Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
FORM 10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 20192020
OR
 
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from___to___
Commission file number 0-24000

ERIE INDEMNITY COMPANY
(Exact name of registrant as specified in its charter)

Pennsylvania25-0466020
(State or other jurisdiction of(IRS Employer
incorporation or organization)Identification No.)
100 Erie Insurance Place,Erie,Pennsylvania1653025-0466020
(AddressState or other jurisdiction of principal executive offices)(Zip Code)IRS Employer
incorporation or organization)Identification No.)

814100 Erie Insurance Place,870-2000Erie,Pennsylvania16530
(Address of principal executive offices)(Zip Code)

814870-2000
(Registrant’s telephone number, including area code)

Not applicable
(Former name, former address and former fiscal year, if changed since last report)
 
Securities registered pursuant to Section 12(b) of the Act:
Class A common stock,stated value $0.0292 per shareERIENASDAQ Stock Market, LLC
(Title of each class)(Trading Symbol)(Name of each exchange on which registered)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

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

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

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

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

The number of shares outstanding of the registrant’s Class A Common Stock as of the latest practicable date was 46,189,068 at July 12, 2019.24, 2020.
 
The number of shares outstanding of the registrant’s Class B Common Stock as of the latest practicable date was 2,542 at July 12, 2019.

24, 2020.

Table of Contents
Item 1.
Statements of Operations – Three and six months ended June 30, 2020 and 2019 and 2018

2
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PART I. FINANCIAL INFORMATION

ITEM 1.
ITEM 1. FINANCIAL STATEMENTS


ERIE INDEMNITY COMPANY
STATEMENTS OF OPERATIONS (UNAUDITED)
(dollars in thousands, except per share data)

Three months endedSix months ended
June 30,June 30,
2020201920202019
Operating revenue  
Management fee revenue - policy issuance and renewal services, net
$483,795  $480,513  $927,545  $911,496  
Management fee revenue - administrative services, net14,813  14,195  29,584  28,146  
Administrative services reimbursement revenue151,965  146,095  303,519  288,575  
Service agreement revenue6,446  6,907  13,108  13,599  
Total operating revenue657,019  647,710  1,273,756  1,241,816  
Operating expenses
Cost of operations - policy issuance and renewal services413,865  405,005  793,357  770,509  
Cost of operations - administrative services151,965  146,095  303,519  288,575  
Total operating expenses565,830  551,100  1,096,876  1,059,084  
Operating income91,189  96,610  176,880  182,732  
Investment income
Net investment income7,373  8,030  15,742  16,547  
Net realized investment gains (losses)6,526  1,302  (4,280) 3,805  
Net impairment losses recognized in earnings(17) (84) (3,070) (162) 
Equity in (losses) earnings of limited partnerships(2,329) 404  (6,034) (743) 
Total investment income11,553  9,652  2,358  19,447  
Interest expense, net2  272  5  721  
Other (expense) income(258) 48  (624) 95  
Income before income taxes102,482  106,038  178,609  201,553  
Income tax expense20,505  18,284  37,306  38,488  
Net income$81,977  $87,754  $141,303  $163,065  
Net income per share  
Class A common stock – basic$1.76  $1.88  $3.03  $3.50  
Class A common stock – diluted$1.57  $1.68  $2.70  $3.12  
Class B common stock – basic and diluted$264  $283  $455  $525  
Weighted average shares outstanding – Basic  
Class A common stock46,187,808  46,188,994  46,188,299  46,188,668  
Class B common stock2,542  2,542  2,542  2,542  
Weighted average shares outstanding – Diluted  
Class A common stock52,302,981  52,314,700  52,313,667  52,313,371  
Class B common stock2,542  2,542  2,542  2,542  
Dividends declared per share  
Class A common stock$0.965  $0.90  $1.93  $1.80  
Class B common stock$144.75  $135.00  $289.50  $270.00  
 Three months ended Six months ended
 June 30, June 30,
 2019 2018 2019 2018
Operating revenue     
  
Management fee revenue - policy issuance and renewal services, net
$480,513
 $454,572
 $911,496
 $860,550
Management fee revenue - administrative services, net14,195
 13,299
 28,146
 26,373
Administrative services reimbursement revenue146,095
 146,507
 288,575
 292,470
Service agreement revenue6,907
 7,080
 13,599
 14,225
Total operating revenue647,710
 621,458
 1,241,816
 1,193,618
        
Operating expenses       
Cost of operations - policy issuance and renewal services405,005
 379,628
 770,509
 728,258
Cost of operations - administrative services146,095
 146,507
 288,575
 292,470
Total operating expenses551,100
 526,135
 1,059,084
 1,020,728
Operating income96,610
 95,323
 182,732
 172,890
        
Investment income       
Net investment income8,030
 7,104
 16,547
 13,924
Net realized investment gains (losses)1,302
 (32) 3,805
 (497)
Net impairment losses recognized in earnings(84) (646) (162) (646)
Equity in earnings (losses) of limited partnerships404
 (219) (743) (411)
Total investment income9,652
 6,207
 19,447
 12,370
        
Interest expense, net272
 602
 721
 1,155
Other income48
 58
 95
 102
Income before income taxes106,038
 100,986
 201,553
 184,207
Income tax expense18,284
 21,280
 38,488
 38,743
Net income$87,754
 $79,706
 $163,065
 $145,464
        
        
Net income per share     
  
Class A common stock – basic$1.88
 $1.71
 $3.50
 $3.12
Class A common stock – diluted$1.68
 $1.52
 $3.12
 $2.78
Class B common stock – basic$283
 $257
 $525
 $469
Class B common stock – diluted$283
 $257
 $525
 $468
        
Weighted average shares outstanding – Basic     
  
Class A common stock46,188,994
 46,188,705
 46,188,668
 46,188,309
Class B common stock2,542
 2,542
 2,542
 2,542
        
Weighted average shares outstanding – Diluted     
  
Class A common stock52,314,700
 52,312,849
 52,313,371
 52,311,741
Class B common stock2,542
 2,542
 2,542
 2,542
        
Dividends declared per share     
  
Class A common stock$0.90
 $0.84
 $1.80
 $1.68
Class B common stock$135.00
 $126.00
 $270.00
 $252.00

See accompanying notes to Financial Statements. See Note 12, "Accumulated Other Comprehensive Income (Loss)", for amounts reclassified out of accumulated other comprehensive income (loss) into the Statements of Operations. 

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ERIE INDEMNITY COMPANY
STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(in thousands)

Three months ended Six months endedThree months endedSix months ended
June 30, June 30,June 30,June 30,
2019 2018 2019 20182020201920202019
Net income$87,754
 $79,706
 $163,065
 $145,464
Net income$81,977  $87,754  $141,303  $163,065  
       
Other comprehensive income (loss), net of tax     
  
Change in unrealized holding gains (losses) on available-for-sale securities2,579
 (551) 8,057
 (5,978)
Other comprehensive income, net of taxOther comprehensive income, net of tax  
Change in unrealized holding gains on available-for-sale securitiesChange in unrealized holding gains on available-for-sale securities37,451  2,579  5,215  8,057  
Amortization of prior service costs and net actuarial loss on pension and other postretirement plans1,231
 0
 2,463
 0
Amortization of prior service costs and net actuarial loss on pension and other postretirement plans2,660  1,231  5,320  2,463  
Total other comprehensive income (loss), net of tax3,810
 (551) 10,520
 (5,978)
Total other comprehensive income, net of taxTotal other comprehensive income, net of tax40,111  3,810  10,535  10,520  
Comprehensive income$91,564
 $79,155
 $173,585
 $139,486
Comprehensive income$122,088  $91,564  $151,838  $173,585  
 
See accompanying notes to Financial Statements. See Note 12, "Accumulated Other Comprehensive Income (Loss)", for amounts reclassified out of accumulated other comprehensive income (loss) into the Statements of Operations.

4
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ERIE INDEMNITY COMPANY
STATEMENTS OF FINANCIAL POSITION
(dollars in thousands, except per share data)

June 30,December 31,
20202019
Assets(Unaudited)
Current assets:
Cash and cash equivalents$257,738  $336,739  
Available-for-sale securities27,409  32,810  
Equity securities1,416  2,381  
Receivables from Erie Insurance Exchange and affiliates, net506,690  468,636  
Prepaid expenses and other current assets60,668  44,943  
Federal income taxes recoverable0  462  
Accrued investment income5,317  5,433  
Total current assets859,238  891,404  
Available-for-sale securities, net777,416  697,891  
Equity securities73,973  64,752  
Limited partnership investments15,463  26,775  
Fixed assets, net246,572  221,379  
Agent loans, net58,602  60,978  
Deferred income taxes, net18,895  17,186  
Other assets32,702  35,875  
Total assets$2,082,861  $2,016,240  
Liabilities and shareholders' equity
Current liabilities:
Commissions payable$282,436  $262,963  
Agent bonuses60,264  96,053  
Accounts payable and accrued liabilities137,745  134,957  
Dividends payable44,940  44,940  
Contract liability36,625  35,938  
Deferred executive compensation9,674  10,882  
Federal income taxes payable15,441  0  
Current portion of long-term borrowings1,998  1,979  
Total current liabilities589,123  587,712  
Defined benefit pension plans161,458  145,659  
Long-term borrowings94,849  95,842  
Contract liability18,826  18,435  
Deferred executive compensation9,571  13,734  
Other long-term liabilities14,895  21,605  
Total liabilities888,722  882,987  
Shareholders’ equity
Class A common stock, stated value $0.0292 per share; 74,996,930 shares authorized; 68,299,200 shares issued; 46,189,068 shares outstanding1,992  1,992  
Class B common stock, convertible at a rate of 2,400 Class A shares for one Class B share, stated value $70 per share; 3,070 shares authorized; 2,542 shares issued and outstanding178  178  
Additional paid-in-capital16,487  16,483  
Accumulated other comprehensive loss(106,333) (116,868) 
Retained earnings2,427,905  2,377,558  
Total contributed capital and retained earnings2,340,229  2,279,343  
Treasury stock, at cost; 22,110,132 shares held(1,162,546) (1,158,910) 
Deferred compensation16,456  12,820  
Total shareholders’ equity1,194,139  1,133,253  
Total liabilities and shareholders’ equity$2,082,861  $2,016,240  

  June 30, December 31,
  2019 2018
Assets (Unaudited)  
Current assets:    
Cash and cash equivalents $338,262
 $266,417
Available-for-sale securities 61,210
 402,339
Receivables from Erie Insurance Exchange and affiliates 483,319
 449,873
Prepaid expenses and other current assets 42,300
 36,892
Federal income taxes recoverable 7,791
 8,162
Accrued investment income 4,365
 5,263
Total current assets 937,247
 1,168,946
     
Available-for-sale securities 627,898
 346,184
Equity securities 12,445
 11,853
Limited partnership investments 30,344
 34,821
Fixed assets, net 173,055
 130,832
Deferred income taxes, net 19,090
 24,101
Other assets 89,568
 61,590
Total assets $1,889,647
 $1,778,327
     
Liabilities and shareholders' equity    
Current liabilities:    
Commissions payable $267,403
 $241,573
Agent bonuses 51,357
 103,462
Accounts payable and accrued liabilities 124,794
 111,291
Dividends payable 41,913
 41,910
Contract liability 35,374
 33,854
Deferred executive compensation 12,605
 13,107
Current portion of long-term borrowings 1,914
 1,870
Total current liabilities 535,360
 547,067
     
Defined benefit pension plans 129,674
 116,866
Long-term borrowings 96,860
 97,860
Contract liability 18,339
 17,873
Deferred executive compensation 13,199
 13,075
Other long-term liabilities 32,761
 11,914
Total liabilities 826,193
 804,655
     
Shareholders’ equity    
Class A common stock, stated value $0.0292 per share; 74,996,930 shares authorized; 68,299,200 shares issued; 46,189,068 shares outstanding 1,992
 1,992
Class B common stock, convertible at a rate of 2,400 Class A shares for one Class B share, stated value $70 per share; 3,070 shares authorized; 2,542 shares issued and outstanding 178
 178
Additional paid-in-capital 16,483
 16,459
Accumulated other comprehensive loss (119,764) (130,284)
Retained earnings 2,310,655
 2,231,417
Total contributed capital and retained earnings 2,209,544
 2,119,762
Treasury stock, at cost; 22,110,132 shares held (1,158,300) (1,157,625)
Deferred compensation 12,210
 11,535
Total shareholders’ equity 1,063,454
 973,672
Total liabilities and shareholders’ equity $1,889,647
 $1,778,327

See accompanying notes to Financial Statements. 

