FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For quarter ended September 30, 1999 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 (I.R.S. Employer incorporation or organization) Identification No.) 100 Erie Insurance Place, Erie, Pennsylvania 16530 (Address of principal executive offices) (Zip Code) (814) 870-2000 Registrant's telephone number, including area code Not applicable Former name, former address and former fiscal year, if changed since last report. 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 periods 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Class A Common Stock, no par value, with a stated value of $.0292 per share-- 65,366,736 shares as of October 20, 1999. Class B Common Stock, no par value, with a stated value of $70.00 per share-- 3,070 shares as of October 20, 1999. The common stock is the only class of stock the Registrant is presently authorized to issue. 1
INDEX ERIE INDEMNITY COMPANY PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Consolidated Statements of Financial Position--September 30, 1999 and December 31, 1998 Consolidated Statements of Operations--Three and nine months ended September 30, 1999 and 1998 Consolidated Statements of Comprehensive Income--Three and nine months ended September 30, 1999 and 1998 Consolidated Statements of Cash Flows--Nine months ended September 30, 1999 and 1998 Notes to Consolidated Financial Statements--September 30, 1999 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations PART II. OTHER INFORMATION Item 1. Legal Proceedings Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K SIGNATURES 2
PART I. FINANCIAL INFORMATION ERIE INDEMNITY COMPANY CONSOLIDATED STATEMENTS OF FINANCIAL POSITION <TABLE> <CAPTION> September 30, December 31, ASSETS 1999 1998 ----------------- ----------------- (Unaudited) <S> <C> <C> INVESTMENTS Fixed Maturities Available-for-Sale at fair value (amortized cost of $468,818,005 and $421,101,561, respectively) $ 471,121,281 $ 441,353,427 Equity Securities (cost of $179,481,645 and $169,976,774, respectively) 206,707,043 202,804,068 Real Estate Mortgage Loans 8,265,809 8,287,129 Other Invested Assets 30,919,610 17,493,496 ----------------- ----------------- Total Investments $ 717,013,743 $ 669,938,120 Cash and Cash Equivalents 32,945,494 53,580,043 Accrued Investment Income 8,964,821 7,252,439 Note Receivable from Erie Family Life Insurance Company 15,000,000 15,000,000 Premiums Receivable from Policyholders 118,288,376 114,695,231 Prepaid Federal Income Tax 0 2,508,908 Reinsurance Recoverables from Erie Insurance Exchange 407,281,771 381,301,722 Other Receivables from Erie Insurance Exchange and Affiliates 112,936,234 108,612,264 Reinsurance Recoverable Non-affiliates 945,546 938,894 Deferred Policy Acquisition Costs 11,826,911 10,863,107 Property and Equipment 15,250,185 12,388,650 Equity in Erie Family Life Insurance Company 36,151,686 39,478,746 Other Assets 40,775,193 36,873,922 ----------------- ----------------- Total Assets $ 1,517,379,960 $ 1,453,432,046 ================= ================= <FN> See Notes to Consolidated Financial Statements. </FN> </TABLE> 3
ERIE INDEMNITY COMPANY CONSOLIDATED STATEMENTS OF FINANCIAL POSITION <TABLE> <CAPTION> September 30, December 31, LIABILITIES AND SHAREHOLDERS' EQUITY 1999 1998 ----------------- ----------------- (Unaudited) <S> <C> <C> LIABILITIES Unpaid Losses and Loss Adjustment Expenses $ 441,846,800 $ 426,164,578 Unearned Premiums 246,608,685 229,056,597 Accrued Commissions 90,515,461 85,005,699 Accounts Payable and Accrued Expenses 25,084,369 20,252,904 Deferred Income Taxes 8,535,026 17,121,777 Federal Income Tax Payable 1,246,585 0 Dividends Payable 7,919,212 8,099,100 Employee Benefit Obligations 13,688,550 12,508,130 ----------------- ----------------- Total Liabilities $ 835,444,688 $ 798,208,785 ----------------- ----------------- SHAREHOLDERS' EQUITY Capital Stock Class A Common, stated value $.0292 per share; authorized 74,996,930 shares; issued 67,032,000 shares ; outstanding 65,595,136 shares $ 1,955,100 $ 1,955,100 Class B Common, stated value $70.00 per share; authorized 3,070 shares; issued and outstanding 3,070 shares 214,900 214,900 Additional Paid-In Capital 7,830,000 7,830,000 Accumulated Other Comprehensive Income 19,493,063 40,178,626 Retained Earnings 692,152,287 605,044,635 ----------------- ----------------- Total Contributed Capital and Retained Earnings $ 721,645,350 $ 655,223,261 ----------------- ----------------- Treasury Stock (1,436,864 shares repurchased in 1999) 39,710,078 0 ----------------- ----------------- Total Shareholders' Equity $ 681,935,272 $ 655,223,261 ----------------- ----------------- Total Liabilities and Shareholders' Equity $ 1,517,379,960 $ 1,453,432,046 ================= ================= <FN> See Notes to Consolidated Financial Statements. </FN> </TABLE> 4
ERIE INDEMNITY COMPANY CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30 September 30 ----------------------------------- ----------------------------------- MANAGEMENT OPERATIONS: 1999 1998 1999 1998 <S> <C> <C> <C> <C> Management Fee Revenue $ 135,796,427 $ 129,046,712 $ 395,133,491 $ 376,555,339 Service Agreement Revenue 3,792,303 3,944,646 11,225,977 9,886,891 Other Operating Revenue 318,776 369,086 966,684 1,116,876 ----------------- ---------------- ----------------- ---------------- Total Revenue from Management Operations 139,907,506 133,360,444 407,326,152 387,559,106 Cost of Management Operations 97,962,068 93,313,277 290,427,431 274,686,379 ----------------- ---------------- ----------------- ---------------- Net Revenue From Management Operations $ 41,945,438 $ 40,047,167 $ 116,898,721 $ 112,872,727 ----------------- ---------------- ----------------- ---------------- INSURANCE UNDERWRITING OPERATIONS: Premiums Earned $ 29,449,004 $ 28,387,446 $ 87,573,069 $ 83,995,073 Losses and Loss Adjustment Expenses Incurred 22,374,731 19,653,955 63,896,239 58,604,908 Policy Acquisition and Other Underwriting Expenses 8,653,731 8,830,200 24,750,680 24,366,116 ----------------- ---------------- ----------------- ---------------- Total Losses and Expenses 31,028,462 28,484,155 88,646,919 82,971,024 ----------------- ---------------- ----------------- ---------------- Underwriting (Loss) Gain $ (1,579,458) $ (96,709) $ (1,073,850) $ 1,024,049 ----------------- ---------------- ----------------- ---------------- INVESTMENT OPERATIONS: Equity in Earnings of Erie Family Life Insurance Company $ 1,456,208 $ 792,289 $ 3,783,675 $ 3,401,333 Net Investment Income 10,904,443 9,824,865 32,303,583 27,900,142 Net Realized Gain on Investments 4,088,931 1,230,011 11,309,953 5,416,377 ----------------- ---------------- ----------------- ---------------- Total Revenue from Investment Operations 16,449,582 11,847,165 47,397,211 36,717,852 ----------------- ---------------- ----------------- ---------------- Income Before Income Taxes 56,815,562 51,797,623 163,222,082 150,614,628 Provision for Income Taxes 18,390,973 16,101,086 52,164,953 47,748,551 ----------------- ---------------- ----------------- ---------------- Net Income $ 38,424,589 $ 35,696,537 $ 111,057,129 $ 102,866,077 ================= ================ ================= ================ Net Income per Share $ 0.52 $ 0.48 $ 1.51 $ 1.38 ================= ================ ================== ================ Weighted Average Shares Outstanding 73,322,329 74,400,000 73,780,876 74,400,000 ================= ================ ================== ================ Dividends Declared per Share: Class A non-voting Common $ 0.12 $ 0.1075 $ 0.36 $ 0.3225 ----------------- ---------------- ------------------ ---------------- Class B Common $ 18.00 $ 16.125 $ 54.00 $ 48.375 ----------------- ---------------- ----------------- ---------------- <FN> See Notes to Consolidated Financial Statements. </FN> </TABLE> 5
ERIE INDEMNITY COMPANY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30 September 30 --------------------------------- ---------------------------------- 1999 1998 1999 1998 <S> <C> <C> <C> <C> Net Income $ 38,424,589 $ 35,696,537 $ 111,057,129 $ 102,866,077 ---------------- --------------- ---------------- ---------------- Unrealized (Losses) Gains on Securities: Unrealized Holding (Losses) Gains Arising During Period (14,571,524) (16,780,584) (20,513,991) 693,271 Less: Reclassification Adjustment for Gains Included in Net Income 4,088,931 1,230,011 11,309,953 5,416,377 ---------------- --------------- ---------------- ---------------- Net Unrealized Holding Losses Arising During Period $ (18,660,455) $ (18,010,595) $ (31,823,944) $ (4,723,106) Income Tax Benefit Related to Unrealized Gains or Losses 6,531,160 6,303,708 11,138,381 1,653,087 ---------------- --------------- ---------------- ---------------- Other Comprehensive Loss, Net of Tax $ (12,129,295) $ (11,706,887) $ (20,685,563) $ (3,070,019) ---------------- --------------- ---------------- ---------------- Comprehensive Income $ 26,295,294 $ 23,989,650 $ 90,371,566 $ 99,796,058 ================ =============== ================ ================ <FN> See Notes to Consolidated Financial Statements. </FN> </TABLE> 6
