business by the Exchange, which generates service fee revenue for the Company. Service fee income comprised $7.2 million and $12.8 million of the service agreement revenue received in 2003 and 2002, respectively. Cash flows used in operating activities may be impacted in 2004 by the change in the agent compensation package. The changes are expected to increase the commissions paid to agents in 2004, relative to the agent contingency awards, by approximately $10 million to $12 million. This increase is anticipated to be offset in 2005 by the reduction in certain commercial commission rates which become effective January 1,2005. Salaries and wages paid could be impacted by the redeployment of staff from the eCommerce project to the Company.

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Proceeds from the sales, calls and maturities of fixed maturity positions totaled $357.1 million, $232.3 million and $189.9 million in 2003, 2002 and 2001, respectively. The market interest rates declines of 2002 and 2001 continued into 2003 contributing to greater levels of calls. In 2002 and 2001, there were record numbers of credit quality downgrades and defaults, which led the Company to sell many of these issues in order to improve the overall credit quality of the fixed income portfolio.

In 2003, the Company issued a surplus note to EFL in the amount of $25 million to further strengthen EFL’s surplus and to support continued sales growth. The surplus note will be payable on demand on or after December 31, 2018, however, principal and interest payments by EFL to the Company are subject to the prior approval of the Pennsylvania Insurance Commissioner. Interest is scheduled to be paid semi-annually to the Company.

During 2003, the Company made a capital contribution of $50 million to its wholly-owned subsidiary, Erie Insurance Company. The capital will be used to strengthen the surplus of the property/casualty insurance subsidiary and to bring its premium to surplus leverage ratio in line with the other members of the Property and Casualty Group.

Dividends declared to shareholders totaled $50.6 million, $45.0 million and $40.4 million in 2003, 2002 and 2001, respectively. There are no regulatory restrictions on the payment of dividends to the Company’s shareholders, although there are state law restrictions on the payment of dividends from the Company’s subsidiaries to the Company. Dividends from subsidiaries are not material to the Company’s cash flows.

The Company established a stock repurchase program in 1999 for the repurchase of shares through 2002. In 2002, there were 207,217 shares repurchased at a total cost of $8.5 million. Total shares repurchased under the plan were 3.4 million with a total cost of $101.9 million. The Company discontinued share repurchases under this plan in 2002 due to the secondary offering by a major shareholder of the Company’s non-voting Class A common stock.

In December 2003, the stock repurchase program was reauthorized to allow the Company to repurchase up to $250 million of its outstanding Class A common stock through December 31, 2006. There were no shares repurchased under this plan in 2003. The Company intends to be active in repurchasing shares, however, the Company is unable to estimate the number of shares that will be repurchased during a specified period.

Financial ratings

The following table summarizes the current A. M. Best Company ratings for the insurers of the Erie Insurance Group:

Erie Insurance Exchange A+
Erie Insurance Company A+
Erie Insurance Property and Casualty Company A+
Erie Insurance Company of New York A+
Flagship City Insurance Company A+
Erie Family Life Insurance Company A

According to A.M. Best,a superior rating (A+) is assigned to those companies that, in A. M. Best’s opinion, have achieved superior overall performance when compared to the standards established by A. M. Best and have a superior ability to meet their obligations to policyholders over the long term. The A (Excellent) rating of EFL continues to affirm its strong financial position, indicating that EFL has an excellent ability to meet its ongoing obligations to policyholders. By virtue of its affiliation with the Property and Casualty Group, EFL is typically rated one financial strength rating lower than the property/casualty companies by A.M. Best Company. The insurers of the Erie Insurance Group are also rated by Standard & Poor’s, but this rating is based solely on public information. Standard & Poor’s rates these insurers Api, “strong.” Financial strength ratings continue to be an important factor in evaluating the competitive position of insurance companies.

Regulatory risk-based capital

The standard set by the National Association of Insurance Commissioners (NAIC) for measuring the solvency of insurance companies, referred to as Risk-Based Capital (RBC), is a method of measuring the minimum amount of capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. At December 31, 2003, the companies comprising the Property and Casualty Group all had RBC levels substantially in excess of levels that would require regulatory action. The Exchange’s RBC levels strengthened in 2003 due to its gain in surplus, lower ratio of common stocks to surplus and decision to exit the reinsurance business.