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ERIE INDEMNITY COMPANY
STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED)
Three and six months ended June 30, 20192020 and 20182019
(dollars in thousands, except per share data)
Class A common stockClass B common stockAdditional paid-in-capitalAccumulated other comprehensive (loss) incomeRetained earningsTreasury stockDeferred compensationTotal shareholders' equity
Balance, December 31, 2019$1,992  $178  $16,483  $(116,868) $2,377,558  $(1,158,910) $12,820  $1,133,253  
Cumulative effect adjustment (1)
(1,075) (1,075) 
Net income59,326  59,326  
Other comprehensive loss(29,576) (29,576) 
Dividends declared:
Class A $0.965 per share(44,572) (44,572) 
Class B $144.75 per share(368) (368) 
Net purchase of treasury stock (2)
4  0  4  
Deferred compensation(772) 772  0  
Balance, March 31, 2020$1,992  $178  $16,487  $(146,444) $2,390,869  $(1,159,682) $13,592  $1,116,992  
Net income81,977  81,977  
Other comprehensive income40,111  40,111  
Dividends declared:
Class A $0.965 per share(44,573) (44,573) 
Class B $144.75 per share(368) (368) 
Net purchase of treasury stock (2)
0  0  0  
Deferred compensation(3,568) 3,568  0  
Rabbi trust distribution (3)
704  (704) 0  
Balance, June 30, 2020$1,992  $178  $16,487  $(106,333) $2,427,905  $(1,162,546) $16,456  $1,194,139  
 Class A common stockClass B common stockAdditional paid-in-capitalAccumulated other comprehensive income (loss)Retained earningsTreasury stockDeferred compensationTotal shareholders' equity
Balance, December 31, 2018$1,992
$178
$16,459
$(130,284)$2,231,417
$(1,157,625)$11,535
$973,672
Net income    75,311
  75,311
Other comprehensive income   6,710
   6,710
Dividends declared:        
Class A $0.90 per share    (41,570)  (41,570)
Class B $135.00 per share    (343)  (343)
Net purchase of treasury stock (1)
  24
  0
 24
Deferred compensation     (1,154)1,154
0
Balance, March 31, 2019$1,992
$178
$16,483
$(123,574)$2,264,815
$(1,158,779)$12,689
$1,013,804
Net income    87,754
  87,754
Other comprehensive income   3,810
   3,810
Dividends declared:        
Class A $0.90 per share    (41,570)  (41,570)
Class B $135.00 per share    (344)  (344)
Net purchase of treasury stock (1)
  0
  0
 0
Deferred compensation     (443)443
0
Rabbi trust distribution (2)
     922
(922)0
Balance, June 30, 2019$1,992
$178
$16,483
$(119,764)$2,310,655
$(1,158,300)$12,210
$1,063,454


Class A common stockClass B common stockAdditional paid-in-capitalAccumulated other comprehensive (loss) incomeRetained earningsTreasury stockDeferred compensationTotal shareholders' equity
Balance, December 31, 2018$1,992  $178  $16,459  $(130,284) $2,231,417  $(1,157,625) $11,535  $973,672  
Net income75,311  75,311  
Other comprehensive income6,710  6,710  
Dividends declared:
Class A $0.90 per share(41,570) (41,570) 
Class B $135.00 per share(343) (343) 
Net purchase of treasury stock (2)
24  0 ��24  
Deferred compensation(1,154) 1,154  0  
Balance, March 31, 2019$1,992  $178  $16,483  $(123,574) $2,264,815  $(1,158,779) $12,689  $1,013,804  
Net income87,754  87,754  
Other comprehensive income3,810  3,810  
Dividends declared:
Class A $0.90 per share(41,570) (41,570) 
Class B $135.00 per share(344) (344) 
Net purchase of treasury stock (2)
0  0  0  
Deferred compensation(443) 443  0  
Rabbi trust distribution (3)
922  (922) 0  
Balance, June 30, 2019$1,992  $178  $16,483  $(119,764) $2,310,655  $(1,158,300) $12,210  $1,063,454  

(1)The cumulative effect adjustment is related to the implementation of new credit loss allowance accounting guidance effective January 1, 2020. See Note 2. "Significant Accounting Policies".
 Class A common stockClass B common stockAdditional paid-in-capitalAccumulated other comprehensive income (loss)Retained earningsTreasury stockDeferred compensationTotal shareholders' equity
Balance, December 31, 2017$1,992
$178
$16,470
$(156,059)$2,140,853
$(1,155,668)$9,578
$857,344
Cumulative effect adjustments (3)
    (38,392)  (38,392)
Net income    65,758
  65,758
Other comprehensive loss   (5,427)   (5,427)
Dividends declared:        
Class A $0.84 per share    (38,799)  (38,799)
Class B $126.00 per share    (320)  (320)
Net purchase of treasury stock (1)
  (9)  0
 (9)
Deferred compensation     (1,663)1,663
0
Balance, March 31, 2018$1,992
$178
$16,461
$(161,486)$2,129,100
$(1,157,331)$11,241
$840,155
Net income    79,706
  79,706
Other comprehensive loss   (551)   (551)
Dividends declared:        
Class A $0.84 per share    (38,799)  (38,799)
Class B $126.00 per share    (321)  (321)
Net purchase of treasury stock (1)
  (2)  0
 (2)
Deferred compensation     (276)276
0
Rabbi trust distribution (2)
     608
(608)0
Balance, June 30, 2018$1,992
$178
$16,459
$(162,037)$2,169,686
$(1,156,999)$10,909
$880,188

(1) (2)Net purchases of treasury stock in 20192020 and 20182019 include the repurchase of our Class A common stock in the open market that were subsequently distributed to satisfy stock based compensation awards. See Note 11, "Capital Stock", for additional information on treasury stock transactions.
(2) (3)Distributions of our Class A shares were made from the rabbi trust to a retired directorsdirector in 20192020 and 2018.2019.
(3) Cumulative effect adjustments are primarily related to the implementation of new revenue recognition guidance effective January 1, 2018.

See accompanying notes to Financial Statements.



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ERIE INDEMNITY COMPANY
STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)

Six months ended
June 30,
20202019
Cash flows from operating activities
Management fee received$937,962  $902,958  
Administrative services reimbursements received279,689  296,390  
Service agreement fee received13,108  13,599  
Net investment income received18,217  16,799  
Limited partnership distributions532  1,292  
Commissions paid to agents(448,622) (434,599) 
Agents bonuses paid(100,185) (108,540) 
Salaries and wages paid(100,360) (101,765) 
Employee benefits paid(15,962) (22,085) 
General operating expenses paid(133,422) (117,915) 
Administrative services expenses paid(298,046) (291,136) 
Income taxes paid(25,625) (39,863) 
Interest paid(4) (719) 
Net cash provided by operating activities127,282  114,416  
Cash flows from investing activities
Purchase of investments:
Available-for-sale securities(198,192) (615,384) 
Equity securities(44,407) 0  
Limited partnerships(19) (9) 
Other investments(603) (124) 
Proceeds from investments:
Available-for-sale securities sales68,977  430,596  
Available-for-sale securities maturities/calls58,722  261,902  
Equity securities35,684  0  
Limited partnerships577  2,450  
Purchase of fixed assets(37,426) (34,260) 
Loans to agents(2,313) (6,947) 
Collections on agent loans3,577  3,991  
Net cash (used in) provided by investing activities(115,423) 42,215  
Cash flows from financing activities
Dividends paid to shareholders(89,881) (83,824) 
Net payments on long-term borrowings(979) (962) 
Net cash used in financing activities(90,860) (84,786) 
Net (decrease) increase in cash and cash equivalents(79,001) 71,845  
Cash and cash equivalents, beginning of period336,739  266,417  
Cash and cash equivalents, end of period$257,738  $338,262  
Supplemental disclosure of noncash transactions
Transfer of investments from limited partnerships to equity securities$4,188  $0  
Operating lease assets obtained in exchange for new operating lease liabilities$3,440  $33,136  
Liability incurred to purchase fixed assets$814  $14,980  
  Six months ended
  June 30,
  2019 2018
Cash flows from operating activities    
Management fee received $902,958
 $859,694
Administrative services reimbursements received 296,390
 298,056
Service agreement fee received 13,599
 14,225
Net investment income received 16,799
 17,279
Limited partnership distributions 1,292
 3,037
Commissions paid to agents (434,599) (413,880)
Agents bonuses paid (108,540) (126,594)
Salaries and wages paid (101,765) (102,601)
Pension contributions and employee benefits paid (22,085) (99,334)
General operating expenses paid (117,915) (111,381)
Administrative services expenses paid (291,136) (295,635)
Income taxes paid (39,863) (208)
Interest paid (719) (1,065)
Net cash provided by operating activities 114,416
 41,593
     
Cash flows from investing activities    
Purchase of investments:    
Available-for-sale securities (615,384) (114,848)
Equity securities 0
 (1,035)
Limited partnerships (9) (215)
Other investments (124) 0
Proceeds from investments:    
Available-for-sale securities sales 430,596
 76,387
Available-for-sale securities maturities/calls 261,902
 69,674
Equity securities 0
 1,157
Limited partnerships 2,450
 2,682
Purchase of fixed assets (34,260) (18,121)
Distributions on agent loans (6,947) (24,440)
Collections on agent loans 3,991
 3,106
Net cash provided by (used in) investing activities 42,215
 (5,653)
     
Cash flows from financing activities    
Dividends paid to shareholders (83,824) (78,235)
Net (payments) proceeds from long-term borrowings (962) 24,986
Net cash used in financing activities (84,786) (53,249)
     
Net increase (decrease) in cash and cash equivalents 71,845
 (17,309)
Cash and cash equivalents, beginning of period 266,417
 215,721
Cash and cash equivalents, end of period $338,262
 $198,412
     
Supplemental disclosure of noncash transactions    
Operating lease assets obtained in exchange for new operating lease liabilities $33,136
 $—
Liability incurred to purchase fixed assets $14,980
 $—

See accompanying notes to Financial Statements.

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NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
 
Note 1.  Nature of Operations
 
Erie Indemnity Company ("Indemnity", "we", "us", "our") is a publicly held Pennsylvania business corporation that has since its incorporation in 1925 served as the attorney-in-fact for the subscribers (policyholders) at the Erie Insurance Exchange ("Exchange").  The Exchange, which also commenced business in 1925, is a Pennsylvania-domiciled reciprocal insurer that writes property and casualty insurance.
 
Our primary function as attorney-in-fact is to perform policy issuance and renewal services on behalf of the subscribers at the Exchange. We also act as attorney-in-fact on behalf of the Exchange with respect to all claims handling and investment management services, as well as the service provider for all claims handling, life insurance, and investment management services for its insurance subsidiaries, collectively referred to as "administrative services". Acting as attorney-in-fact in these two2 capacities is done in accordance with a subscriber's agreement (a limited power of attorney) executed individually by each subscriber (policyholder), which appoints us as their common attorney-in-fact to transact certain business on their behalf.  Pursuant to the subscriber's agreement for acting as attorney-in-fact in these two2 capacities, we earn a management fee calculated as a percentage of the direct and affiliated assumed premiums written by the Exchange.

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

By virtue of its legal structure as a reciprocal insurer, the Exchange does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and Indemnity. Claims handling services include costs incurred in the claims process, including the adjustment, investigation, defense, recording and payment functions. Life insurance management services include costs incurred in the management and processing of life insurance business. Investment management services are related to investment trading activity, accounting and all other functions attributable to the investment of funds. Included in these expenses are allocations of costs for departments that support these administrative functions. The amounts incurred for these services are reimbursed to Indemnity at cost in accordance with the subscriber's agreement and the service agreements. State insurance regulations require that intercompany service agreements and any material amendments be approved in advance by the state insurance department.

Our results of operations are tied to the growth and financial condition of the Exchange. If any events occurred that impaired the Exchange’s ability to grow or sustain its financial condition, including but not limited to reduced financial strength ratings, disruption in the independent agency relationships, significant catastrophe losses, or products not meeting customer demands, the Exchange could find it more difficult to retain its existing business and attract new business. A decline in the business of the Exchange almost certainly would have as a consequence a decline in the total premiums paid and a correspondingly adverse effect on the amount of the management fees we receive. We also have an exposure to a concentration of credit risk related to the unsecured receivables due from the Exchange for its management fee and cost reimbursements. See Note 13, "Concentrations of Credit Risk".


Coronavirus ("COVID-19") pandemic
On March 11, 2020, the outbreak of the coronavirus ("COVID-19") was declared a global pandemic. The significant volatility in the financial markets, economic disruption and uncertainty resulting from the COVID-19 pandemic that began in the first quarter of 2020 continues to evolve and the pandemic’s ultimate impact and duration remain highly uncertain at this time. The Exchange’s previously announced rate reductions that become effective in the second half of 2020, coupled with the uncertain economic conditions, will likely continue to constrain the Exchange’s premium growth which would impact our management fee revenue.The Exchange’s underwriting profitability has improved largely due to declines in claims frequency.The extent and duration of changes in consumer behavior and driving patterns and the resulting impact to the Exchange’s growth and financial condition remain uncertain.