ERIE INDEMNITY COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) <TABLE> <CAPTION> Nine Months Ended Nine Months Ended September 30, 1999 September 30, 1998 ------------------- ------------------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 111,057,129 $ 102,866,077 Adjustment to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 1,361,111 1,512,252 Deferred income tax (benefit)expense (649,247) 1,973,432 Amortization of deferred policy acquisition costs 16,757,832 15,902,016 Realized gain on investments (11,309,953) (5,416,377) Net amortization of bond premium (discount) 82,988 (100,054) Undistributed earnings of Erie Family Life (2,771,945) (2,481,579) Deferred compensation 584,390 462,203 Increase in accrued investment income (1,712,382) (1,918,871) Increase in receivables (33,903,816) (39,159,997) Policy acquisition costs deferred (17,721,637) (16,843,061) Increase in prepaid expenses and other assets (3,735,362) (6,880,040) Increase in accounts payable and accrued expenses 5,427,496 6,011,782 Increase in accrued commissions 5,509,763 5,903,638 Increase in income taxes payable 3,755,493 3,966,928 Increase in loss reserves 15,682,222 19,538,250 Increase in unearned premiums 17,552,088 20,066,258 ------------------- ------------------- Net cash provided by operating activities $ 105,966,170 $ 105,402,857 CASH FLOWS FROM INVESTING ACTIVITIES Purchase of investments: Fixed maturities (122,197,234) (68,532,043) Equity securities (48,471,461) (63,385,866) Mortgage loans (66,286) 0 Other invested assets (13,219,481) (9,847,958) Sales/maturities of investments: Fixed maturities Maturities and calls 37,969,478 6,393,339 Sales 36,891,489 20,314,279 Equity securities 49,849,204 32,267,890 Mortgage loans 87,800 92,124 Other invested assets 783,778 3,087,762 Purchase of property and equipment (337,762) (340,834) Purchase of computer software (3,884,884) (2,422,645) Loans to Agents (2,349,831) (1,452,913) Collections on Agent loans 2,183,912 1,071,634 ------------------- ------------------- Net cash used in investing activities $ (62,761,278) $ (82,755,230) CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid to shareholders $ (24,129,363) $ (21,766,335) Treasury stock (39,710,078) 0 ------------------- ------------------- Net cash used in financing activities $ (63,839,441) $ (21,766,335) ------------------- ------------------- Net (decrease) increase in cash and cash equivalents (20,634,549) 881,292 Cash and cash equivalents at beginning of period 53,580,043 53,148,495 ------------------- ------------------- Cash and cash equivalents at end of period $ 32,945,494 $ 54,029,787 =================== =================== Supplemental disclosures of cash flow information: Cash paid during the nine months ended September 30, 1999 and 1998 for income taxes was $46,475,000 and $45,016,115 respectively. <FN> See Notes to Consolidated Financial Statements. </FN> </TABLE> 7
ERIE INDEMNITY COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE A -- BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements, which include the accounts of the Erie Indemnity Company and its' wholly owned subsidiaries Erie Insurance Company, Erie Insurance Company of New York and Erie Insurance Property & Casualty Company, have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine-month period ended September 30, 1999 are not necessarily indicative of the results that may be expected for the year ending December 31, 1999. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Form 10-K for the year ended December 31, 1998. NOTE B -- EARNINGS PER SHARE Earnings per share is based on the weighted average number of Class A shares outstanding giving effect to the conversion of the weighted average number of Class B shares outstanding at a rate of 2,400 Class A shares for one Class B share as set out in the Articles of Incorporation. Weighted average equivalent shares outstanding totaled 73,322,329 for the three months ended September 30, 1999 and 73,780,876 for the nine months ended September 30, 1999. For the three and nine month periods ended September 30, 1998 the weighted average equivalent shares outstanding totaled 74,400,000. NOTE C -- INVESTMENTS Management considers all fixed maturities and marketable equity securities available-for-sale. Marketable equity securities consist primarily of common and nonredeemable preferred stocks while fixed maturities consist of bonds, notes and redeemable preferred stock. Available-for-sale securities are stated at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of shareholders' equity. Management determines the appropriate classification of fixed maturities at the time of purchase and reevaluates such designation as of each statement of financial position date. 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued) The following is a summary of available-for-sale securities: <TABLE> <CAPTION> Gross Gross Estimated Amortized Unrealized Unrealized Fair (In Thousands) Cost Gains Losses Value ------------- ------------ ------------- ------------- <S> <C> <C> <C> <C> September 30, 1999 Fixed Maturities: U.S. Treasuries & Government Agencies $ 11,038 $ 248 $ 40 $ 11,246 States & Political Subdivisions 52,078 1,859 281 53,656 Special Revenue 122,288 3,496 414 125,370 Public Utilities 20,969 41 306 20,704 U.S. Industrial & Miscellaneous 226,885 1,925 4,353 224,457 Foreign Industrial & Miscellaneous 12,649 6 650 12,005 Foreign Governments-Agency 1,991 0 110 1,881 ------------- ------------ ------------- ------------- Total Bonds $ 447,898 $ 7,575 $ 6,154 $ 449,319 Redeemable Preferred Stock 20,920 1,184 302 21,802 ------------- ------------ ------------- ------------- Total Fixed Maturities $ 468,818 $ 8,759 $ 6,456 $ 471,121 ------------- ------------ ------------- ------------- Equity Securities: Common Stock $ 66,927 $ 39,106 $ 10,334 $ 95,699 Non-Redeemable Preferred Stock 112,555 2,643 4,190 111,008 ------------- ------------ ------------- ------------- Total Equity Securities $ 179,482 $ 41,749 $ 14,524 $ 206,707 ------------- ------------ ------------- ------------- Total Available-for-Sale Securities $ 648,300 $ 50,508 $ 20,980 $ 677,828 ============= ============ ============= ============= Gross Gross Estimated Amortized Unrealized Unrealized Fair (In Thousands) Cost Gains Losses Value ------------- ------------ ------------- ------------- December 31, 1998 Fixed Maturities: U.S. Treasuries & Government Agencies $ 13,018 $ 689 $ 0 $ 13,707 States & Political Subdivisions 48,307 3,293 0 51,600 Special Revenue 132,025 7,215 5 139,235 Public Utilities 13,116 300 0 13,416 U.S. Industrial & Miscellaneous 195,296 9,028 629 203,695 Foreign Industrial & Miscellaneous 5,159 165 86 5,238 Foreign Governments-Agency 1,990 0 181 1,809 ------------- ------------ ------------- ------------- Total Bonds $ 408,911 $ 20,690 $ 901 $ 428,700 Redeemable Preferred Stock 12,191 577 115 12,653 ------------- ------------ ------------- ------------- Total Fixed Maturities $ 421,102 $ 21,267 $ 1,016 $ 441,353 ------------- ------------ ------------- ------------- Equity Securities: Common Stock $ 60,622 $ 37,626 $ 8,018 $ 90,230 Non-Redeemable Preferred Stock 109,355 4,813 1,594 112,574 ------------- ------------ ------------- ------------- Total Equity Securities $ 169,977 $ 42,439 $ 9,612 $ 202,804 ------------- ------------ ------------- ------------- Total Available-for-Sale Securities $ 591,079 $ 63,706 $ 10,628 $ 644,157 ============= ============ ============= ============= </TABLE> 9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued) The deferred income tax liability related to the change in unrealized gains (losses) on available-for-sale securities decreased by $7,937,499 at September 30, 1999 compared to a $5,342,948 increase at December 31, 1998. Mortgage loans on real estate are recorded at unpaid balances, adjusted for amortization of premium or discount. A valuation allowance is provided for impairment in net realizable value based on periodic valuations. The change in the allowance is reflected on