Factors that may affect future results

Financial condition of the Exchange

The Company has a direct interest in the financial condition of the Exchange because management fee revenues are based on the direct written premiums of the Exchange and the other members of the Property and Casualty Group. Additionally, the Company participates in the underwriting results of the Exchange through the pooling arrangement in which the Company’s insurance subsidiaries have a 5.5% participation. The Company’s property/casualty insurance subsidiaries have in effect an all-lines aggregate excess-of-loss reinsurance agreement with the Exchange to reduce potential exposure to catastrophe losses and variations in long-term underwriting results. Additionally, a concentration of credit

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risk exists related to the unsecured receivables due from the Exchange for certain fees, costs and reimbursements.

To the extent that the Exchange incurs underwriting losses or investment losses resulting from declines in the value of its marketable securities, the Exchange’s policyholders’surplus would be adversely affected. If the surplus of the Exchange were to decline significantly from its current level, the Property and Casualty Group could find it more difficult to retain its existing business and attract new business. A decline in the business of the Property and Casualty Group would have an adverse effect on the amount of the management fees the Company receives and the underwriting results of the Property and Casualty Group in which the Company has a 5.5% participation. In addition, a decline in the surplus of the Exchange from its current level would make it more likely that the management fee rate would be further reduced.

The Company disclosed in its’third quarter 2003 Form 10Q that it believed under Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46), that the Erie Insurance Exchange (Exchange) was a variable interest entity (VIE) and that the Company was the primary beneficiary of the Exchange, under the interpretation, and must consolidate the financial results of the Exchange with those of the Company. The Company re-evaluated its’position in response to revisions made by the FASB to FIN46 in the fourth quarter 2003. The FASB revised FIN46 to provide that only the variability in fees paid to decision maker should be included in the calculation of the primary beneficiary of a VIE. Prior to the change, FIN46 required that the gross fees paid to the decision maker should be included in the expected residual returns computation in determination of the primary beneficiary. As a result of this change, management concluded that the Company is not the primary beneficiary of the Exchange. Consequently, under FIN46 the results of the Exchange will not be consolidated with the results of the Company.

Additional information, including condensed financial statements of the Exchange, is presented in Note 13 to the Consolidated Financial Statements. See page 57.

Underwriting profitability

Underwriting practices affect the number of new policyholders eligible for coverage with the Property and Casualty Group as well as the number eligible to renew and the terms of renewal. The gravity of risks accepted by the Property and Casualty Group is a major factor influencing underwriting profitability. Underwriting profitability is also largely affected by trends underlying the cost of settling claims. Taken together, the Property and Casualty Group’s pricing actions, underwriting practices and claims severity initiatives are designed to improve the overall underwriting result of the Property and Casualty Group. The following actions were implemented in management’s effort to improve underwriting profitability during 2003:

  Controlling loss severity;
 
  Instituted programs to control exposure growth and improve underwriting risk selection;
 
  Obtained additional premium on risks through rate increases;
 
  Exited the Property and Casualty Group’s assumed reinsurance business;
 
  Suspended new agent appointments for the latter half of 2003;
 
  Relaxed the timeframe for Erie Insurance Group to begin operations in Minnesota; and
 
  Modified agent contingency award program for independent agents

Controlling loss severity —Loss severity has trended upward for many of the Property and Casualty Group’s lines of business over the last several years. Private passenger automobile liability, homeowners’property, commercial multi-peril and workers compensation lines of insurance have experienced accelerated increases in loss severity.

The Property and Casualty Group has responded to these trends by implementing a number of initiatives aimed at controlling loss severity. Management has established specialty adjusting units to address loss severity in both private passenger auto bodily injury and uninsured/ underinsured motorists liability claims as well as workers compensation claims. New medical management loss review services have also been introduced to address medical claim severity in these lines. To address property severity in the homeowners and commercial lines, the Property and Casualty Group has implemented new property estimating tools and extensive third party property training for all property adjusters. To address fraudulent claims, the Property and Casualty Group implemented intelligent fraud detection tools, which utilize the Company’s databases to evaluate trends or anomalies in claims and identify fraudulent claims. These initiatives, along with numerous other activities within the Group’s field operations, are targeted to reverse the recent deterioration in loss severity trends.

Control exposure growth and improve underwriting risk selection —The AWARE program, the acronym for Agents Writing And Reunderwriting Excellence, is a comprehensive set of initiatives directed at improving the pool of risks insured by the Property and Casualty Group. This program was initiated at the beginning of 2003 and consisted of reinforcing underwriting guidelines for new business and increased rigor in reunderwriting renewal business. The Property and Casualty Group has experienced slower growth in premiums, partially as a result of the AWARE program. New policies decreased 14.0% to 581,538 from 676,427 and the twelve-month moving average policy retention rate declined to 90.2% for 2003 from 91.2% for 2002. Downward trends may continue into 2004 as the revised underwriting practices may dampen new policy sales and renewal policy retention rates.