The economic conditions resulting from the COVID-19 pandemic may negatively impact the collectability of the Exchange’s premiums receivable, however no such impact has been noted through the date of this report. While our investment portfolio
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was negatively impacted by the volatility in the financial markets in the first quarter of 2020, market conditions partially recovered in the second quarter of 2020. We are unable to predict the duration or extent of the business disruption or the financial impact given the ongoing development of the pandemic and its impacts on the economy and financial markets.


Note 2.  Significant Accounting Policies

Basis of presentation
The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by GAAP 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 six months ended June 30, 20192020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.2020. For further information, refer to the financial statements and footnotes included in our Form 10-K for the year ended December 31, 20182019 as filed with the Securities and Exchange Commission on February 21, 2019.27, 2020.


Use of estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Recently adopted accounting standards
In FebruaryJune 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Codification ("ASC") 842, "Leases", which requires lessees to recognize assets and liabilities arising from operating leases on the Statements of Financial Position and to disclose certain information about leasing arrangements. We adopted ASC 842 on January 1, 2019 using the optional transition method, which permits entities to apply the new guidance prospectively with certain practical expedients available. We elected the package of practical expedients which among other things allowed us to carry forward the historical lease classifications. We did not elect the hindsight practical expedient in determining the lease term for existing leases.

The adoption of the new standard resulted in the recognition of operating lease assets of $32.7 million and operating lease liabilities of $32.1 million on the Statement of Financial Position at January 1, 2019. The adoption of this standard did not have a material impact on our Statement of Operations and had no impact on our net cash flows.

Recently issued accounting standards
In August 2018, the FASB issued Accounting Standards Update ("ASU") 2018-15, 2016-13"Intangibles-Goodwill and Other Internal-Use Software", which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. ASU 2018-15 is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. The amendments under ASU 2018-15 may be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption and early adoption is permitted. We plan to adopt this guidance on a prospective basis and do not expect a material impact on our financial statements or disclosures.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments-Credit Losses", which requires financial assets measured at amortized cost to be presented at the net amount expected to be collected through the use of a new forward-looking current expected credit loss model and credit losses relating to available-for-sale debt securities to be recognized through an allowance for credit losses. ASU 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019. Early adoption for interim and annual periods beginning after December 15, 2018 is permitted. We have evaluated the impact ofadopted this guidance, which applies to our receivable from Erie Insurance Exchange and affiliates, agent loans and investments, on our financial assets.January 1, 2020.

For assets measured at amortized cost for which a current expected credit loss allowance was required, we adopted the guidance using the modified-retrospective approach. At January 1, 2020, we recorded current expected credit loss allowances related to agent loans of $0.8 million and receivables from Erie Insurance Exchange and affiliates of $0.6 million. This resulted in the recording of a cumulative effect adjustment, net of taxes, to retained earnings of $1.1 million. Our available-for-sale investments are not measured at amortized cost, and therefore do not require the use of a newcurrent expected credit loss model. Our available-for-sale debt securities will continueAny credit losses, however, are required to be monitored for credit losses which would be limited to the amount by which the fair value is below amortized cost and reflectedrecorded as an allowance for credit losses rather than a reduction of the carrying value of the asset. Our receivables from Erie Insurance ExchangeFor available-for-sale securities, we adopted the guidance using the prospective approach and affiliates are unlikely torecorded an initial allowance for credit losses of $0.6 million at March 31, 2020. The adoption of this standard did not have a significantmaterial impact on our Statements of Financial Position, net income or net cash flows.

Investments
Available-for-sale securities –Fixed maturity debt securities and redeemable preferred stock are classified as available-for-sale and reported at fair value with unrealized investment gains and losses, net of income taxes, recognized in other comprehensive income. Available-for-sale securities with a remaining maturity of 12 months or less and any security that we intend to sell as of the reporting date are classified as current assets.

Available-for-sale securities in an unrealized loss position are evaluated to determine whether the impairment is a result of credit loss exposure givenor other factors. If we have the financial strengthintent to sell or it's more likely than not that we would be required to sell the security before recovery of the Exchangeamortized cost basis, the entire impairment is recognized in earnings. Securities that have experienced a decline in fair value that we do not intend to sell, and that we will not be required to sell before recovery, are evaluated to determine if the decline in fair value is credit related. Impairment resulting from a credit loss is recognized in earnings with a corresponding allowance on the balance sheet. Future recoveries of credit loss result in an adjustment to the allowance and earnings in the period the credit conditions improve. Factors considered in the evaluation of credit loss include the extent to which fair value is less than cost and fundamental factors specific to the issuer such as demonstrated by its strong surplus position, industryfinancial condition, changes in credit ratings, near and historical experiencelong-term business prospects and other factors, as well as the likelihood of norecovery of the amortized cost of the security. If the qualitative review indicates credit losses.impairment, the allowance for credit loss is measured as the amount that the security’s amortized cost exceeds the present value of cash flows expected to be collected and is limited to the amount that fair value is below amortized cost.

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Realized gains and losses and investment income –Realized gains and losses on sales of available-for-sale and equity securities are recognized in income based upon the specific identification method and reported as net realized investment gains (losses). Interest income is recognized as earned and includes amortization of premium and accretion of discount.  Income is recognized based on the constant effective yield method, which includes periodically updated prepayment assumptions obtained from third party data sources on our prepaying securities.  The effective yield for prepaying securities is recalculated on a retrospective basis.  Dividend income is recognized at the ex-dividend date. Both interest and dividend income are reported as net investment income. We currently do not record an allowance for credit losses related to our agenton accrued investment income as any amount deemed uncollectible is reversed from interest income in the period the expected payment defaults.

Agent loans as historical default amounts have been insignificant and
Agent loans, the majority of the loanswhich are senior secured. Accordingly, when we establish an allowance related to agent loans upon adoption of this guidance, we do not expect it to be material. Our cash equivalents include money market mutual funds comprised of U.S. government securities, therefore a corresponding allowance, if any, would be expected to be immaterial. As a result of our evaluation, we do not expect a material impact on our financial statements.

Other assets
Other assets include agent loans, operating lease assets and other long-term prepaid assets. Agent loanssecured, are carried at unpaid principal balance with interest recorded in investment income as earned. ItThe current portion of agent loans is our policyrecorded in prepaid expenses and other current assets. The adoption of ASU 2016-13 on January 1, 2020 requires the recording of a current expected credit loss allowance on these loans. The allowance is estimated using available loss history and/or external loss rates based on comparable loan losses and considers current conditions and forecasted information. When establishing the expected credit loss allowance upon implementation of ASU 2016-13, a cumulative effect adjustment was recorded to chargebeginning retained earnings. Future changes to the loans that areallowance will be recognized in default directlyearnings as adjustments to expense. We donet impairment losses. Prior to the adoption of ASU 2016-13, we did not record an allowance for credit losses on these loans, as the majority of thethese loans are senior secured and historically have had insignificant default amounts.

Other assets
Other assets include operating lease assets and other long-term prepaid assets. The determination of whether an arrangement is a lease, and the related lease classification, is made at inception of a contract. Our leases are classified as operating leases. Operating lease assets and liabilities are recorded at inception based on the present value of the future minimum lease payments over the lease term at commencement date. When an implicit rate for the lease is not available, we use our incremental borrowing rate based on the information available at commencement date to determine the present value of future payments. Lease terms include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Most of our lease contracts contain lease and non-lease components. Non-lease components are expensed as incurred. Operating lease assets are included in other assets, and the current and noncurrent portions of the operating lease liabilities are included in accounts payable and accrued expenses and other long-term liabilities, respectively, in the Statementrespectively.

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Table of Financial Position.Contents

Note 3.  Revenue

The majority of our revenue is derived from the subscriber’s agreement between us and the subscribers (policyholders) at the Exchange. Pursuant to the subscriber’s agreement, we earn a management fee calculated as a percentage, not to exceed 25%, of all direct and affiliated assumed written premiums of the Exchange.

We allocate a portion of our management fee revenue, currently 25% of the direct and affiliated assumed written premiums of the Exchange, between the two2 performance obligations we have under the subscriber’s agreement. The first performance obligation is to provide policy issuance and renewal services to the subscribers (policyholders) at the Exchange, and the second is to act as attorney-in-fact on behalf of the Exchange, as well as the service provider for its insurance subsidiaries, with respect to all administrative services. The transaction price, including management fee revenue and administrative service reimbursement revenue, is allocated based on the estimated standalone selling prices developed using industry information and other available information for similar services. We update the transaction price allocation annually based upon the most recent information available. There wasavailable or more frequently if there have been significant changes in any components considered in the transaction price. In 2020, we are reviewing our transaction price allocation quarterly to consider the most current economic conditions related to the COVID-19 pandemic. These reviews have resulted in no material change to the allocation in 2019.allocation.

The first performance obligation is to provide policy issuance and renewal services that result in executed insurance policies between the Exchange or one of its insurance subsidiaries and the subscriber (policyholder). Our customer, the subscriber (policyholder), receives economic benefits when substantially all the policy issuance or renewal services are complete and an insurance policy is issued or renewed by the Exchange or one of its insurance subsidiaries. It is at the time of policy issuance or renewal that the allocated portion of revenue is recognized.

The Exchange, by virtue of its legal structure as a reciprocal insurer, does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services in accordance with the subscriber's agreement. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and Indemnity. Collectively, these services represent a second performance obligation under the subscriber’s agreement and the service agreements. The revenue allocated to this performance obligation is recognized over time as these services are provided. The portion of revenue not yet earned is recorded as a contract liability in the Statements of Financial Position. The administrative services expenses we incur and the related reimbursements we receive are recorded gross in the Statements of Operations.

Indemnity records a receivable from the Exchange for management fee revenue when the premium is written or assumed by the Exchange. Indemnity collects the management fee from the Exchange when the Exchange collects the premiums from the subscribers (policyholders). As the Exchange issues policies with annual terms only, cash collections generally occur within one year.

A constraining estimate exists around the management fee received as consideration related to the potential for management fee to be returned if a policy were to be cancelled mid-term. Management fees are returned to the Exchange when policyholders cancel their insurance coverage mid-term and unearned premiums are refunded to them. We maintain an estimated allowance to reduce the management fee to its estimated net realizable value to account for the potential of mid-term policy cancellations based on historical cancellation rates. In 2020, our historical cancellation rates were adjusted to include the potential for increased cancellations given the current economic conditions related to the COVID-19 pandemic. This resulted in a $3.5 million increase in the allowance for the three months ended March 31, 2020 and an additional $0.9 million increase in the allowance for the three months ended June 30, 2020 for a cumulative increase of $4.4 million for the six months ended June 30, 2020. The increases to the allowance were $2.0 million and $2.9 million for the three and six months ended June 30, 2019 primarily driven by premium growth.

This estimated allowance has been allocated between the two2 performance obligations consistent with the revenue allocation proportions.

The following table disaggregates revenue by our two2 performance obligations:
Three months ended June 30,Six months ended June 30,
(in thousands)2020201920202019
Management fee revenue - policy issuance and renewal services, net$483,795  $480,513  $927,545  $911,496  
Management fee revenue - administrative services, net14,813  14,195  29,584  28,146  
Administrative services reimbursement revenue151,965  146,095  303,519  288,575  
Total administrative services$166,778  $160,290  $333,103  $316,721  
 Three months ended June 30, Six months ended June 30,
(in thousands)20192018 20192018
Management fee revenue - policy issuance and renewal services, net$480,513
$454,572
 $911,496
$860,550
      
Management fee revenue - administrative services, net14,195
13,299
 28,146
26,373
Administrative services reimbursement revenue146,095
146,507
 288,575
292,470
Total administrative services$160,290
$159,806
 $316,721
$318,843
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Note 4.  Earnings Per Share
 
Class A and Class B basic earnings per share and Class B diluted earnings per share are calculated under the two-class method. The two-class method allocates earnings to each class of stock based upon its dividend rights.  Class B shares are convertible into Class A shares at a conversion ratio of 2,400 to 1. See Note 11, "Capital Stock".

Class A diluted earnings per share are calculated under the if-converted method, which reflects the conversion of Class B shares to Class A shares. Diluted earnings per share calculations include the dilutive effect of assumed issuance of stock-based awards under compensation plans that have the option to be paid in stock using the treasury stock method.