the income statement in realized gain (loss) on investments. Other invested assets (primarily investments in real estate and private equity limited partnerships) are recorded under the equity method of accounting. NOTE D -- SUMMARIZED FINANCIAL STATEMENT INFORMATION OF AFFILIATE The Company has a 21.63% investment in Erie Family Life Insurance Company (EFL) and accounts for this investment using the equity method. The following represents summarized financial statement information for EFL: <TABLE> <CAPTION> Nine Months Ended Nine Months Ended September 30, 1999 September 30, 1998 ------------------ ------------------ <S> <C> <C> Revenues $ 77,914,775 $ 70,773,994 Benefits and expenses 51,692,881 46,230,129 ------------------ ------------------ Income before income taxes 26,221,894 24,543,865 Income taxes 8,729,171 8,818,793 ------------------ ------------------ Net income $ 17,492,723 $ 15,725,072 ================== ================== Dividends declared to shareholders $ 6,237,000 $ 5,670,000 ================== ================== Net unrealized appreciation (depreciation) on investment securities at September 30, net of deferred taxes $ (2,399,545) $ 18,876,966 ================== ================== </TABLE> NOTE E -- NOTE RECEIVABLE FROM ERIE FAMILY LIFE INSURANCE COMPANY On December 29, 1995, EFL issued a surplus note to the Company in return for cash of $15 million. The note bears an annual interest rate of 6.45% and all payments of interest and principal of the note may be repaid only out of unassigned surplus of EFL and are subject to prior approval of the Pennsylvania Insurance Commissioner. Interest on the surplus note is scheduled to be paid semi-annually. The note will be payable on demand on or after December 31, 2005. The Company has accrued $483,750 for related interest in the third quarter of 1999. NOTE F -- TREASURY STOCK In December 1998, the Board of Directors of the Company authorized the repurchase of up to $70 million of its Class A common stock from January 1, 1999 through December 31, 2001. The Company's repurchase of shares of common stock are recorded as "Treasury Stock" and result in a reduction of "Shareholders' Equity." Treasury shares are recorded on the Consolidated Statements of Financial Position at cost. In the third quarter of 1999, 503,469 shares were repurchased at a total cost of $14,282,763 or an average price of $28.37. During the first nine months of 1999, 1,436,864 shares were repurchased at a total cost of $39,710,078 or an average price of $27.64. 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the financial statements and related notes found on pages 3 through 10, since they contain important information that is helpful in evaluating the Company's operating results and financial condition. RESULTS OF OPERATIONS Financial Overview Consolidated net income increased by 7.6% for the third quarter of 1999 to $38,424,589, or $.52 per share, from $35,696,537 or $.48 per share, for the third quarter of 1998. Gains made in the Company's management operations and its investment operations were partially offset by losses experienced in the Company's insurance underwriting operations as a result of Hurricane Floyd. For the nine months ended September 30, 1999, net income increased 8.0% to $111,057,129 or $1.51 per share, from $102,866,077 or $1.38 per share reported for the same period in 1998. On an operating basis excluding capital gains and federal income taxes on these gains, the net operating income increased 1.9% to $35,452,824, or $.48 per share for the three months ended September 30, 1999 from $34,788,159, or $.47 per share for the three months ended September 30, 1998. For the nine months ended September 30, 1999, net operating income increased 4.2% to $103,019,549, or $1.40 per share, from $98,857,161, or $1.33 per share, for the same period in 1998. Analysis of Management Operations Net revenue from the Company's management operations increased 4.7% to $41,945,438 for the three months ended September 30, 1999 from $40,047,167 for the same period in 1998. The gross margin from management operations (net revenue divided by total revenue), was 30.0% in the third quarter of 1999 and 1998. For the nine months ended September 30, 1999 net revenue from management operations totaled $116,898,721, an increase of 3.6% when compared to the first nine months of 1998. Management fee revenue derived from the management operations of the Company, which serves as attorney-in-fact for the Erie Insurance Exchange (the Exchange), increased 5.2% to $135,796,427 for the three months ended September 30, 1999 from $129,046,712 for the three months ended September 30, 1998. Management fee revenue increased 4.9% to $395,133,491 in the first nine months of 1999 compared to $376,555,339 for the same period in 1998. The direct and affiliated assumed premiums of the Exchange, upon which management fee is based, grew by 2.1% to $543,185,707 in the third quarter of 1999 compared to $532,170,808 in the third quarter of 1998. The rate of growth in management fee revenue was greater than the rate of growth in direct and affiliated assumed premium of the Exchange because the management fee rate charged the Exchange beginning January 1, 1999 was 25% compared to a rate of 24.25% charged in the third quarter of 1998. The Company's Board of Directors has the authority to change the management fee rate at its discretion, but cannot exceed a rate of 25%. For the year to date period, premiums written increased 1.8% to $1,580,533,960 compared to $1,552,805,527 written for the first nine months of 1998. Premium growth continues to be modest due to previously announced pricing actions in the private passenger auto line of insurance. Policy growth for the first nine months of 1999 when compared to the same period in 1998 was strong as policy retention rates and new policy growth improved. Policies in force increased 4.7% to 2,659,174 for the period ended September 30, 1999 from 2,539,444 policies in force at September 30, 1998. Policy retention (the percentage of current policyholders that have renewed their policy) was 91.3% and 90.6% for the period ended September 30, 1999 and 1998, respectively, for private passenger auto and 90.0% and 89.4% for the nine months ended September 30, 1999 and 1998, respectively, overall for all lines combined. 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Service agreement revenue totaled $3,792,303 and $3,944,646 for the quarter ended September 30, 1999 and 1998, respectively. Service agreement revenue is derived from two sources. First, the Company is reimbursed by the Exchange for providing extended payment terms on policies written by the Group. Reimbursements totaled $1,623,263 for the three months ended September 30, 1999 compared to $2,143,513 during the same period in 1998. Second, service income is received from the Exchange as compensation for the management and administration of voluntary assumed reinsurance from non-affiliated insurers. The Company receives a 7.0% service fee on the premiums from this business. These fees totaled $2,169,040 and $1,801,133 for the three months ended September 30, 1999 and 1998, respectively on net voluntary assumed reinsurance premiums of $30,986,280 and $25,730,479 in the third quarter of 1999 and 1998, respectively. For the nine months ended September 30, 1999 service agreement revenue increased 13.5% to $11,225,977 from $9,886,891. Extended payment term reimbursements decreased 1.8% to $5,068,653 from $5,159,675, while service agreement income rose by 30.3% to $6,157,324. Net voluntary assumed reinsurance premiums totaled $88,861,773 and $68,431,663 for the first nine months of 1999 and 1998, respectively. The cost of management operations increased 5.0% for the third quarter of 1999 to $97,962,068 from $93,313,277 during the third quarter of 1998. For the nine months ended September 30, 1999 the cost of management operations grew by 5.7% to $290,427,431 compared to $274,686,379 for the same period in 1998. Commissions are the largest component of the cost of management operations. The Company is responsible for the payment of commissions to the independent Agents who sell insurance products for the Company's subsidiaries and the Exchange, and its subsidiary, Flagship City Insurance Company. The Agents receive commissions based on fixed percentage fee schedules with different commission rates by product line of insurance. Also included in commission expense are the costs of promotional incentives for Agents and Agent contingency awards. Agent contingency awards are based upon