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Insurance premium rate increases— The premium growth attributable to rate increases of the Property and Casualty Group bears directly on the management fee revenue and ongoing profitability of the Company. In recent years, prices for commercial and personal lines insurance have increased considerably in the industry. The property/casualty insurers of the Property and Casualty Group have also increased prices considerably through 2004. The Company continually evaluates pricing levels, balancing competitive conditions and the need to maintain the solid financial condition of the insurers of the Property and Casualty Group. Pricing actions contemplated or taken by the Property and Casualty Group are subject to various regulatory requirements of the states in which these insurers operate. The pricing actions already implemented, or to be implemented through 2004, will have an effect on the market competitiveness of the Property and Casualty Group’s insurance products. Such pricing actions, and those of our competitors, could affect the ability of our agents to sell and/or renew business.

Rate increases filed by the Property and Casualty Group for certain lines of business in various states were sought to offset growing loss costs in those lines. Premium increases anticipated due to pricing actions approved through December 31, 2003, could amount to approximately $254.1 million in written premium for the Property and Casualty Group in 2004. There is also the potential for an additional $66.2 million in written premium for the Property and Casualty Group in 2004 resulting from pricing actions contemplated or filed and awaiting approval. The majority of the anticipated increase stems from the private passenger and commercial multiple-peril, workers’compensation and commercial auto lines of business as well as the homeowners line of business. Further rate actions continue to be contemplated for 2004. Price increases can reduce the Property and Casualty Group’s ability to attract new policyholders and to retain existing policyholders because of the possibility of acquiring coverage at more competitive prices from other insurers.

Rate increases accounted for $208.4 million in written premium for the Property and Casualty Group in 2003, including the effects of rate increases filed in 2002. This was a substantial increase, 68.3%, over the 2002 written premium attributable to rate filings of $122.2 million. Because all policies issued by the Property and Casualty Group are for a one-year term, it will take 24 months before the full impact of rate increases are recognized in earned premiums of the Property and Casualty Group.

Exiting the Property and Casualty Group’s assumed reinsurance business —The Property and Casualty Group exited its assumed reinsurance business effective December 31, 2003. This action was taken in order to dedicate capital and align resources around the Property and Casualty Group’s core business operations—personal and small commercial property/casualty lines—and to lessen underwriting exposure. Premiums from the voluntary assumed reinsurance business were $119.8 million in 2003, down from $183.2 million, or a decline of 34.6% from 2002. The Company receives a fee (service agreement revenue) as compensation from the Exchange for the management and administration of the voluntary assumed reinsurance business. Service agreement revenue totaled $7.2 million and $12.8 million in 2003 and 2002, respectively. The Company expects only a nominal amount of assumed reinsurance premium will be written in 2004 as this operation is discontinued. Consequently, service fees will also be nominal.

Suspension of new agency appointments— During the first half of 2003, the Property and Casualty Group appointed about 50 new agencies. Agent appointment efforts were suspended for the remainder of 2003 to enable field managers to focus their attention on agency performance, including training new agents, supporting agents’ reunderwriting efforts, and helping them effectively apply the underwriting guidelines to ensure that appropriate risks are being underwritten. In 2004, the Company estimates that it will appoint approximately 50 agencies.

Relaxing the timeframe for entrance into new states— The Company planned to begin writing business in Minnesota by the end of 2004. In mid-2003, management decided to relax the timeframe for entry into the state of Minnesota, while continuing efforts toward obtaining a license in Minnesota in anticipation of entry into the state at a future date.

Modified agent contingency award program for independent agents —Agency compensation was modified to align contingency awards with the Property and Casualty Group’s underwriting profitability and quality growth goals. Changes to the agent contingency award program place more emphasis on underwriting profitability and quality growth in new and renewal property/casualty business. Agents also receive an award for life insurance production, contingent upon meeting underwriting profitability objectives under the plan. The changes to the agent contingency award program are effective as of January 1, 2004. In 2004, total commission expenses are expected to increase as a result of the changes to the agent contingency award program.