A reconciliation of the numerators and denominators used in the basic and diluted per-share computations is presented as follows for each class of common stock: 
Three months ended June 30,
20202019
(dollars in thousands, except per share data)Allocated net income (numerator)Weighted shares (denominator)Per-share amountAllocated net income (numerator)Weighted shares (denominator)Per-share amount
Class A – Basic EPS:
Income available to Class A stockholders$81,306  46,187,808  $1.76  $87,036  46,188,994  $1.88  
Dilutive effect of stock-based awards0  14,373  —  0  24,906  —  
Assumed conversion of Class B shares671  6,100,800  —  718  6,100,800  —  
Class A – Diluted EPS:
Income available to Class A stockholders on Class A equivalent shares$81,977  52,302,981  $1.57  $87,754  52,314,700  $1.68  
Class B – Basic and diluted EPS:
Income available to Class B stockholders$671  2,542  $264  $718  2,542  $283  
Six months ended June 30,
20202019
(dollars in thousands, except per share data)Allocated net income (numerator)Weighted shares (denominator)Per-share amountAllocated net income (numerator)Weighted shares (denominator)Per-share amount
Class A – Basic EPS:
Income available to Class A stockholders$140,146  46,188,299  $3.03  $161,730  46,188,668  $3.50  
Dilutive effect of stock-based awards0  24,568  —  0  23,903  —  
Assumed conversion of Class B shares1,157  6,100,800  —  1,335  6,100,800  —  
Class A – Diluted EPS:
Income available to Class A stockholders on Class A equivalent shares$141,303  52,313,667  $2.70  $163,065  52,313,371  $3.12  
Class B – Basic and diluted EPS:
Income available to Class B stockholders$1,157  2,542  $455  $1,335  2,542  $525  
  Three months ended June 30,
  2019 2018
(dollars in thousands, except per share data) Allocated net income (numerator) Weighted shares (denominator) Per-share amount Allocated net income (numerator) Weighted shares (denominator) Per-share amount
Class A – Basic EPS:            
Income available to Class A stockholders $87,036
 46,188,994
 $1.88
 $79,053
 46,188,705
 $1.71
Dilutive effect of stock-based awards 0
 24,906
 —
 0
 23,344
 —
Assumed conversion of Class B shares 718
 6,100,800
 —
 653
 6,100,800
 —
Class A – Diluted EPS:            
Income available to Class A stockholders on Class A equivalent shares $87,754
 52,314,700
 $1.68
 $79,706
 52,312,849
 $1.52
Class B – Basic EPS:            
Income available to Class B stockholders $718
 2,542
 $283
 $653
 2,542
 $257
Class B – Diluted EPS:            
Income available to Class B stockholders $718
 2,542
 $283
 $653
 2,542
 $257


12
  Six months ended June 30,
  2019 2018
(dollars in thousands, except per share data) Allocated net income (numerator) Weighted shares (denominator) Per-share amount Allocated net income (numerator) Weighted shares (denominator) Per-share amount
Class A – Basic EPS:  
  
  
  
  
  
Income available to Class A stockholders $161,730
 46,188,668
 $3.50
 $144,273
 46,188,309
 $3.12
Dilutive effect of stock-based awards 0
 23,903
 —
 0
 22,632
 —
Assumed conversion of Class B shares 1,335
 6,100,800
 —
 1,191
 6,100,800
 —
Class A – Diluted EPS:  
  
  
  
  
  
Income available to Class A stockholders on Class A equivalent shares $163,065
 52,313,371
 $3.12
 $145,464
 52,311,741
 $2.78
Class B – Basic EPS:  
  
  
  
  
  
Income available to Class B stockholders $1,335
 2,542
 $525
 $1,191
 2,542
 $469
Class B – Diluted EPS:            
Income available to Class B stockholders $1,335
 2,542
 $525
 $1,191
 2,542
 $468

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Note 5. Fair Value
 
Financial instruments carried at fair value
Our available-for-sale debt securities and equity securities are recorded at fair value, which is the price that would be received to sell the asset in an orderly transaction between willing market participants as of the measurement date.
 
Valuation techniques used to derive the fair value of our available-for-sale debt securities and equity securities are based upon observable and unobservable inputs.  Observable inputs reflect market data obtained from independent sources.  Unobservable inputs reflect our own assumptions regarding fair market value for these securities.  Although virtually all of our prices are obtained from third party sources, we also perform an internal pricing review on outliers. The outlier review includes securities with price changes that vary from current market conditions or independent third party price sources. Financial instruments are categorized based upon the following characteristics or inputs to the valuation techniques:

•Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.

•Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

•Level 3 – Unobservable inputs for the asset or liability.
 
Estimates of fair values for our investment portfolio are obtained primarily from a nationally recognized pricing service.  Our Level 1 category includes those securities are valued using an exchange traded price provided by the pricing service. The methodologies used by the pricingPricing service that support avaluations for Level 2 classification of a financial instrumentsecurities include multiple verifiable, observable inputs including benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data.  Pricing service valuations for Level 3 securities are based upon proprietary models and are used when observable inputs are not available or in illiquid markets.
 
Although virtually all of our prices are obtained from third party sources, we also perform internal pricing reviews, including evaluating the methodology and inputs used to ensure that we determine the proper classification level of the financial instrument and reviewing securities with price changes that vary significantly from current market conditions or independent price sources.  Price variances are investigated and corroborated by market data and transaction volumes. We have reviewed the pricing methodologies of our pricing service as well as other observable inputs and believe that the prices adequately consider market activity in determining fair value. 

In limited circumstances we adjust the price received from the pricing service when, in our judgment, a better reflection of fair value is available based upon corroborating information and our knowledge and monitoring of market conditions such as a disparity in price of comparable securities and/or non-binding broker quotes.  In other circumstances, certain securities are internally priced because prices are not provided by the pricing service.
 
We perform continuous reviews of the prices obtained from the pricing service.  This includes evaluating the methodology and inputs used by the pricing service to ensure that we determine the proper classification level of the financial instrument.  Price variances, including large periodic changes, are investigated and corroborated by market data.  We have reviewed the pricing methodologies of our pricing service as well as other observable inputs, such as market data, and transaction volumes and believe that the prices adequately consider market activity in determining fair value. 
When a price from the pricing service is not available, values are determined by obtaining broker/dealer quotes and/or market comparables. When available, we obtain multiple quotes for the same security. The ultimate value for these securities is determined based upon our best estimate of fair value using corroborating market information. Our evaluation includes the considerationAs of benchmark yields, reported trades, issuer spreads, two-sided markets, benchmarkJune 30, 2020, nearly all of our available-for-sale and equity securities bids, offers, and reference data.were priced using a third party pricing service.








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The following tables present our fair value measurements on a recurring basis by asset class and level of input:input as of: 
June 30, 2020
(in thousands)TotalLevel 1Level 2Level 3
Available-for-sale securities:
Corporate debt securities$469,655  $2,104  $462,635  $4,916  
Residential mortgage-backed securities119,599  0  119,599  0  
Commercial mortgage-backed securities106,542  0  88,476  18,066  
Collateralized debt obligations96,288  0  96,029  259  
Other debt securities12,741  0  12,741  0  
Total available-for-sale securities804,825  2,104  779,480  23,241  
Equity securities - nonredeemable preferred and common stock:
Financial services sector60,149  20,943  39,206  0  
Utilities sector7,712  4,259  3,453  0  
Communications sector3,894  3,894  0  0  
Consumer sector2,599  892  912  795  
Energy sector1,035  0  1,035  0  
Total equity securities75,389  29,988  44,606  795  
Total$880,214  $32,092  $824,086  $24,036  
  At June 30, 2019
(in thousands) Total Level 1 Level 2 Level 3
Available-for-sale securities:        
U.S. Treasury (1)
 $151,094
 $0
 $151,094
 $0
States & political subdivisions (1)
 3,360
 0
 3,360
 0
Corporate debt securities (1)
 356,656
 0
 350,283
 6,373
Residential mortgage-backed securities 66,186
 0
 66,186
 0
Commercial mortgage-backed securities 46,142
 0
 43,591
 2,551
Collateralized debt obligations 57,345
 0
 57,345
 0
Other debt securities 8,325
 0
 8,325
 0
Total available-for-sale securities 689,108
 0
 680,184
 8,924
Equity securities:        
Nonredeemable preferred stock - financial services sector 12,445
 2,003
 10,442
 0
Total equity securities 12,445
 2,003
 10,442
 0
Total $701,553
 $2,003
 $690,626
 $8,924


December 31, 2019
(in thousands)TotalLevel 1Level 2Level 3
Available-for-sale securities:
Corporate debt securities$454,880  $2,683  $443,873  $8,324  
Residential mortgage-backed securities125,343  0  125,343  0  
Commercial mortgage-backed securities67,541  0  64,220  3,321  
Collateralized debt obligations77,856  0  77,856  0  
Other debt securities5,081  0  5,081  0  
Total available-for-sale securities730,701  2,683  716,373  11,645  
Equity securities - nonredeemable preferred and common stock:
Financial services sector53,513  14,927  38,586  0  
Utilities sector6,818  3,190  3,628  0  
Communications sector3,433  3,433  0  0  
Energy sector1,881  0  1,881  0  
Industrial sector980  0  980  0  
Consumer sector508  0  508  0  
Total equity securities67,133  21,550  45,583  0  
Total$797,834  $24,233  $761,956  $11,645  
  At December 31, 2018
(in thousands) Total Level 1 Level 2 Level 3
Available-for-sale securities:        
U.S. Treasury (1)
 $208,412
 $0
 $208,412
 $0
States & political subdivisions (1)
 159,023
 0
 159,023
 0
Corporate debt securities 249,947
 0
 237,370
 12,577
Residential mortgage-backed securities 4,609
 0
 4,609
 0
Commercial mortgage-backed securities 46,515
 0
 46,515
 0
Collateralized debt obligations 64,239
 0
 64,239
 0
Other debt securities 15,778
 0
 15,778
 0
Total available-for-sale securities 748,523
 0
 735,946
 12,577
Equity securities:        
Nonredeemable preferred stock - financial services sector 11,853
 1,809
 10,044
 0
Total equity securities 11,853
 1,809
 10,044
 0
Other limited partnership investments (2)
 3,206
 —
 —
 —
Total $763,582
 $1,809
 $745,990
 $12,577

(1)In the fourth quarter of 2018, we began selling off our municipal bonds as part of a portfolio rebalancing. We have currently invested proceeds from these sales primarily in U.S. Treasuries and corporate debt securities.
(2)The limited partnership investment measured at fair value represents one real estate fund included on the balance sheet as a limited partnership investment reported under the fair value option using the net asset value (NAV) practical expedient, which is not required to be categorized in the fair value hierarchy. The fair value of this investment is based on our proportionate share of the NAV from the most recent partners' capital statements received from the general partner, which is generally one quarter prior to our balance sheet date. We consider observable market data and perform a review validating the appropriateness of the NAV at each balance sheet date. Liquidation of this fund was completed in January 2019 and a final distribution totaling $3.2 million was received. There were no unfunded commitments related to the investment at December 31, 2018. During the year ended December 31, 2018, no contributions were made and distributions totaling $1.2 million were received from this investment.

The following table presents our fair value measurements on a recurring basis by pricing source:
  At June 30, 2019
(in thousands) Total Level 1 Level 2 Level 3
Available-for-sale securities:        
Priced via pricing services $688,958
 $0
 $680,184
 $8,774
Priced via internal modeling 150
 0
 0
 150
Total available-for-sale securities 689,108
 0
 680,184
 8,924
Equity securities priced via pricing services 12,445
 2,003
 10,442
 0
Total $701,553
 $2,003
 $690,626
 $8,924



Quantitative and Qualitative Disclosures about Unobservable Inputs

The following table presents quantitative information about the significant unobservable inputs utilized in the fair value measurements of Level 3 assets. Level 3 securities where cost is the best estimate of fair value totaled $0.2 million at June 30, 2019 and are excluded from the table below. When a non-binding broker quote was the only input available, the security was classified within Level 3. The quantitative detail of the unobservable inputs is neither provided nor reasonably available to us and therefore has not been included in the table below. These investments totaled $0.8 million at June 30, 2019 and $12.6 million at December 31, 2018. The weighted average is calculated based on estimated fair value.














14
  At June 30, 2019
(dollars in thousands) 
Fair
value
Valuation techniquesUnobservable inputRange
(basis points)		Weighted
average
(basis points)		Impact of increase in input on estimated fair value
     


Corporate debt securities - bank loans $6,093
Syndicated loan model
Market residual yield (1)
-130 - +730+54Decrease
Commercial mortgage-backed securities 1,866
Relative value pricing model
Credit spread (2)
+44 - +52+48Decrease
Table of Contents
(1)Values for bank loans classified as Level 3 are determined by our pricing vendor based on model yield curves adjusted for observable inputs. The market residual yield represents a net adjustment to the model yield curve for unobservable input factors.
(2)Values for commercial mortgage-backed securities classified as Level 3 include adjustments to the base spread over the appropriate U.S. Treasury yield assuming no prepayments until penalty provisions have expired.