the underwriting profitability of the insurance written and serviced by the Agent within the Erie Insurance Group of companies. Commission costs totaled $68,592,632 for the third quarter of 1999, a 6.0% increase over the $64,704,256 reported in the third quarter of 1998. Commissions grew by 5.8% to $198,660,015 from $187,761,899 recorded for the first nine months of 1998. Commission costs grew faster than the rate of growth in written premiums due to increased provisions for agent contingency awards and incentive awards and an increase in the average commission rate. The provision for agent contingency awards has increased due to excellent insurance underwriting results experienced in the past several years while the average commission rate has increased due to a slight shift in the insurance product mix to more commercial and personal property lines of business from private passenger auto. The cost of management operations excluding commission costs, increased $760,415 for the three months ended September 30, 1999 to $29,369,436. Personnel costs, including salaries, employee benefits, and payroll taxes, are the second largest component in the cost of operations, after commissions. The Company's personnel costs totaled $17,730,694 for the three month period ended September 30, 1999, an increase of $1,095,142 over the same period in 1998. Analysis of Insurance Underwriting Operations Insurance underwriting results are produced from the Company's property and casualty insurance subsidiaries, Erie Insurance Company and Erie Insurance Company of New York, which together assume a 5.5% share of the underwriting results of the Erie Insurance Group under an intercompany reinsurance pooling arrangement. Insurance underwriting operations incurred losses of $1,579,458 in the third quarter of 1999 compared to a loss of $96,709 in the third quarter of 1998. In the third quarter of 1999, premiums earned increased 3.7% to 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) $29,449,004 compared to $28,387,446 for the same period in 1998. Losses, loss adjustment expenses and other underwriting expenses incurred increased at a greater rate than premiums earned, up 8.9% for the third quarter of 1999 amounting to $31,028,462 compared to $28,484,155 for the prior year's third quarter. Catastrophe losses were $1,342,000 in the third quarter of 1999 compared to $659,000 in the third quarter of 1998. Losses resulting from Hurricane Floyd were partly responsible for the increased underwriting loss for the three months ended September 30, 1999. Losses from Hurricane Floyd amounted to approximately $1.1 million at the end of the third quarter or about $.01 per share, after federal income taxes. For the nine months ended September 30, 1999, the Company posted an underwriting loss of $1,073,850 compared to an underwriting gain of $1,024,049 for the same period in 1998. The GAAP combined ratio for the Company's property and casualty insurance operations increased to 105.4% for the three months ended September 30, 1999 compared to a ratio of 100.3% for the same period in 1998. The GAAP combined ratio, excluding catastrophe losses was 99.7% for the third quarter 1999, compared to 97.1% for the same period in 1998. On a year to date basis, the GAAP combined ratio amounted to 101.2% and 98.8% at September 30, 1999 and 1998, respectively. The GAAP combined ratio represents the ratio of loss, loss adjustment, acquisition, and other underwriting expenses incurred to premiums earned. Analysis of Investment Operations Total revenue from investment operations for the third quarter of 1999 improved significantly to $16,449,582 from $11,847,165 in the third quarter of 1998. This increase was driven by a $2,858,920 increase in realized gains on investments, a $1,079,578 increase in net investment income and a $663,919 increase in the earnings recognized from the Company's 21.63% ownership of Erie Family Life Insurance Company. Total revenue from investment operations for the nine months ended September 30, 1999 increased 29.1% to $47,397,211 from $36,717,852 for the same period in 1998. This year to date increase resulted from a $5,893,576 increase in net realized gains on investments and a $4,403,441 increase in net investment income. 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 September 30, 1999, the Company's investment portfolio of investment-grade bonds, common stock and preferred stock, all of which are readily marketable, and cash and short-term investments, totaled $702 million, or 46.3%, of total assets. These resources provide the liquidity the Company requires to meet demands on its funds. At September 30, 1999, 94.5% of total investments consist of fixed maturities and equity securities. Mortgage loans and other invested assets represented only 5.5% of total investments at that date. Mortgage loans and real estate investments have the potential for higher returns, but also carry more risk, including less liquidity and greater uncertainty in the rate of return. The Company's investments are subject to certain risks, including interest rate and reinvestment risk. Fixed maturity and preferred stock security values generally fluctuate inversely with movements in interest rates. The Company's corporate and municipal bond investments may contain call and sinking fund features which may result in early redemptions. Declines in interest rates could cause early redemptions or prepayments which could require the Company to reinvest at lower rates. 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) LIQUIDITY AND CAPITAL RESOURCES Liquidity is a measure of the Company's ability to secure enough cash to meet its contractual obligations and operating needs. Operating cash flows are generated from management operations as the attorney-in-fact for the Exchange, the net cash flow from the Erie Insurance Company's 5% and the Erie Insurance Company of New York's .5% participation in the underwriting results of the reinsurance pool with the Exchange, and the Company's investment income from affiliated and non-affiliated investments. With respect to the management fee, funds are generally received from the Exchange on a premiums collected basis. The Company pays commissions on premiums collected rather than written premiums. The Company generates sufficient net positive cash flow from its operations to fund its commitments, repurchase its common stock, and build its investment portfolio, thereby increasing future investment returns. The Company also maintains a high degree of liquidity in its investment portfolio in the form of readily marketable fixed maturities, common stocks and short-term investments. Net cash flows provided by operating activities for the nine months ended September 30, 1999 and 1998, were $105,966,170 and $105,402,857, respectively. Dividends declared and paid to shareholders in the three months ended September 30, 1999 and 1998, totaled $7,919,212 and $7,255,444, 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 insurance subsidiaries to the Company. Dividends from subsidiaries are not material to the Company's cash flow. Temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to deferred tax assets and liabilities resulted in net deferred tax liabilities at September 30, 1999 of $8,535,026 and at December 31, 1998 of $17,121,777. The National Association of Insurance Commissioners (NAIC) standard 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, 1998, the Exchange, its subsidiary Flagship City Insurance Company and the Company's property/casualty insurance subsidiaries' financial statements prepared under Statutory Accounting Practices are all substantially in excess of levels that would require regulatory action. At September 30, 1999 and December 31, 1998, the Company's receivables from its affiliates totaled $520,218,005 and $489,913,986, respectively. These receivables, primarily due from the Exchange, as a result of the management fee, expense reimbursements and the intercompany reinsurance pool, potentially expose the Company to concentrations of credit risk. 