These actions may reduce the growth rate of the Property and Casualty Group’s new and renewal premium and could adversely affect policy retention rates currently enjoyed by the Property and Casualty Group. To the extent the premium growth rate of the Property and Casualty Group direct written premiums is impacted by these actions, the growth in the Company’s management fee revenue will be proportionally affected. Offsetting the potential negative impacts on growth and policy retention from more rigorous underwriting practices are the beneficial impacts to underwriting

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profitability. As the quality of the business improves, profitability should improve, and premium rates can be reduced, making the Property and Casualty Group products more attractive to potential customers and more desirable to existing customers. Improvements in underwriting profitability could directly affect the Company by virtue of its 5.5% share of the intercompany pooling agreement.

Catastrophe losses

The Property and Casualty Group conducts business in 11 states and the District of Columbia, primarily in the mid-Atlantic, midwestern and southeastern portions of the United States. A substantial portion of the business is private passenger and commercial automobile, homeowners and workers’ compensation insurance in Ohio, Maryland, Virginia and, particularly, Pennsylvania. As a result, a single catastrophe occurrence or destructive weather pattern could materially adversely affect the results of operations and surplus position of the members of the Property and Casualty Group. Common catastrophe events include hurricanes, earthquakes, tornadoes, wind and hail storms, fires and explosions. From 1993 to 2001, the Property and Casualty Group had not purchased catastrophe reinsurance because Company management concluded the benefits of such coverage were outweighed by the costs of the coverage in light of the Exchange’s substantial surplus position and its ratio of net premiums written to surplus. In 2002, the lowering of the surplus levels of the Exchange, along with increasing catastrophe risk exposure as a result of accelerating policy growth, resulted in management’s decision to purchase catastrophe occurrence reinsurance coverage. For 2003, the Property and Casualty Group entered into a reinsurance treaty to mitigate the future potential catastrophe loss exposure. The property catastrophe reinsurance treaty provided coverage of up to 95.0% of a loss of $415 million in excess of the Property and Casualty Group’s loss retention of $115 million per occurrence. This agreement was renewed for 2004 under the terms of coverage of up to 95.0% of a loss of $460 million in excess of the Property and Casualty Group’s loss retention of $140 million per occurrence.

Incurred But Not Reported (IBNR) losses

The Property and Casualty Group is exposed to new claims on previously closed files and to larger than historical settlements on pending and unreported claims. The Company is exposed to increased losses by virtue of its 5.5% participation in the intercompany reinsurance pooling agreement with the Exchange. The Company strives to establish reserves at the end of each period that are fully reflective of the ultimate value of all claims incurred. However these reserves are, by their nature, only estimates and cannot be established with absolute certainty.

Insurance company insolvencies

The insurance companies of the Property and Casualty Group pay assessments under the solvency or guaranty laws of the various states in which they are licensed. Insolvencies have not had a material effect in the recent three years but future insolvencies of property/casualty insurers in states where the Erie Insurance Group does business could result in future assessments.

Information technology costs

In 2001, the Erie Insurance Group began a comprehensive program of eCommerce initiatives in support of the Erie Insurance Group’s agency force and back office policy underwriting, issuance and administration. The eCommerce program is intended to improve service and efficiency, as well as result in increased sales. The program will produce an enduring benefit to the subscribers of the Exchange and all Property and Casualty Group policyholders as the system avails the Erie Insurance Group of infrastructure and processing capability that is progressive, expandable and capable of supporting the Group’s strategic direction.

The first major component of the eCommerce program (network and desktop hardware deployment) was completed during the second quarter of 2002. Also, the Erie Insurance Group completed a pilot of the new Web interface to a limited number of agents and employees in July 2002.

In August 2002, the eCommerce program took advantage of a significant business opportunity to work with a well-known provider of information technology services and solutions to develop the Erie Insurance Group’s eCommerce system called ERIEConnection ®. The Erie Insurance Group is now working with that service provider to be the chief integrator and co-manager of the eCommerce program and to co-develop software applications that meet the Company’s needs.

The Erie Insurance Group has spent approximately $148 million on the technology effort through 2003. In addition to this amount, $3.9 million has been committed for computer and equipment leases. Target delivery dates established in 2002 have generally not been met as management has devoted increased effort to quality assurance efforts to ensure that the rollout creates only minimal business disruption. Revised target dates and program costs are in the process of being developed and are expected to exceed original target delivery dates and costs.

Post-implementation expenses will be incurred for maintaining ERIEConnection ® and related staffing costs. These expenses will be borne by the Property and Casualty Group,and the Company will share in the expenses by virtue of the Cost-Sharing Agreement for Information Technology Development.