We review the fair value hierarchy classifications each reporting period.  Transfers between hierarchy levels may occur due to changes in available market observable inputs.

Level 3 Assets – 2020 Quarterly Change:

(in thousands) 		Beginning balance at March 31, 2020
Included in earnings(1)
Included
in other
comprehensive
income		PurchasesSales
Transfers into
Level 3(2)
Transfers out of Level 3(2)
Ending balance at June 30, 2020
Available-for-sale securities:        
Corporate debt securities$12,056  $(2) $867  $783  $(115) $1,142  $(9,815) $4,916  
Commercial mortgage-backed securities7,383  (34) 268  6,891  (201) 4,334  (575) 18,066  
Collateralized debt obligations0  0  12  247  0  0  0  259  
Total available-for-sale securities19,439  (36) 1,147  7,921  (316) 5,476  (10,390) 23,241  
Nonredeemable preferred stock0  (25) 0  820  0  0  0  795  
Total Level 3 securities$19,439  $(61) $1,147  $8,741  $(316) $5,476  $(10,390) $24,036  


Level 3 Assets – 2020 Year-to-Date Change:

(in thousands) 		Beginning balance at December 31, 2019
Included in earnings(1)
Included
in other
comprehensive
income		PurchasesSales
Transfers into
Level 3(2)
Transfers out of Level 3(2)
Ending balance at June 30, 2020
Available-for-sale securities:        
Corporate debt securities$8,324  $5  $(511) $2,501  $(542) $8,037  $(12,898) $4,916  
Commercial mortgage-backed securities3,321  (42) 120  7,203  (287) 8,891  (1,140) 18,066  
Collateralized debt obligations0  0  12  247  0  0  0  259  
Total available-for-sale securities11,645  (37) (379) 9,951  (829) 16,928  (14,038) 23,241  
Nonredeemable preferred stock0  (25) 0  820  0  0  0  795  
Total Level 3 securities$11,645  $(62) $(379) $10,771  $(829) $16,928  $(14,038) $24,036  


Level 3 Assets – 2019 Quarterly Change:
(in thousands)Beginning balance at March 31, 2019
Included in earnings(1)
Included
in other
comprehensive
income		PurchasesSales
Transfers into
Level 3(2)
Transfers out of Level 3(2)
Ending balance at June 30, 2019
Available-for-sale securities:
Corporate debt securities$11,523  $(20) $23  $0  $(5,841) $2,581  $(1,893) $6,373  
Residential mortgage-backed securities915  4  15  0  (26) 0  (908) 0  
Commercial mortgage-backed securities1,182  15  (8) 0  (1,065) 2,551  (124) 2,551  
Total Level 3 available-for-sale securities$13,620  $(1) $30  $0  $(6,932) $5,132  $(2,925) $8,924  






15

(in thousands) 		 Beginning balance at March 31, 2019 
Included in earnings(1)
 Included
in other
comprehensive
income		 Purchases Sales 
Transfers into Level 3(2)
 
Transfers out of Level 3(2)
 Ending balance at June 30, 2019
Available-for-sale securities:                
Corporate debt securities $11,523
 $(20) $23
 $0
 $(5,841) $2,581
 $(1,893) $6,373
Residential mortgage-backed securities 915
 4
 15
 0
 (26) 0
 (908) 0
Commercial mortgage-backed securities 1,182
 15
 (8) 0
 (1,065) 2,551
 (124) 2,551
Total Level 3 available-for-sale securities $13,620
 $(1) $30
 $0
 $(6,932) $5,132
 $(2,925) $8,924
Table of Contents








Level 3 Assets – 2019 Year-to-Date Change:
(in thousands)Beginning balance at December 31, 2018
Included in earnings(1)
Included
in other
comprehensive
income		PurchasesSales
Transfers into
Level 3(2)
Transfers out of Level 3(2)
Ending balance at June 30, 2019
Available-for-sale securities:
Corporate debt securities$12,577  $(9) $291  $734  $(6,272) $7,394  $(8,342) $6,373  
Residential mortgage-backed securities0  4  15  921  (32) 0  (908) 0  
Commercial mortgage-backed securities0  13  (8) 478  (1,065) 3,257  (124) 2,551  
Total Level 3 available-for-sale securities$12,577  $8  $298  $2,133  $(7,369) $10,651  $(9,374) $8,924  
(in thousands) Beginning balance at December 31, 2018 
Included in earnings(1)
 
Included
in other
comprehensive
income
 Purchases Sales 
Transfers into Level 3(2)
 
Transfers out of Level 3(2)
 Ending balance at June 30, 2019
Available-for-sale securities:                
Corporate debt securities $12,577
 $(9) $291
 $734
 $(6,272) $7,394
 $(8,342) $6,373
Residential mortgage-backed securities 0
 4
 15
 921
 (32) 0
 (908) 0
Commercial mortgage-backed securities 0
 13
 (8) 478
 (1,065) 3,257
 (124) 2,551
Total Level 3 available-for-sale securities $12,577
 $8
 $298
 $2,133
 $(7,369) $10,651
 $(9,374) $8,924
(1)These amounts are reported as net investment income and net realized investment gains (losses) for each of the periods presented above.
(2)Transfers into and/or (out) of Level 3 are primarily attributable to the availability of market observable information and the re-evaluation of the observability of pricing inputs.


Level 3 Assets – 2018 Quarterly Change:

(in thousands) 		 Beginning balance at March 31, 2018 
Included in earnings(1)
 Included
in other
comprehensive
income		 Purchases Sales 
Transfers into Level 3(2)
 
Transfers out of Level 3(2)
 Ending balance at June 30, 2018
Available-for-sale securities:                
Corporate debt securities $6,309
 $10
 $(53) $3,047
 $(472) $5,370
 $(3,091) $11,120
Total Level 3 available-for-sale securities $6,309
 $10
 $(53) $3,047
 $(472) $5,370
 $(3,091) $11,120


Quantitative and Qualitative Disclosures about Unobservable Inputs
Level 3 Assets – 2018 Year-to-Date Change:
(in thousands) Beginning balance at December 31, 2017 
Included in earnings(1)
 
Included
in other
comprehensive
income
 Purchases Sales 
Transfers into Level 3(2)
 
Transfers out of Level 3(2)
 Ending balance at June 30, 2018
Available-for-sale securities:                
Corporate debt securities $7,879
 $1
 $(48) $3,047
 $(965) $7,782
 $(6,576) $11,120
Collateralized debt obligations 2,200
 0
 7
 0
 0
 0
 (2,207) 0
Total Level 3 available-for-sale securities $10,079
 $1
 $(41) $3,047
 $(965) $7,782
 $(8,783) $11,120
(1)These amounts are reported in the Statements of Operations as net investment income and net realized investment gains (losses) for the each of the periods presented above.
(2)Transfers into and/or (out) of Level 3 are primarily attributable to the availability of market observable information and the re-evaluation of the observability of pricing inputs.

The change in unrealized gains or losses included in other comprehensive income related to Level 3 securities held at the reporting date is as follows:
 Three months ended June 30, Six months ended June 30,
(in thousands)2019 2018 2019 2018
Available-for-sale securities:       
Corporate debt securities$(18) $(53) $158
 $(28)
Commercial mortgage-backed securities29
 —
 26
 —
Net unrealized gains (losses) on Level 3 securities held at reporting date$11
 $(53) $184
 $(28)


Investments totaling $6.0 million and $1.3 million at June 30, 2020 and December 31, 2019, respectively, were priced using a non-binding broker quote as the only pricing input and were classified within Level 3.The quantitative detail of the unobservable inputs supporting these quotes is neither provided nor reasonably available to us.  Our Level 3 assets are not material in total and, with the exception of the tables above, additional Level 3 disclosures are not provided. 







Financial instruments disclosed, but not carried at fair value
The following table presents the carrying values and fair value measurements, which arevalues of financial instruments categorized as Level 3 in the fair value
hierarchy that are recorded at carrying value as of:
June 30, 2020December 31, 2019
(in thousands)Carrying valueFair valueCarrying valueFair value
Agent loans (1)
$65,450  $63,030  $67,696  $71,602  
Long-term borrowings (2)
97,101  117,604  98,080  101,888  
(1)The discount rate used to calculate fair value at June 30, 2020 is reflective of an increase in the BB+ financial instruments disclosed, but not carriedyield curve due to the market volatility resulting from the COVID-19 pandemic.
(2)The discount rate used to calculate fair value at fair value:June 30, 2020 is reflective of a decline in U.S. Treasury bond yields due to the market volatility resulting from the COVID-19 pandemic.
  At June 30, 2019 At December 31, 2018
(in thousands) Carrying value Fair value Carrying value Fair value
Agent loans $60,962
 $61,321
 $58,006
 $54,110
Long-term borrowings 99,038
 100,129
 99,730
 94,057



16
Table of Contents
Note 6.  Investments
 
Available-for-sale securities
See Note 5, "Fair Value" for additional fair value disclosures. The following tables summarize the cost and fair value, net of credit loss allowance, of our available-for-sale securities. See also Note 5, "Fair Value" for additional fair value disclosures. securities as of:
June 30, 2020
 (in thousands)Amortized costGross unrealized gainsGross unrealized lossesEstimated fair value
Corporate debt securities$461,398  $14,508  $6,251  $469,655  
Residential mortgage-backed securities115,631  3,970  2  119,599  
Commercial mortgage-backed securities104,403  3,390  1,251  106,542  
Collateralized debt obligations98,603  281  2,596  96,288  
Other debt securities12,435  355  49  12,741  
Total available-for-sale securities, net$792,470  $22,504  $10,149  $804,825  
  At June 30, 2019
 (in thousands) 
Amortized
cost
 Gross unrealized gains Gross unrealized losses Estimated fair value
Available-for-sale securities:        
U.S. Treasury (1)
 $150,171
 $923
 $0
 $151,094
States & political subdivisions (1)
 3,354
 6
 0
 3,360
Corporate debt securities (1)
 356,899
 1,706
 1,949
 356,656
Residential mortgage-backed securities 65,910
 297
 21
 66,186
Commercial mortgage-backed securities 45,527
 625
 10
 46,142
Collateralized debt obligations 57,710
 16
 381
 57,345
Other debt securities 8,209
 116
 0
 8,325
Total available-for-sale securities $687,780
 $3,689
 $2,361
 $689,108
  At December 31, 2018
(in thousands) 
Amortized
cost
 Gross unrealized gains Gross unrealized losses Estimated fair value
Available-for-sale securities:        
U.S. Treasury (1)
 $208,610
 $18
 $216
 $208,412
States & political subdivisions (1)
 157,003
 2,020
 0
 159,023
Corporate debt securities 259,362
 139
 9,554
 249,947
Residential mortgage-backed securities 4,603
 38
 32
 4,609
Commercial mortgage-backed securities 47,022
 80
 587
 46,515
Collateralized debt obligations 65,039
 30
 830
 64,239
Other debt securities 15,756
 33
 11
 15,778
Total available-for-sale securities $757,395
 $2,358
 $11,230
 $748,523

(1)In the fourth quarter of 2018, we began selling off our municipal bonds as part of a portfolio rebalancing. We have currently invested proceeds from these sales primarily in U.S. Treasuries and corporate debt securities.

December 31, 2019
(in thousands)Amortized costGross unrealized gainsGross unrealized lossesEstimated fair value
Corporate debt securities$450,295  $6,289  $1,704  $454,880  
Residential mortgage-backed securities124,337  1,056  50  125,343  
Commercial mortgage-backed securities67,210  479  148  67,541  
Collateralized debt obligations78,059  44  247  77,856  
Other debt securities5,049  71  39  5,081  
Total available-for-sale securities, net$724,950  $7,939  $2,188  $730,701  


The amortized cost and estimated fair value of available-for-sale securities at June 30, 20192020 are shown below by remaining contractual term to maturity.  Mortgage-backed securities are allocated based upon stated maturity dates.  Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
June 30, 2020
AmortizedEstimated
(in thousands)costfair value
Due in one year or less$24,154  $24,233  
Due after one year through five years362,607  372,299  
Due after five years through ten years129,547  128,334  
Due after ten years276,162  279,959  
Total available-for-sale securities (1)
$792,470  $804,825  
  At June 30, 2019
  Amortized Estimated
(in thousands) cost fair value
Due in one year or less $62,962
 $63,031
Due after one year through five years 358,056
 358,508
Due after five years through ten years 127,215
 127,364
Due after ten years 139,547
 140,205
Total available-for-sale securities $687,780
 $689,108
(1)The contractual maturities of our available-for-sale securities are included in the table. However, given our intent to sell certain impaired securities, these securities are classified as current assets in our Statements of Financial Position at June 30, 2020.