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) STOCK REDEMPTION PLAN The Erie Indemnity Company Stock Redemption Plan entitles estates of qualified shareholders to cause the Company to redeem shares of stock of the Company at a price equal to the fair market value of the stock at time of redemption. The redemption amount is limited to an aggregation of: (1) an initial amount of $10 million as of December 31, 1995 and (2) beginning in 1996 and annually thereafter, an additional annual amount as determined by the Board is its sole discretion, not to exceed 20% of the Company's net income from management operations during the prior fiscal year. This aggregate amount is reduced by redemption amounts paid. However, at no time shall the aggregate redemption limitation exceed 20% of the Company's retained earnings determined as of the close of the prior year. In addition, the plan limits the repurchase from any single shareholder's estate to 33% of total share holdings of such shareholder. On April 27, 1999 the Board approved an increase in the redemption amount of $19,190,347 to $77,987,383. As of September 30, 1999, no shares have been redeemed under the Stock Redemption Plan. STOCK REPURCHASE PLAN At the December 16, 1998 regular meeting of the Board of Directors of the Erie Indemnity Company, the Board approved a stock repurchase plan beginning January 1, 1999, under which the Company may repurchase as much as $70 million of its outstanding Class A common stock through December 31, 2001. The Company may purchase the shares from time to time in the open market or through privately negotiated transactions, depending on prevailing market conditions and alternative uses of the Company's capital. In the third quarter of 1999, 503,469 shares were repurchased at a total cost of $14,282,763 or an average price of $28.37. During the first nine months of 1999, 1,436,864 shares were repurchased at a total cost of $39,710,078 or an average price of $27.64. YEAR 2000 READINESS DISCLOSURE Erie Indemnity Company and the property/casualty insurance companies it manages are dependent on electronic processing and information systems, automation technology and certain outside parties to conduct business. Like all companies with such dependencies, the Company is continually faced with significant decisions and technology challenges. Among these challenges is the so-called "Year 2000 Issue," the inability of many computer systems to recognize dates beginning with the year 2000 and beyond. The Year 2000 Issue is perhaps more pervasive than any previous risk management issue faced by businesses of all types. To effectively manage the risks associated with the Year 2000 Issue, management has taken measures over the past six years designed to reduce the Company's potential for business interruption. References to the Company in the description below, including cost information, pertain to the Company and the property/casualty insurance companies under its management. The effect of the Year 2000 Issue cannot be measured exactly with certainty; any forecasts about the effect of the Year 2000 Issue and remediation projections are necessarily forward-looking statements and are subject to the risks and uncertainties noted on page 18. 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Company's State of Readiness Exposure to systems failure is a risk faced by the Company every day. Unlike these every day risks, the date change to the Year 2000 is predictable. Efforts to mitigate the Company's exposure through effective identification, remediation, testing and contingency planning are organized and have been conducted on all major business processes to minimize the risks. To assure that the Company effectively addressed this risk, management put in place a structure that provides oversight of Year 2000 project activities, which were conducted within the major business units of the Company. Oversight by Executive and Senior Management was facilitated through a dedicated project office. This office, (the Y2K Office) worked in consultation with each business unit to assure consistency and adequacy of risk management activities and to collect companywide project status and cost information. Within each business unit, each key business process was evaluated to assure that underlying systems and components exposed to potential Year 2000 failure were appropriately identified and addressed. Underlying system components include internal operating systems (hardware and software), infrastructure elements including non-information technology components and systems, communications systems and devices, internally developed mainframe applications, personal computer hardware and software, external parties and providers and peripheral devices. Each underlying component supporting key business processes was identified and mission critical business processes were prioritized during 1998. Priority was assigned based on the relative importance of the component to the business process and based on the importance of the business process relative to other business processes. Efforts to remediate non-compliant internal components (principally mainframe applications) began in the mid-1990's as a routine part of systems development and maintenance. Remediation of the Company's mainframe applications was completed and component testing was conducted during the first quarter of 1999. To supplement component testing and to provide a greater degree of assurance that business functions will be uninterrupted, Year 2000 simulation testing on the full insurance operations system was performed during March and April of 1999 and was completed April 30, 1999. Full systems testing included simultaneous testing of underlying components necessary to the support of key insurance operations business processes. Testing environments that closely approximate operating environments for mainframe and LAN-based PC applications were developed for use during this testing. The results of testing did not indicate that key business processing applications will encounter any material problems in the year 2000 due to the inability to recognize dates in the year 2000. Certain administrative systems (non-insurance operations) which operate in LAN based PC environments also underwent Year 2000 simulation testing which was completed at the end of July, 1999. These systems are vendor certified as compliant; however, management believed the presence of certain customizations made testing prudent. Test results; however, indicated no material problems. The Y2K Office conducts ongoing monitoring of key external parties including utility suppliers, voice and data communications providers and financial institutions. Where possible and practicable, focused testing has been accomplished with these parties. No matter has come to our attention concerning the state of readiness of these key third parties that causes management to believe any of these parties will be unable to provide continuous service to the Company. 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) During the second quarter of 1999, each business unit developed contingency plans designed to respond to potential component or total systems failure. The plans incorporated a variety of back up processes some of which are automated, some manual. The plans provide that several operating areas accelerate work into 1999 or postpone work into later January 2000, where possible. Provisions for back up capabilities on services provided by key third parties are also included in the plans where feasible. With the approval of the plans by Executive Management in July, 1999, the Company began carrying out the steps necessary to support the back up plans during the third quarter. These steps included the orientation and training of employees integral to the plan as well as the procurement of supplies and equipment necessary to conduct business in the back up environment, should that become necessary. Orientation and training is targeted for completion by October 31, 1999. Cost to Address Year 2000 Issues Prior to 1998, the Company did not establish a specific budget to address the Year 2000 Issue. By including Year 2000 changes in the scope of each system development and maintenance project, the Year 2000 Issue became an extension of all system projects. It is estimated that through September 30, 1999 costs incurred for specific Y2K activities including programming, testing, integrated test planning, contingency plan development and administrative efforts approximate $2.4 million. This estimate includes the cost of internal efforts based on salary and benefit rates for personnel engaged in these activities. Future costs will be incurred as contingency plan testing continues during 1999. Management believes that the cost to complete contingency planning and administrative support will approximate $100,000 during the remaining three months of 1999 based on the project plans for these activities. Costs incurred to replace non-compliant software and hardware during 1999 have not been and are not expected to be significant. Risk of the Company's Year 2000 Issues The proper functioning of the Company's computer systems and applications is critical to the continued operations of the Company. By addressing the Year 2000 Issue over several years in the ordinary course of business, the costs and uncertainty associated with it have been reduced significantly. Management does not believe that critical business operations of the Company will be adversely affected to any significant degree by the Year 2000 Issue. It is possible that certain key external parties will certify their systems as year 2000 compliant when in fact they are not. The inability of the Company to respond to uncontrollable circumstances remains a concern. For example, if numerous key third parties are unable to support the operations of the Company, operations could be adversely affected. The Company, as part of overall risk management, has prepared contingency plans to respond, where feasible, to the possibility of key third party failure(s). Management does not believe that these scenarios have a greater than remote possibility of occurrence. 