Certain staffing costs in future, post-implementation years will increase given the need to support two systems. The future costs and their impact on the Company can not yet be estimated. Post-implementation staffing costs related to personnel no longer deployed to the eCommerce program will not be subject to the Agreement. They will be subject to cost allocations which will likely result in a greater proportion of cost absorbed by the Company.

In addition to the impact of eCommerce on costs, the implementation of this new system will require a significant

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investment in training and orientation for the independent agency force. During implementation, as agency resources are dedicated to learning the new system, new business production is expected to be curtailed over the short term. The amount of lost production will correlate to the timing and duration of the rollout effort as well as the number and types of issues encountered. Precise measurement of this impact on production can not yet be estimated.

Repurchase program

In December 2003, the Board approved a share repurchase program authorizing the repurchase of up to $250 million of the Company’s class A shares through December 31,2006. The Company may repurchase shares in the open market or blocks of shares privately (subject to certain limitations). The Company may or may not repurchase shares equal to the amount authorized by the Board depending on trading volume, price movements, availability of block purchases or other factors affecting the Company’s class A shares.

Sarbanes-Oxley Act of 2002—Section 404 Internal Control Reporting

The Sarbanes-Oxley Act of 2002 established numerous compliance requirements for public companies including the Company. These requirements include, among others, the annual evaluation of internal controls. To the extent this evaluation uncovers business processes or practices felt by management to require improvement or revision, Company business practices could be altered, producing financial or competitive changes to the Company. The Company has not estimated the total cost of compliance with Sarbanes-Oxley, but the impact of this cost could be significant to the Company.

Terrorism

The World Trade Center terrorist attack resulted in staggering losses for the insurance industry and has caused uncertainty in the insurance and reinsurance markets. The Property and Casualty Group recorded a loss of $150 million in 2001 related to this attack.

The Company’s 5.5% share of this incurred loss was $5.8 million, after consideration of recoveries under the excess-of-loss reinsurance agreement. Accordingly, the industry was compelled to re-examine policy language and to address the potential for future threats of terrorist events and losses. The Property and Casualty Group’s personal and commercial property/casualty insurance policies were not priced to cover the risk of terrorist attacks and losses such as those suffered in the World Trade Center terrorist attack. The Property and Casualty Group initially excluded or limited some coverages and exposures where permitted by state regulators prior to enactment of the Terrorism Risk Insurance Act of 2002, discussed below.

On November 26,2002, President Bush signed the Terrorism Risk Insurance Act of 2002 (“Act”), establishing a program for commercial property/casualty losses, including workers’compensation, resulting from foreign acts of terrorism. The Act requires commercial insurers to make terrorism coverage available immediately and provides limited federal protection above individual company retention levels, based upon a percentage of direct earned premium, and above aggregate industry retention levels that range from $10 billion in the second year to $15 billion in the third year. The federal government will pay 90% of covered terrorism losses that exceed retention levels. The Act is scheduled to expire on December 31,2005. Personal lines are not included under the protection of the Act, and state regulators have not approved exclusions for acts of terrorism on personal lines policies. The Property and Casualty Group is exposed to terrorism losses for personal and commercial lines and workers’compensation, although commercial lines are afforded a backstop above certain retention levels for foreign acts of terrorism under the federal program. The Property and Casualty Group could incur large losses if future terrorist attacks occur.

The Erie Insurance Group has taken the steps necessary to comply with the Act by providing notices to all commercial policyholders, disclosing the premium, if any, attributable to coverage for acts of terrorism, as defined in the Act, and disclosing federal participation in payment of terrorism losses. Efforts are continuing to provide appropriate notices to new and renewal policyholders. The Act pre-empted any exclusion or provision in place prior to November 26,2002 that excluded or limited coverage for losses from foreign acts of terrorism. Insurers may exclude coverage for foreign acts of terrorism under the Act if the policyholder accepts an exclusion and rejects coverage or fails to pay additional premium charges after notice is given. Exclusions are not allowed under workers’compensation policies and rates for terrorism coverage are applied in accordance with state laws.

The Erie Insurance Group continues to evaluate procedures that have been established to comply with the Act. Premium charges for terrorism coverage for property/casualty lines other than workers’compensation are currently applied only for a small number of new and renewal commercial policies where deemed appropriate based upon individual risk factors and characteristics. Appropriate disclosure notices are provided in accordance with the Act. The Erie Insurance Group is evaluating systems and procedures and developing a rate structure and guidelines to accommodate premium charges for terrorism coverage where deemed appropriate for new and renewal commercial policies.