Available-for-sale securities in a gross unrealized loss position are as follows.  Data is provided by length of time for securities in a gross unrealized loss position.
  At June 30, 2019
  Less than 12 months 12 months or longer Total
(dollars in thousands) 
Fair
value
 Unrealized losses 
Fair
value
 Unrealized losses 
Fair
 value
 Unrealized losses No. of holdings
Available-for-sale securities:              
Corporate debt securities 104,809
 844
 58,666
 1,105
 163,475
 1,949
 334
Residential mortgage-backed securities 15,710
 21
 0
 0
 15,710
 21
 2
Commercial mortgage-backed securities 6,965
 6
 547
 4
 7,512
 10
 7
Collateralized debt obligations 40,402
 165
 14,842
 216
 55,244
 381
 41
Total available-for-sale securities $167,886
 $1,036
 $74,055
 $1,325
 $241,941
 $2,361
 384
Quality breakdown of available-for-sale securities:              
Investment grade $136,432
 $296
 $59,023
 $354
 $195,455
 $650
 111
Non-investment grade 31,454
 740
 15,032
 971
 46,486
 1,711
 273
Total available-for-sale securities $167,886
 $1,036
 $74,055
 $1,325
 $241,941
 $2,361
 384


  At December 31, 2018
  Less than 12 months 12 months or longer Total
(dollars in thousands) 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
 
No. of
holdings
Available-for-sale securities:              
U.S. Treasury $129,474
 $19
 $11,656
 $197
 $141,130
 $216
 7
Corporate debt securities 157,300
 6,866
 86,586
 2,688
 243,886
 9,554
 635
Residential mortgage-backed securities 777
 6
 1,618
 26
 2,395
 32
 3
Commercial mortgage-backed securities 17,624
 175
 16,997
 412
 34,621
 587
 30
Collateralized debt obligations 55,246
 826
 1,248
 4
 56,494
 830
 39
Other debt securities 8,213
 11
 0
 0
 8,213
 11
 7
Total available-for-sale securities $368,634
 $7,903
 $118,105
 $3,327
 $486,739
 $11,230
 721
Quality breakdown of available-for-sale securities:              
Investment grade $242,821
 $1,295
 $98,118
 $1,641
 $340,939
 $2,936
 147
Non-investment grade 125,813
 6,608
 19,987
 1,686
 145,800
 8,294
 574
Total available-for-sale securities $368,634
 $7,903
 $118,105
 $3,327
 $486,739
 $11,230
 721













17
Table of Contents
The abovebelow securities have been evaluated and determined to be temporary impairmentsdeclines in fair value for which we expect to recover our entire principal plus interest.  The primary componentsfollowing table presents available-for-sale securities based on length of this analysis includetime in a general reviewgross unrealized loss position as of:
June 30, 2020
Less than 12 months12 months or longerTotal
(dollars in thousands)Fair
value		Unrealized
losses		Fair
value		Unrealized
losses		Fair
value		Unrealized
losses		No. of
holdings
Corporate debt securities$81,468  $4,358  $8,058  $1,893  $89,526  $6,251  494  
Residential mortgage-backed securities1,407  2  0  0  1,407  2  3  
Commercial mortgage-backed securities30,808  1,251  0  0  30,808  1,251  47  
Collateralized debt obligations75,876  2,070  13,721  526  89,597  2,596  92  
Other debt securities2,780  49  0  0  2,780  49  7  
Total available-for-sale securities$192,339  $7,730  $21,779  $2,419  $214,118  $10,149  643  
Quality breakdown of available-for-sale securities:
Investment grade$135,419  $3,849  $13,721  $526  $149,140  $4,375  170  
Non-investment grade56,920  3,881  8,058  1,893  64,978  5,774  473  
Total available-for-sale securities$192,339  $7,730  $21,779  $2,419  $214,118  $10,149  643  

December 31, 2019
Less than 12 months12 months or longerTotal
(dollars in thousands)Fair
value		Unrealized
losses		Fair
value		Unrealized
losses		Fair
value		Unrealized
losses		No. of
holdings
Corporate debt securities$25,804  $342  $15,699  $1,362  $41,503  $1,704  158  
Residential mortgage-backed securities16,712  50  0  0  16,712  50  7  
Commercial mortgage-backed securities21,981  147  372  1  22,353  148  30  
Collateralized debt obligations20,889  33  41,010  214  61,899  247  49  
Other debt securities2,350  39  0  0  2,350  39  2  
Total available-for-sale securities$87,736  $611  $57,081  $1,577  $144,817  $2,188  246  
Quality breakdown of available-for-sale securities:
Investment grade$76,315  $287  $46,390  $218  $122,705  $505  100  
Non-investment grade11,421  324  10,691  1,359  22,112  1,683  146  
Total available-for-sale securities$87,736  $611  $57,081  $1,577  $144,817  $2,188  246  


Credit loss allowance on investments
As of market conditionsJune 30, 2020, the current expected credit loss allowance on agent loans is $1.0 million and financial performance of the issuer along with the extent and duration at which fair valuecredit loss allowance on available-for-sale securities is less than cost.  Any securities that we intend to sell or will more likely than not be required to sell before recovery are included in other-than-temporary impairments, which are recognized in earnings.$0.4 million.


Net investment income
Investment income, net of expenses, was generated from the following portfolios:
Three months ended June 30,Six months ended June 30,
(in thousands)2020201920202019
Available-for sale securities$5,670  $5,488  $11,458  $11,649  
Equity securities901  141  1,757  282  
Cash equivalents and other1,115  2,660  3,089  5,125  
Total investment income7,686  8,289  16,304  17,056  
Less: investment expenses313  259  562  509  
Investment income, net of expenses$7,373  $8,030  $15,742  $16,547  
  Three months ended June 30, Six months ended June 30,
(in thousands) 2019 2018 2019 2018
Fixed maturities (1)
 $5,488
 $6,263
 $11,649
 $12,373
Equity securities 141
 142
 282
 284
Cash equivalents and other 2,660
 1,026
 5,125
 2,034
Total investment income 8,289
 7,431
 17,056
 14,691
Less: investment expenses 259
 327
 509
 767
Investment income, net of expenses $8,030
 $7,104
 $16,547
 $13,924


(1)



18
Includes interest earned on note receivable from Erie Family Life Insurance Company of $0.4 million and $0.8 million for the three and six months ended June 30, 2018, respectively. The note was repaid in full in December 2018.

Realized investment gains (losses)
Realized gains (losses) on investments were as follows:
Three months ended June 30,Six months ended June 30,
(in thousands)2020201920202019
Available-for-sale securities:  
Gross realized gains$1,721  $2,062  $2,795  $4,320  
Gross realized losses(1,366) (823) (1,825) (1,163) 
Net realized gains on available-for-sale securities355  1,239  970  3,157  
Equity securities (1)
6,170  63  (5,252) 648  
Miscellaneous1  0  2  0  
Net realized investment gains (losses)$6,526  $1,302  $(4,280) $3,805  
  Three months ended June 30, Six months ended June 30,
(in thousands) 2019 2018 2019 2018
Available-for-sale securities:  
  
    
Gross realized gains $2,062
 $235
 $4,320
 $575
Gross realized losses (823) (301) (1,163) (986)
Net realized gains (losses) on available-for-sale securities 1,239
 (66) 3,157
 (411)
Equity securities 63
 (68) 648
 (188)
Miscellaneous 0
 102
 0
 102
Net realized investment gains (losses) $1,302
 $(32) $3,805
 $(497)
(1)While our investment portfolio was negatively impacted in the first quarter of 2020 primarily due to the financial market volatility resulting from the COVID-19 pandemic, market conditions partially recovered in the second quarter of 2020, resulting in significant gains in the three months ended June 30, 2020.


The portion of net unrealized gains and losses recognized during the reporting period related to equity securities still held at the reporting date is calculated as follows:
Three months ended June 30,Six months ended June 30,
(in thousands)2020201920202019
Equity securities:
Net gains (losses) recognized during the period (1)
$6,170  $63  $(5,252) $648  
Less: net gains (losses) recognized on securities sold1,357  0  (2,157) 0  
Net unrealized gains (losses) recognized on securities held at reporting date$4,813  $63  $(3,095) $648  
  Three months ended June 30, Six months ended June 30,
(in thousands) 2019 2018 2019 2018
Equity securities:        
Net gains (losses) recognized during the period $63
 $(68) $648
 $(188)
Less: net losses recognized on securities sold 0
 0
 0
 (34)
Net unrealized gains (losses) recognized on securities held at reporting date $63
 $(68) $648
 $(154)
(1)While our investment portfolio was negatively impacted in the first quarter of 2020 primarily due to the financial market volatility resulting from the COVID-19 pandemic, market conditions partially recovered in the second quarter of 2020, resulting in significant gains in the three months ended June 30, 2020.



Net impairments losses recognized in earnings
Other-than-temporaryUpon adoption of ASU 2016-13 on January 1, 2020, impairments on available-for-sale securities that are deemed to be credit related are recognized in earnings were $0.1 million and $0.6 million for the quarters ended June 30, 2019 and 2018, respectively, and $0.2 million and $0.6 million for the six months ended June 30, 2019 and 2018, respectively. We havewith a corresponding available-for-sale security allowance. All unrealized losses related to factors other than credit are recorded in other comprehensive income. Prior to January 1, 2020, we had the intent to sell all credit-impaired available-for-sale debt securities; therefore, the entire amount of the impairment charges werewas included in earnings and no impairments were recognized in other comprehensive income. See also Note 2, "Significant Accounting Policies".











Limited partnerships
The majority of our limited partnership holdings are considered investment companies where the general partners record assets at fair value. These limited partnerships are recorded using the equity method of accountingImpairments on available-for-sale securities and are generally reported on a one-quarter lag; therefore, our year-to-date limited partnership results through June 30, 2019 are comprised of partnership financial results for the fourth quarter of 2018 and first quarter of 2019.  Given the lag in reporting, our limited partnership results do not reflect the market conditions of the second quarter of 2019. Cash contributions made to and distributions received from the partnerships are recorded in the period in which the transaction occurs. At December 31, 2018 we also owned one real estate limited partnership that did not meet the criteria of an investment company. This partnership prepared audited financial statements on a cost basis. We elected to report this limited partnership under the fair value option, which was based on the NAV from our partner's capital statement reflecting the general partner's estimate of fair value for the fund's underlying assets. Fair value provides consistency in the evaluation and financial reporting for these limited partnerships and limited partnerships accounted for under the equity method. This real estate limited partnership was fully liquidated in January 2019.

Equity in earnings (losses) of limited partnerships by method of accountingagent loans were as follows:
  Three months ended June 30, Six months ended June 30,
(in thousands) 2019 2018 2019 2018
Equity in earnings (losses) of limited partnerships - equity method $404
 $(216) $(743) $(21)
Change in fair value of limited partnerships - fair value option 0
 (3) 0
 (390)
Equity in earnings (losses) of limited partnerships $404
 $(219) $(743) $(411)



The following table summarizes limited partnership investments by sector:
(in thousands) At June 30, 2019 At December 31, 2018
Private equity $26,793
 $28,271
Mezzanine debt 1,053
 1,152
Real estate 2,498
 2,192
Real estate - fair value option 0
 3,206
Total limited partnership investments $30,344
 $34,821



See also Note 14, "Commitments and Contingencies" for investment commitments related to limited partnerships.
Three months ended June 30,Six months ended June 30,
(in thousands)2020201920202019
Available-for-sale securities:
Intent to sell$0  $84  $2,242  $162  
Credit impaired17  —  658  —  
Total available-for-sale securities17  84  2,900  162  
Agent loans - expected credit losses0  —  170  —  
Net impairment losses recognized in earnings$17  $84  $3,070  $162  
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Note 7.  Leases

LeaseThe following table summarizes our lease assets and liabilities recorded on our Statement of Financial Position were as follows:of:
(in thousands)June 30, 2020December 31, 2019
Operating lease assets$19,267  $22,401  
Operating lease liabilities - current$11,216  $11,289  
Operating lease liabilities - long-term7,664  10,665  
Total operating lease liabilities$18,880  $21,954  
(in thousands) June 30, 2019
Operating lease assets $26,587
   
Operating lease liabilities - current $11,736
Operating lease liabilities - long-term 14,539
Total operating lease liabilities $26,275



We currently have leases for real estate, technology equipment, copiers, and vehicles. Our largest operating lease asset at June 30, 20192020 of $14.7$9.2 million is for office space leased from the Exchange, including the home office. Under this lease, rent is based on rental rates of like property and all operating expenses are the responsibility of the tenant (Indemnity). The lease agreement expires December 31, 2021.