17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Company's Contingency Plans if a Vendor or the Company Fail to Address Year 2000 Issues This risk described above has been addressed through contingency planning. The level of contingency planning is commensurate with the relative importance of the external party to the operations of the Company and the relative risk that the party will be unable to operate satisfactorily in 2000. Such contingency plans have been developed and will be tested during the first half of the fourth quarter 1999. The statements containing the beliefs of management about the Company's state of readiness for Year 2000 Issues are necessarily forward-looking statements that involve risks and uncertainties. These risks and uncertainties include but are not limited to: human or mechanical errors in correcting Year 2000 Issues; incorrect or improper (intentional or otherwise) representations by third parties as to their compliance or remediation efforts; the failure of third parties to follow through on their remediation efforts; and the inability to identify and/or locate processing chips that are subject to Year 2000 problems. "Safe Harbor" Statement Under the Private Securities Litigation Reform Act of 1995: Statements contained herein expressing the beliefs of management such as those contained in the "Financial Condition - Investments", and the "Liquidity and Capital Resources" sections hereof, and the other statements which are not historical facts contained in this report are forward looking statements that involve risks and uncertainties. These risks and uncertainties include but are not limited to: legislative, judicial and regulatory changes, the impact of competitive products and pricing, product development, geographic spread of risk, weather and weather-related events, other types of catastrophic events, securities markets fluctuations, and technological difficulties and advancements. 18
PART II. OTHER INFORMATION Item 1. Legal Proceedings The H.O. Hirt Trusts collectively own 2,340 shares of the Company's Class B Common Stock, which has the exclusive right to vote in the election of directors of the Company. Since such shares represent 76.22% of the outstanding share of the Company Class B Common Stock, the vote of the H.O. Hirt Trusts is sufficient to determine the outcome of any election of directors. The trustees of the H.O. Hirt Trusts are F. William Hirt, Chairman of the Board of the Company, a director of the Company, a beneficial owner of more that 10% of the Company's outstanding Class A Common Stock and a beneficiary of one of the two H.O. Hirt Trusts; his sister, Susan Hirt Hagen, a director of the Company, a beneficial owner of more than 10% of the Company's outstanding Class A Common Stock and a beneficiary of the other H.O. Hirt Trust and Mellon Bank, N.A. Under the provisions of the H.O. Hirt Trusts, the shares of the company's Class B Common Stock held by the H.O. Hirt Trusts are to be voted as directed by a majority of the three trustees. Under the Pennsylvania Insurance Company Law and the Company's By-laws, the candidates for the election as directors of the Company are to be nominated by a committee consisting solely of persons who are not officers or employees of the Company or of any entity controlling, controlled by or under common control with the Company and who are not beneficial owners of a controlling interest in the voting securities of the Company. On March 11, 1998, the Nominating Committee of the Company's Board of Directors nominated 12 persons as candidates for election as directors of the Company at the Company's April 28, 1998 annual meeting of shareholders. The 12 persons nominated did not include Thomas B. Hagen, the husband of Susan Hirt Hagen, as a candidate for election as a director of the Company at such annual meeting. Thomas B. Hagen had served as a director of the Company since 1979. On April 2, 1998, Susan Hirt Hagen, a director, filed duplicate petitions in the Orphans' Court Division of the Court of Common Pleas of Erie County, Pennsylvania (the "Court") seeking the removal of Mellon Bank N.A. ("Mellon") as a co-trustee of the H.O. Hirt Trusts. The principal basis for the alleged relief was the allegation that Mellon, as the owner of an insurance agency, was a competitor of the Company. Among the relief requested by Susan Hirt Hagen in the petitions was the grant of a preliminary injunction against Mellon from voting the Class B Common Stock held by the H.O. Hirt Trusts for the purpose of the election of directors at the Company's April 28, 1998 Annual Meeting of Shareholders. Because of the potential substantial harm to the Company if the preliminary injunction was granted, the Company filed a petition to intervene in the preliminary injunction proceedings which the Court granted on April 21, 1998 and an order denying Susan Hirt Hagen's request for a preliminary injunction. On April 28, 1998, the Company's 1998 Annual Meeting of Shareholders was held as scheduled and each of the candidates for election as a director of the Company named in the Company's April 1, 1998 proxy statement was elected as a director of the Company with the affirmative votes of Mellon and F. William Hirt as a majority of the trustees of the H.O. Hirt Trusts. On June 3, 1998, the Company, because of its substantial interest in the outcome of any matter involving a change in Mellon's status as a co-trustee of the H.O. Hirt Trusts, petitioned the Court to intervene in the trial of the issues remaining under Susan Hirt Hagen's petitions to remove Mellon as a co-trustee. On June 24, 1998, the Court denied the Company's petition, and, on July 13, 1998, the Company appealed the Court's denial to the Superior Court of Pennsylvania. On August 5, 1998, Susan Hirt Hagen, a director of the Company, filed a motion with the Superior Court of Pennsylvania to quash the Company's appeal. On August 17, 1998, the Company filed its response to Susan Hirt Hagen's motion to quash the Company's appeal. On October 19, 1998, the Superior Court of Pennsylvania denied without prejudice Susan Hirt Hagen's motion to quash the Company's appeal, and the Superior Court of Pennsylvania established a schedule for the submission of briefs on the merits of the Company's appeal. 19