“Safe Harbor” Statement Under the Private Securities Litigation Reform Act of 1995: Certain forward-looking statements contained herein involve risks and uncertainties. These statements include certain discussions relating to management fee revenue, cost of management operations, underwriting, premium and investment income volume, business strategies, profitability and business relationships and the Company’s other business activities during 2003 and beyond. In some cases,you can identify forward-looking statements by terms such as“may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “intend,” “anticipate,” “believe,“estimate,” “project,” “predict,” “potential“and similar expressions. These forward-looking statements reflect the Company’s current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties that may cause results to differ materially from those anticipated in those statements. Many of the factors that will determine future events or achievements are beyond our ability to control or predict.

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(SELECTED SEGMENT INFORMATION) Selected segment information

The direct written premiums of the Property and Casualty Group have a direct impact on the Company’s management fee revenue and, consequently, the Company’s management operations. The Company’s insurance underwriting operations are impacted by the mix of the Group’s direct written premium. Below is a summary of direct written premiums of the Property and Casualty Group by state and line of business.

 
                             
        Years ended December
       
        2003   2002   2001
       
 
 
Premiums written as a percent of total by state:
                       
 
District of Columbia
    0.4 %     0.4 %     0.3 %
 
Illinois
    2.5       2.0       1.2  
 
Indiana
    4.4       4.3       4.2  
 
Maryland
    12.0       11.7       11.9  
 
New York
    3.8       3.6       3.1  
 
North Carolina
    5.9       5.7       5.3  
 
Ohio
    8.8       8.6       8.2  
 
Pennsylvania
    46.6       48.8       51.7  
 
Tennessee
    1.9       1.8       1.6  
 
Virginia
    8.2       8.1       8.0  
 
West Virginia
    4.7       4.5       4.4  
 
Wisconsin
    0.8       0.5       0.1  
 
 
   
     
     
 
 
Total direct premiums written
    100.0 %     100.0 %     100.0 %
 
   
     
     
 
Premiums written by line of business:
                       
 
Personal
                       
   
Automobile
    51.1 %     52.6 %     54.6 %
   
Homeowners
    16.8       15.8       16.0  
   
Other
    2.3       2.1       1.2  
 
 
   
     
     
 
 
Total personal
    70.2 %     70.5 %     71.8 %
 
Commercial
                       
   
Automobile
    8.4 %     8.5 %     8.3 %
   
Workers’ compensation
    8.8       8.6       8.0  
   
Commercial multi-peril
    10.9       10.7       10.2  
   
Other
    1.7       1.7       1.7  
 
 
   
     
     
 
 
Total commercial
    29.8 %     29.5 %     28.2 %
 
 
   
     
     
 

    The growth rate of policies in force and policy retention trends can impact the Company’s management and insurance operating segments. Below is a summary of each by line of business for the Property and Casualty Group business.
 
                         
    Years ended December 31 (amounts in thousands)
   
    2003   2002   2001
   
 
 
Policies in force:
                       
Personal lines
    3,273       3,072       2,724  
Commercial lines
    470       437       386  
 
   
     
     
 
Total policies in force
    3,743       3,509       3,110  
 
   
     
     
 
Policy retention percentages:
                       
Personal policy retention percentages
    90.5 %     91.5 %     91.3 %
Commercial policy retention percentages
    87.3       88.2       87.7  
Total policy retention percentages
    90.2       91.2       90.9  
 
   
     
     
 

88


 

(REPORT OF MANAGEMENT)

89


 

(CONSOLIDATED STATEMENTS OF OPERATIONS) Erie Indemnity Company
Consolidated statements of operations

 
                           
      Years ended December 31
      (amounts in thousands, except per share data)
      2003   2002   2001
     
 
 
Operating revenue
                       
Management fee revenue
  $ 830,069     $ 733,036     $ 600,043  
Premiums earned
    191,592       163,958       137,648  
Service agreement revenue
    27,127       23,729       27,247  
 
   
     
     
 
 
Total operating revenue
    1,048,788       920,723       764,938  
 
   
     
     
 
Operating expenses
                       
Cost of management operations
    616,382       526,785       451,374  
Losses and loss adjustment expenses incurred
    152,984       139,225       117,201  
Policy acquisition and other underwriting expenses
    51,112