Operating lease costs for the three months ended June 30, 2020 and 2019 were $3.3 million and $3.6 million, respectively, and $6.7 million and $7.2 million for the six months ended June 30, 2019 were $3.6 million2020 and $7.2 million,2019, respectively. Of this amount, the Exchange and its subsidiaries reimbursed us $1.4 million and $1.6 million for the three months ended June 30, 2020 and 2019, respectively, and $2.8 million and $3.1 million for the three and six months ended June 30, 2020 and 2019, respectively, which represents the allocated share of lease costs supporting administrative services activities.



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Note 8.  Borrowing Arrangements
 
Bank line of credit
As of June 30, 2019,2020, we have access to a $100 million bank revolving line of credit with a $25 million letter of credit sublimit that expires on October 30, 2023. As of June 30, 2019,2020, a total of $99.1 million remains available under the facility due to $0.9 million outstanding letters of credit, which reduce the availability for letters of credit to $24.1 million.  We had no0 borrowings outstanding on our line of credit as of June 30, 2019.2020.  Investments with a fair value of $109.3$124.4 million were pledged as collateral on the line at June 30, 2019.2020. The investments pledged as collateral have no trading restrictions and are reported as available-for-sale securities and cash and cash equivalents and available-for-sale securities in the Statements of Financial Position as of June 30, 2019.2020. The banks require compliance with certain covenants, which include leverage ratios and debt restrictions, for our line of credit.  We are in compliance with all covenants at June 30, 2019.2020.

Term loan credit facility
In 2016, we entered into a credit agreement for a $100 million senior secured draw term loan credit facility ("Credit Facility") for the acquisition of real property and construction of an office building that will serve as part of our principal headquarters. On January 1, 2019, the Credit Facility converted to a fully-amortized term loan with monthly payments of principal and interest at a fixed rate of 4.35% over a period of 28 years. Investments with a fair value of $108.6$126.1 million were pledged as collateral for the facility and are reported as available-for-sale securities and cash and cash equivalents and available-for-sale securities in the Statements of Financial Position as of June 30, 2019.2020. The bank requires compliance with certain covenants, which include leverage ratios, debt restrictions and minimum net worth, for our Credit Facility. We are in compliance with all covenants at June 30, 2019.2020.

The remaining unpaid balance from the Credit Facility is reported at carrying value on our Statements of Financial Position, net of unamortized loan origination and commitment fees. See Note 5, "Fair Value" for the estimated fair value of these borrowings.

Annual principal payments
The following table sets forth future principal payments:
(in thousands)
YearPrincipal payments
2020$1,000  
20212,019  
20222,109  
20232,226  
20242,302  
Thereafter87,445  
(in thousands)  
Year Principal payments
2019$946
2020 1,955
2021 2,042
2022 2,132
2023 2,227
Thereafter 89,737


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Note 9.  Postretirement Benefits
 
Pension plans
Our pension plans consist of a noncontributory defined benefit pension plan covering substantially all employees and an unfunded supplemental employee retirement plan for certain members of executive and senior management. Although we are the sponsor of these postretirement plans and record the funded status of these plans, the Exchange and its subsidiaries reimburse us for approximately 58% of the annual benefit expense of these plans, which represents pension benefits for employees performing administrative services and their allocated share of costs for employees in departments that support the administrative functions.
The cost of our pension plans are as follows:
Three months ended June 30,Six months ended June 30,
(in thousands)2020201920202019
Service cost for benefits earned$10,874  $8,464  $21,747  $16,927  
Interest cost on benefits obligation9,394  9,826  18,789  19,653  
Expected return on plan assets(12,353) (11,871) (24,706) (23,742) 
Prior service cost amortization335  348  671  697  
Net actuarial loss amortization3,031  1,278  6,062  2,556  
Pension plan cost (1)
$11,281  $8,045  $22,563  $16,091  
  Three months ended June 30, Six months ended June 30,
(in thousands) 2019 2018 2019 2018
Service cost for benefits earned $8,464
 $9,513
 $16,927
 $19,026
Interest cost on benefits obligation 9,826
 8,845
 19,653
 17,691
Expected return on plan assets (11,871) (12,814) (23,742) (25,629)
Prior service cost amortization 348
 338
 697
 676
Net actuarial loss amortization 1,278
 3,202
 2,556
 6,404
Pension plan cost (1)
 $8,045
 $9,084
 $16,091
 $18,168
(1)The components of pension plan costs other than the service cost component are included in the line item "Other (expense) income" in the Statements of Operations after reimbursements from the Exchange and its subsidiaries.
(1)The components of pension plan costs other than the service cost component are included in the line item "Other income" in the Statements of Operations after reimbursements from the Exchange and its subsidiaries.


Note 10.  Income Taxes

Income tax expense is provided on an interim basis based upon our estimate of the annual effective income tax rate, adjusted each quarter for discrete items. ForOur effective tax rate was 20.0% and 20.9% for the three and six months ended June 30, 2020, respectively. The $6.8 million valuation allowance that was recognized on our net deferred tax assets at March 31, 2020, primarily related to unrealized losses on our investments, was released as of June 30, 2020 driven by the partial recovery experienced in market conditions in the second quarter of 2020. Of the total, $5.8 million was recorded in other comprehensive income and $1.0 million was recorded as an income tax benefit. The amount recognized as an income tax benefit decreased the effective tax rate by 0.9% for the three months ended June 30, 2019 and 2018, our2020. Our effective tax rate was 17.2% and 21.1%, respectively, and19.1% for the three and six months ended June 30, 2019, and 2018, our effective tax rate was 19.1% and 21.0%, respectively. Impacting our effective tax rate in the three and six months ended June 30, 2019 was the settlement of an uncertain tax position. An income tax benefit of $4.1 million was recorded in June 2019, including $1.0 million of related interest expense,position, which reduced our effective tax rate by 3.8% and 2.0% in the three and six months ended June 30, 2019,, respectively.




Note 11.  Capital Stock
 
Class A and B common stock
Holders of Class B shares may, at their option, convert their shares into Class A shares at the rate of 2,400 Class A shares per Class B share.  There were no0 shares of Class B common stock converted into Class A common stock during the six months ended June 30, 20192020 and the year ended December 31, 2018.2019. There is no provision for conversion of Class A shares to Class B shares, and Class B shares surrendered for conversion cannot be reissued.

Stock repurchases
In 2011, our Board of Directors approved a continuation of the current stock repurchase program of $150 million, with no time limitation.  There were no0 shares repurchased under this program during the six months ended June 30, 20192020 and the year ended December 31, 2018.2019. We had approximately $17.8 million of repurchase authority remaining under this program at June 30, 2019.2020.
22
During the six months ended June 30, 2019, we purchased 11,964 shares
Table of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $2.0 million. Of this amount, we purchased 3,246 shares for $0.4 million, or $132.35 per share, for stock-based awards in conjunction with our equity compensation plan, for which the shares were delivered to plan participants in January 2019. We purchased 4,465 shares for $0.9 million, or $190.59 per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The shares were transferred to the rabbi trust in February and May 2019. The remaining 4,253 shares were purchased at a total cost of $0.7 million, or $175.64 per share, to fund the rabbi trust for the incentive compensation deferral plan. The shares were transferred to the rabbi trust in February, March and May 2019.Contents

During the year ended December 31, 2018, we purchased 27,120 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $3.2 million. Of this amount, we purchased 5,830 shares for $0.7 million, or $117.39 per share, for stock-based awards in conjunction with our equity compensation plan. We purchased 9,285 shares for $1.1 million, or $122.19 per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The remaining 12,005 shares were purchased at a total cost of $1.4 million, or $119.28 per share, to fund the rabbi trust for the incentive compensation deferral plan. These shares were delivered in 2018.



Note 12.  Accumulated Other Comprehensive Income (Loss)
 
Changes in accumulated other comprehensive income ("AOCI") (loss) by component, including amounts reclassified to other comprehensive income ("OCI") (loss) and the related line item in the Statements of Operations where net income is presented, are as follows:
Three months endedThree months ended
June 30, 2020June 30, 2019
(in thousands)Before TaxIncome TaxNetBefore TaxIncome TaxNet
Investment securities:
AOCI (loss), beginning of period (1)
$(27,761) $0  $(27,761) $(2,235) $(470) $(1,765) 
OCI before reclassifications (1)
40,364  2,646  37,718  4,420  928  3,492  
Realized investment gains(355) (75) (280) (1,239) (260) (979) 
Impairment losses17  4  13  84  18  66  
OCI40,026  2,575  37,451  3,265  686  2,579  
AOCI (loss), end of period (1)
$12,265  $2,575  $9,690  $1,030  $216  $814  
Pension and other postretirement plans:
AOCI (loss), beginning of period$(150,233) $(31,550) $(118,683) $(154,190) $(32,381) $(121,809) 
Amortization of prior service costs336  70  266  348  73  275  
Amortization of net actuarial loss3,031  637  2,394  1,210  254  956  
OCI3,367  707  2,660  1,558  327  1,231  
AOCI (loss), end of period$(146,866) $(30,843) $(116,023) $(152,632) $(32,054) $(120,578) 
Total
AOCI (loss), beginning of period$(177,994) $(31,550) $(146,444) $(156,425) $(32,851) $(123,574) 
Investment securities40,026  2,575  37,451  3,265  686  2,579  
Pension and other postretirement plans3,367  707  2,660  1,558  327  1,231  
OCI43,393  3,282  40,111  4,823  1,013  3,810  
AOCI (loss), end of period$(134,601) $(28,268) $(106,333) $(151,602) $(31,838) $(119,764) 
Six months endedSix months ended
June 30, 2020June 30, 2019
(in thousands)Before TaxIncome TaxNetBefore TaxIncome TaxNet
Investment securities:
AOCI (loss), beginning of period$5,664  $1,189  $4,475  $(9,169) $(1,926) $(7,243) 
OCI before reclassifications4,671  981  3,690  13,194  2,771  10,423  
Realized investment gains(970) (204) (766) (3,157) (663) (2,494) 
Impairment losses2,900  609  2,291  162  34  128  
OCI6,601  1,386  5,215  10,199  2,142  8,057  
AOCI (loss), end of period$12,265  $2,575  $9,690  $1,030  $216  $814  
Pension and other postretirement plans:
AOCI (loss), beginning of period$(153,600) $(32,257) $(121,343) $(155,749) $(32,708) $(123,041) 
Amortization of prior service costs672  141  531  697  146  551  
Amortization of net actuarial loss6,062  1,273  4,789  2,420  508  1,912  
OCI6,734  1,414  5,320  3,117  654  2,463  
AOCI (loss), end of period$(146,866) $(30,843) $(116,023) $(152,632) $(32,054) $(120,578) 
Total
AOCI (loss), beginning of period$(147,936) $(31,068) $(116,868) $(164,918) $(34,634) $(130,284) 
Investment securities6,601  1,386  5,215  10,199  2,142  8,057  
Pension and other postretirement plans6,734  1,414  5,320  3,117  654  2,463  
OCI13,335  2,800  10,535  13,316  2,796  10,520  
AOCI (loss), end of period$(134,601) $(28,268) $(106,333) $(151,602) $(31,838) $(119,764) 
(1)As of June 30, 2020, the valuation allowance that was recognized on the deferred tax asset primarily related to unrealized losses on our investments at March 31, 2020 was fully released.
23
  Three months ended Three months ended
  June 30, 2019 June 30, 2018
(in thousands) Before TaxIncome TaxNet Before TaxIncome TaxNet
Investment securities:        
AOCI (loss), beginning of period $(2,235)$(470)$(1,765) $(3,460)$(727)$(2,733)
OCI (loss) before reclassifications 4,420
928
3,492
 (1,409)(296)(1,113)
Realized investment (gains) losses (1,239)(260)(979) 66
14
52
Impairment losses 84
18
66
 646
136
510
OCI (loss) 3,265
686
2,579
 (697)(146)(551)
AOCI (loss), end of period $1,030
$216
$814
 $(4,157)$(873)$(3,284)
         
Pension and other postretirement plans:        
AOCI (loss), beginning of period $(154,190)$(32,381)$(121,809) $(200,954)$(42,201)$(158,753)
Amortization of prior service costs (1)
 348
73
275
 0
0
0
Amortization of net actuarial loss (1)
 1,210
254
956
 0
0
0
OCI 1,558
327
1,231
 0
0
0
AOCI (loss), end of period $(152,632)$(32,054)$(120,578) $(200,954)$(42,201)$(158,753)
         