Item 1. Legal Proceedings (Continued) During June and July 1998, substantial discovery took place involving Susan Hirt Hagen's petitions to remove Mellon as co-trustee. Preceding the scheduled trial date of July 30, 1998, discussions took place between counsel for Mellon and counsel for Susan Hirt Hagen concerning a possible basis for settlement of the pending litigation. These discussions involved the circumstances under which Mellon might resign as co-trustee of the H.O. Hirt Trusts and the establishment of procedures pursuant to which a successor trustee would be appointed by the Court or by agreement of Susan Hirt Hagen and F. William Hirt. After a hearing conducted on July 30, 1998, the Court by letter advised counsel for all parties that the Court would not approve the settlement proposal that had been presented during the July 30, 1998 hearing, and that Mellon was to advise the Court on or before August 21, 1998 whether a revised settlement proposal would be submitted or whether the petitions to remove Mellon as co-trustee should be scheduled for trial by the Court for some later unspecified date. On August 4, 1998, the Company filed a further petition with the Court seeking the right to intervene in the proceedings insofar as the proceedings would entail the possible approval of any settlement of the petitions to remove Mellon as co-trustee or the appointment of a successor trustee to Mellon. On October 21, 1998, Mellon submitted to the Court a Petition to Resign Pursuant to and upon the Fulfillment of Certain Conditions Precedent (the "Mellon Petition"). On October 29, 1998, the Court conducted a hearing at which time, among other things, the Court heard testimony from two potential successor corporate trustees to Mellon, each of which potential successors (either Bankers Trust or Bank Boston), the Court was advised, had the approval of Mellon, Susan Hirt Hagen and F. William Hirt. During that same hearing, the Court indicated that it would accept the Mellon Petition and would in the future enter an order providing for the granting of the Mellon Petition, in conjunction with a further hearing on the matter of the appointment of a successor corporate co-trustee and the final Court approval thereof. On November 2, 1998, the Court scheduled such a further hearing for January 6, 1999. On January 6, 1999, with the concurrence of all parties, the Court accepted the resignation of Mellon as co-trustee of the H.O. Trusts and released Mellon from all further obligations with respect to the H.O. Hirt Trusts. On the same date, the Court appointed Bankers Trust as the successor co-trustee of the H.O. Hirt Trusts. On January 26, 1999, the Court assessed $637,500 in costs incurred by Mellon in connection with the removal litigation against Susan Hirt Hagen. On March 3, 1999 Bankers Trust filed with the Court a Petition to Accept Resignation of Trustee (the "Bankers Trust Petition") in which Bankers Trust requested the Court that its resignation as corporate Co-Trustee of the H. O. Hirt Trusts be accepted and a successor corporate Trustee be appointed. On March 4, 1999 the Court appointed Judge William R. Cunningham to serve in the Orphans' Court to preside over the matter of the Bankers Trust Petition, and a hearing was fixed for May 7, 1999. On or about May 6, 1999 Bankers Trust filed a petition for Citation to Show Cause why Declaratory Relief Should not be Granted ("Bankers Trust Declaratory Action Petition"). The Bankers Trust Declaratory Action Petition seeks a determination by the Court whether a provision of the Pennsylvania Insurance Company Law, Section 40 P.S. ss.991.1405(c)(4) provides the exclusive means by which persons may be nominated and elected to the Board, or whether the Trustees have the power to nominate and elect to the Board persons other than those designated by the Nominating Committee. On May 7, 1999 the Court issued an Order approving the resignation of Bankers Trust Company as the corporate Trustee effective upon the entry of an Order appointing a successor corporate Trustee. Also on May 7, 1999 the Court issued an Order setting a schedule for the filing and determination of objections to the Bankers Trust Declaratory Action Petition, indicating that any objections to the Petition must be filed on or before May 25, 1999; responses to the objections must be filed on or before June 15, 1999; and the Court set Oral Argument on any objections and responses on June 29, 1999. Thereafter, if necessary, a Hearing on the merits of the Declaratory Action Petition would be held on July 28, 1999. 20
Item 1. Legal Proceedings (Continued) On June 16, 1999, Susan Hirt Hagen filed with the Court a motion for leave to amend the response she had filed to the Petition, so as to assert a claim against the Company in the nature of a request for a permanent injunction against certain Bylaw amendments adopted by the Company effective June 15, 1999. On June 29, 1999, the Court heard oral argument on the objections which the Company and F. William Hirt filed to the Petition. On July 15, 1999, the Court entered its Order and Opinion which sustained the objections to the Petition and dismissed without prejudice the Petition, and also dismissed without prejudice Susan Hirt Hagen's Motion to Amend. Item 5. Other Information Election of Directors. - ---------------------- At its regularly scheduled quarterly Board Meeting held on September 13, 1999, the Board of Directors of the Company, in accordance with the Company's By-Laws, increased the number of Directors to 13 from 11 and elected 3 new Directors to fill the new positions as well as a position created by the retirement of Director Edmund J. Mehl. Director Mehl had served on the Board of Directors for 30 years and retired under the Board's general retirement policy. Elected to the Board were Gwendolyn S. King who from 1992-1999 served as Senior Vice President and Head of Corporate and Public Affairs for the Philadelphia Electric Company. Prior to that time, from 1989-1992, Ms. King served as a Commissioner for the U.S. Social Security Administration. Also elected was Martin J. Lippert who since 1997 has served as the Vice Chairman and Chief Information Officer of Systems and Technology for Royal Bank of Canada where he also serves a Executive Vice President. From 1981-1997 Mr. Lippert served in various management positions with Mellon Bank, Pittsburgh, Pennsylvania. Also elected was Robert C. Wilburn who has retired as President and Chief Executive Officer of the Colonial Williamsburg Foundation where he served from 1992 until his retirement. Prior to that time, he served as President of the Carnegie Institute Library of Pittsburgh from 1984-1992. Mr. Wilburn is currently an adjunct professor at Carnegie Mellon University. Changes to By-Laws - Shareholder Proposals - ------------------------------------------ A. Deadline for Submitting Shareholder Proposals to the Company for Inclusion in the Company's Proxy Statement Relating to the Company's 2000 Annual Meeting of Shareholders Pursuant to and in Compliance with SEC Rule 14a-8. Any shareholder who, in accordance with and subject to the provisions of Rule 14a-8 of the proxy rules of the Securities and Exchange Commission, wishes to submit a proposal for inclusion in the Company's proxy statement for its 2000 Annual Meeting of Shareholders must deliver such proposal in writing to the Company's Secretary at the Company's principal executive offices at 100 Erie Insurance Place, Erie, Pennsylvania 16530, not later than December 1, 1999. B. Requirements Under the Company's By-laws for Advance Notice to the Company of Shareholder Proposals to be Presented at the Company's 2000 Annual Meeting of Shareholders Otherwise than Pursuant to and in Compliance with SEC Rule 14a-8. The Company amended Section 2.07 of its By-laws relating to shareholder proposals. The following description of Section 2.07 as so amended is a materially complete summary of Section 2.07 as so amended. Reference is made, however, to the complete text of Section 2.07 as included in Exhibit 3.4 to this Form 10-Q Quarterly Report and such summary is qualified in its entirety by such reference. 21
Pursuant to amended Section 2.07 of the Company's By-Laws, if a shareholder desires to present at the 2000 Annual Meeting of Shareholders (i) a proposal relating to candidates for election as directors by shareholders or (ii) a proposal relating to other than nominations for and election of directors, otherwise than pursuant to Rule 14a-8 of the proxy rules of the Securities and Exchange Commission, such shareholder must comply with the provisions for shareholder proposals set forth in the By-Laws which are summarized below. Written notice of any such proposal containing the information required under such By-Law provisions must be delivered during the period commencing on December 1, 1999 and ending on December 31, 1999 to the following address: (i) Written notice of a proposal relating to candidates for election as directors by shareholders must be delivered in person, by first class United States mail postage prepaid or by reputable overnight delivery service to the Nominating Committee of the Board of Directors of the Company to the attention of the Company's Secretary at the Company's principal executive offices at 100 Erie Insurance Place, Erie, Pennsylvania 16530; and (ii) Written notice of a proposal relating to other than candidates for election as directors by shareholders must be delivered in person, by first class United States mail postage prepaid or by reputable overnight delivery service to the Board of Directors of the Company to the attention of the Company's Secretary at the Company's principal executive offices at 100 Erie Insurance Place, Erie, Pennsylvania 16530. (a) Shareholder Proposals Relating to Candidates for Election as Directors by Shareholders. A proposal by a shareholder of a candidate for election by shareholders as a director at any meeting of shareholders at which directors are to be elected may be made by notice in writing, delivered in person or by first class United States mail postage prepaid or by reputable overnight delivery service, to the Nominating Committee of the Board of Directors of the Company to the attention of the Secretary of the Company at the principal office of the Company, within the time limits specified herein. In the case of an annual meeting of shareholders, any such written proposal of a candidate must be received by the Nominating Committee not less than 90 calendar days nor more than 120 calendar days before the first anniversary of the date on which the Company first mailed its proxy statement to shareholders for the annual meeting of shareholders in the immediately preceding year; provided, however, that in the case of an annual meeting of shareholders that is called for a date which is not within 30 calendar days before or after the first anniversary date of the annual meeting of shareholders in the immediately preceding year, any such written proposal must be received by the Company's Board of Directors not less than five business days after the date the Company shall have mailed notice to its shareholders that an annual meeting of shareholders will be held or issued a press release, filed a periodic report with the Securities and Exchange Commission or otherwise publicly disseminated notice that an annual meeting of shareholders will be held. In the case of a special meeting of shareholders, any such written proposal of a candidate must be received by the Nominating Committee within five business days after the earlier of the date that the Company shall have mailed notice to its shareholders that a special meeting of shareholders will be held or issued a press release, filed a periodic report with the Securities and Exchange Commission or otherwise publicly disseminated notice that a special meeting of shareholders will be held. Such written proposal of a candidate must set forth (A) the name and address of the shareholder who intends to make the proposal, (B) the name, age, business address and, if known, residence address of each person so proposed, (C) the principal occupation or employment of each person so proposed for the past five years, (D) the number of shares of capital stock of the Company beneficially owned within the meaning of Securities and Exchange Commission Rule 13d-1 by each person so proposed and the earliest date of acquisition of any such capital stock, (E) a description of any arrangement or understanding between each person so proposed and the proposing shareholder with respect to such person's proposed candidate for election as a director by shareholders and actions to be proposed or taken by such person as a director, (F) the written consent of each person so proposed to serve as a director if nominated and elected as a director and (G) such other information regarding each such person as would be required under the proxy solicitation rules of the Securities and Exchange Commission if proxies were to be solicited for the election as a director of each person so proposed. 22
If a written proposal of a candidate submitted to the Nominating Committee fails, in the reasonable judgment of the Nominating Committee, to contain the information specified in the immediately preceding paragraph or is otherwise deficient, the Chairperson of the Nominating Committee shall, as promptly as is practicable under the circumstances, provide written notice to the shareholder of such failure or deficiency in the written proposal of nomination and such shareholder shall have five business days from receipt of such notice to submit a revised written proposal of a candidate that corrects such failure or deficiency in all material respects. (b) Shareholder Proposals Relating to Other Than Candidates for Elections as Directors by Shareholder. A shareholder of the Company may bring a matter (other than a proposal to the Nominating Committee of a candidate for election as a Director by shareholders which is covered by subsection (a) of Section 2.07 of the By-laws) before a meeting of shareholders only if (A) such matter is a proper matter for shareholder action and such shareholder shall have provided notice in writing, delivered in person or by first class United States mail postage prepaid or by reputable overnight delivery service, to the Secretary of the Company at the principal office of the Company, within the time limits specified herein or (B) the shareholder complies with the provisions of Rule 14a-8 under the Securities Exchange Act of 1934 relating to inclusion of shareholder proposals in the Company's proxy statement. In the case of an annual meeting of shareholders, any such written notice of presentation of a matter must be received by the Secretary of the Company not less than 90 calendar days nor more than 120 calendar days before the first anniversary of the date on which the Company first mailed its proxy statement to shareholders for the annual meeting of shareholders in the immediately preceding year; provided, however, that in the case of an annual meeting of shareholders that is called for a date which is not within 30 calendar days before or after the first anniversary date of the annual meeting of shareholders in the immediately preceding year, any such written notice of presentation of a matter must be received by the Secretary of the Company within five business days after the earlier of the date the Company shall have mailed notice to its shareholders that an annual meeting of shareholders will be held, issued a press release, filed a periodic report with the Securities and Exchange Commission or otherwise publicly disseminated notice that an annual meeting of shareholders will be held. In the case of a special meeting of shareholders, any such written notice of presentation of a matter must be received by the Secretary of the Company within five business days after the earlier of the date the Company shall have mailed notice to its shareholders that a special meeting of shareholders will be held, issued a press release, filed a periodic report with the Securities and Exchange Commission or otherwise publicly disseminated notice that a special meeting of shareholders will be held. Such written notice of presentation of a matter shall set forth information regarding such matter equivalent to the information regarding such matter that would be required under the proxy solicitation rules of the Securities and Exchange Commission if proxies were solicited for shareholder consideration of such matter at a meeting of shareholders. If a written notice of presentation of a matter submitted to the Company's Board of Directors fails, in the reasonable judgment of the Company's Board of Directors, to contain the information specified in the immediately preceding paragraph or is otherwise deficient, the Chairperson of the Company's Board of Directors shall, as promptly as is practicable under the circumstances, provide written notice to the shareholder who submitted the written notice of presentation of a matter of such failure or deficiency in the written notice of presentation of a matter and such shareholder shall have five business days from receipt of such notice to submit a revised written notice of presentation of a matter that corrects such failure or deficiency in all material respects. 23
Only matters submitted in accordance with the By-Law provisions summarized herein shall be eligible for presentation of such meeting of shareholders, and any matter not submitted to the Company's Board of Directors in accordance with such provisions shall not be considered or acted upon at such meeting of shareholders. Item 6. Exhibits and Reports on Form 8-K Exhibit 3.4 - Amendement and Restatement of Company By-Laws dated August 16,1999 Exhibit 27 - Financial Data Schedule All other exhibits for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are applicable, and therefore, have been omitted. The Company did not file any reports on Form 8-K during the three-month period ended September 30, 1999. 24
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Erie Indemnity Company (Registrant) Date: October 27, 1999 \s\ Stephen A. Milne (Stephen A. Milne, President & CEO) \s\ Philip A. Garcia (Philip A. Garcia,Executive Vice President & CFO) 25