Total        
AOCI (loss), beginning of period $(156,425)$(32,851)$(123,574) $(204,414)$(42,928)$(161,486)
Investment securities 3,265
686
2,579
 (697)(146)(551)
Pension and other postretirement plans 1,558
327
1,231
 0
0
0
OCI (loss) 4,823
1,013
3,810
 (697)(146)(551)
AOCI (loss), end of period $(151,602)$(31,838)$(119,764) $(205,111)$(43,074)$(162,037)
Table of Contents
  Six months ended Six months ended
  June 30, 2019 June 30, 2018
(in thousands) Before TaxIncome TaxNet Before TaxIncome TaxNet
Investment securities:        
AOCI (loss), beginning of period $(9,169)$(1,926)$(7,243) $3,410
$716
$2,694
OCI (loss) before reclassifications 13,194
2,771
10,423
 (8,539)(1,793)(6,746)
Realized investment (gains) losses (3,157)(663)(2,494) 411
86
325
Impairment losses 162
34
128
 646
136
510
Cumulative effect of adopting ASU 2016-01 (2)
 —
—
—
 (85)(18)(67)
OCI (loss) 10,199
2,142
8,057
 (7,567)(1,589)(5,978)
AOCI (loss), end of period $1,030
$216
$814
 $(4,157)$(873)$(3,284)
         
Pension and other postretirement plans:        
AOCI (loss), beginning of period $(155,749)$(32,708)$(123,041) $(200,954)$(42,201)$(158,753)
Amortization of prior service costs (1)
 697
146
551
 0
0
0
Amortization of net actuarial loss (1)
 2,420
508
1,912
 0
0
0
OCI 3,117
654
2,463
 0
0
0
AOCI (loss), end of period $(152,632)$(32,054)$(120,578) $(200,954)$(42,201)$(158,753)
         
Total        
AOCI (loss), beginning of period $(164,918)$(34,634)$(130,284) $(197,544)$(41,485)$(156,059)
Investment securities 10,199
2,142
8,057
 (7,567)(1,589)(5,978)
Pension and other postretirement plans 3,117
654
2,463
 0
0
0
OCI (loss) 13,316
2,796
10,520
 (7,567)(1,589)(5,978)
AOCI (loss), end of period $(151,602)$(31,838)$(119,764) $(205,111)$(43,074)$(162,037)

(1)Effective January 1, 2019, amounts reclassified from AOCI related to amortization of prior service costs and net actuarial loss were recorded during interim periods. Prior to 2019, amounts reclassified for these items were recorded on an annual basis. These components are included in the computation of net periodic pension cost. See Note 9, "Postretirement Benefits", for additional information.
(2)ASU 2016-01 required a reclassification of unrealized losses of equity securities from AOCI to retained earnings at January 1, 2018.

Note 13. Concentrations of Credit Risk

Financial instruments could potentially expose us to concentrations of credit risk, including unsecured receivables from the Exchange. A large majority of our revenue and receivables are from the Exchange and its affiliates. See also Note 1, "Nature of Operations". ManagementNet management fee amounts and other reimbursements due from the Exchange and its affiliates were $483.3$506.7 million and $449.9$468.6 million at June 30, 20192020 and December 31, 2018,2019, respectively. Given the financial strength of the Exchange and historical experience of no credit losses, we believe it is unlikely these receivables would havepreviously did not record a significant credit loss exposure.allowance to these receivables. Upon adoption of ASU 2016-13, we recorded an allowance for current expected credit losses of $0.6 million related to the receivables from the Exchange and affiliates. See also Note 2, "Significant Accounting Policies". There was 0 change to this allowance for the three and six months ended June 30, 2020.


Note 14.  Commitments and Contingencies
 
We have contractual commitments to invest up to $9.9 million related to our limited partnership investments at June 30, 2019.  These commitments are split among private equity securities of $4.4 million and mezzanine debt securities of $5.5 million. These commitments will be funded as required by the limited partnership agreements.

We are involved in litigation arising in the ordinary course of conducting business.  In accordance with current accounting standards for loss contingencies and based upon information currently known to us, we establish reserves for litigation when it is probable that a loss associated with a claim or proceeding has been incurred and the amount of the loss or range of loss can be reasonably estimated.  When no amount within the range of loss is a better estimate than any other amount, we accrue the minimum amount of the estimable loss.  To the extent that such litigation against us may have an exposure to a loss in excess of the amount we have accrued, we believe that such excess would not be material to our financial condition, results of operations, or cash flows.  Legal fees are expensed as incurred.  We believe that our accruals for legal proceedings are appropriate and, individually and in the aggregate, are not expected to be material to our financial condition, results of operations, or cash flows.

We review all litigation on an ongoing basis when making accrual and disclosure decisions.  For certain legal proceedings, we cannot reasonably estimate losses or a range of loss, if any, particularly for proceedings that are in their early stages of development or where the plaintiffs seek indeterminate damages.  Various factors, including, but not limited to, the outcome of potentially lengthy discovery and the resolution of important factual questions, may need to be determined before probability can be established or before a loss or range of loss can be reasonably estimated.  If the loss contingency in question is not both probable and reasonably estimable, we do not establish an accrual and the matter will continue to be monitored for any developments that would make the loss contingency both probable and reasonably estimable.  In the event that a legal proceeding results in a substantial judgment against, or settlement by, us, there can be no assurance that any resulting liability or financial commitment would not have a material adverse effect on the financial condition, results of operations, or cash flows.


Note 15. Subsequent Events
 
No items were identified in this period subsequent to the financial statement date that required adjustment or additional disclosure.


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ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion of financial condition and results of operations highlights significant factors influencing Erie Indemnity Company ("Indemnity", "we", "us", "our").  This discussion should be read in conjunction with the historical financial statements and the related notes thereto included in Part I, Item 1. "Financial Statements" of this Quarterly Report on Form 10-Q, and with Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" for the year ended December 31, 2018,2019, as contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 21, 2019.27, 2020.
 
 
INDEX
Page Number
25
26
26
29
Page Number
2535
Recent Accounting Standards
26
26
Results of Operations
28
Financial Condition
32
Liquidity and Capital Resources
3437
3639
 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
 
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995:
Statements contained herein that are not historical fact are forward-looking statements and, as such, are subject to risks and uncertainties that could cause actual events and results to differ, perhaps materially, from those discussed herein.  Forward-looking statements relate to future trends, events or results and include, without limitation, statements and assumptions on which such statements are based that are related to our plans, strategies, objectives, expectations, intentions, and adequacy of resources.  Examples of forward-looking statements are discussions relating to premium and investment income, expenses, operating results, and compliance with contractual and regulatory requirements.  Forward-looking statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict.  Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements.  Among the risks and uncertainties, in addition to those set forth in our filings with the Securities and Exchange Commission, that could cause actual results and future events to differ from those set forth or contemplated in the forward-looking statements include the following:
•potential impacts of the COVID-19 pandemic on the growth and financial condition of the Erie Insurance Exchange ("Exchange");
•potential impacts of the COVID-19 pandemic on our operations, the business operations of our customers and/or independent agents, or our third-party vendor operations;
•dependence upon our relationship with the Exchange and the management fee under the agreement with the subscribers at the Exchange;
•dependence upon our relationship with the Exchange and the growth of the Exchange, including:
◦general business and economic conditions;
◦factors affecting insurance industry competition;
◦dependence upon the independent agency system; and
◦ability to maintain our reputation for customer service;
◦general business and economic conditions;
◦factors affecting insurance industry competition;
◦dependence upon the independent agency system; and
◦ability to maintain our reputation for customer service;
•dependence upon our relationship with the Exchange and the financial condition of the Exchange, including:
◦the Exchange's ability to maintain acceptable financial strength ratings;
◦factors affecting the quality and liquidity of the Exchange's investment portfolio;
◦changes in government regulation of the insurance industry;
◦emerging claims and coverage issues in the industry; and
◦severe weather conditions or other catastrophic losses, including terrorism;
◦the Exchange's ability to maintain acceptable financial strength ratings;
◦factors affecting the quality and liquidity of the Exchange's investment portfolio;
◦changes in government regulation of the insurance industry;
◦emerging claims and coverage issues in the industry; and
◦severe weather conditions or other catastrophic losses, including terrorism;
•costs of providing policy issuance and renewal services to the Exchange under the subscriber's agreement;
credit risk from the Exchange;
•ability to attract and retain talented management and employees;
•ability to ensure system availability and effectively manage technology initiatives;
•difficulties with technology or data security breaches, including cyber attacks;
•ability to maintain uninterrupted business operations;
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•factors affecting the quality and liquidity of our investment portfolio;


•our ability to meet liquidity needs and access capital; and
•outcome of pending and potential litigation.

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


RECENT ACCOUNTING STANDARDS
 
See Part I, Item 1. "Financial Statements - Note 2, Significant Accounting Policies, of Notes to Financial Statements" contained within this report for a discussion of recently adopted as well as other recently issued accounting standards and the impact on our financial statements if known.


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

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

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

By virtue of its legal structure as a reciprocal insurer, the Exchange does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and Indemnity. Claims handling services include costs incurred in the claims process, including the adjustment, investigation, defense, recording and payment functions. Life insurance management services include costs incurred in the management and processing of life insurance business. Investment management services are related to investment trading activity, accounting and all other functions attributable to the investment of funds. Included in these expenses are allocations of costs for departments that support these administrative functions. The amounts incurred for these services are reimbursed to Indemnity at cost in accordance with the subscriber's agreement and the service agreements. State insurance regulations require that intercompany service agreements and any material amendments be approved in advance by the state insurance department.

Our results of operations are tied to the growth and financial condition of the Exchange as the Exchange is our sole customer, and our earnings are largely generated from management fees based on the direct and affiliated assumed premiums written by the Exchange. The Exchange generates revenue by insuring preferred and standard risks, with personal lines comprising 71% of the 20182019 direct and affiliated assumed written premiums and commercial lines comprising the remaining 29%.  The principal personal lines products are private passenger automobile and homeowners.  The principal commercial lines products are commercial multi-peril, commercial automobile and workers compensation.


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Coronavirus ("COVID-19") pandemic
On March 11, 2020, the outbreak of the coronavirus ("COVID-19") was declared a global pandemic. The significant volatility in the financial markets, economic disruption and uncertainty resulting from the COVID-19 pandemic that began in the first quarter of 2020 continues to evolve and the pandemic’s ultimate impact and duration remain highly uncertain at this time.

The uncertainty of the COVID-19 pandemic has caused our sole customer, the Exchange, to experience growth constraints, which impacts our management fee revenue. The Exchange experienced declines in new business in the second quarter of 2020 due to business disruptions and recessionary conditions. Continued impacts of the COVID-19 pandemic will likely be incurred in the second half of 2020 and may continue until such time as the spread of the virus is contained. The Exchange previously announced rate reductions that will reduce its premiums and our management fee revenue beginning in the second half of 2020. Also, there may be other market and/or regulatory pressures that could impact the Exchange’s operations. In the first half of 2020, within our cost of operations, we incurred increased agent incentive costs as lower claim frequency resulted in improved agent profitability. We have incurred additional technology costs in support of remote working conditions for our employees. These expenses, among others, could continue to increase as the full extent and duration of the pandemic’s impacts remain uncertain. While the financial market volatility had a negative impact on our investment portfolio in the first quarter of 2020, markets did experience a partial recovery in the second quarter of 2020, contributing to realized and unrealized gains during this period. We could experience future losses and/or impairments to the portfolio given the pandemic’s impacts on market conditions. We have provided additional disclosure of these impacted areas throughout our Management’s Discussion and Analysis that follows. A broader discussion of the potential future impacts has also been disclosed in the Financial Condition, Liquidity and Capital Resources, and Part II. Item 1A. "Risk Factors" related to COVID-19 contained within this report.

We have a dedicated internal committee comprised of management from various finance disciplines reviewing our risk positions on an ongoing basis as circumstances are evolving.  The committee is reviewing risk scenarios and performing stress tests, including the review of cash flow trends, liquidity requirements and other forms of risk quantification. This provides tools for management, as well as our Risk Committee of the Board of Directors, to assess risks and prioritize key issues.

While we were not required to close our physical locations under the state mandated closure of nonessential services, out of concern for the health and safety of our employees, over 90% of our workforce has been working remote since about March 12, 2020. We have had no significant interruption to our core business processes or systems to date. We have had no significant changes to our financial close or reporting processes or related internal controls, nor do we anticipate any significant future challenges at this time. We have a separate dedicated committee developing a return to the office plan that will be implemented when it becomes feasible and safe.
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Financial Overview
Three months ended June 30,Six months ended June 30,
(dollars in thousands, except per share data)20202019% Change20202019% Change
(Unaudited)(Unaudited)
Operating income$91,189  $96,610  (5.6) %$176,880  $182,732  (3.2) %
Total investment income11,553  9,652  19.7  2,358  19,447  (87.9) 
Interest expense, net2  272  NM5  721  NM
Other (expense) income(258) 48  NM(624) 95  NM
Income before income taxes102,482  106,038  (3.4) 178,609  201,553  (11.4) 
Income tax expense20,505  18,284  12.1  37,306  38,488  (3.1) 
Net income$81,977  $87,754  (6.6) %$141,303  $163,065  (13.3) %
Net income per share – diluted$1.57  $1.68  (6.6) %$2.70  $3.12  (13.3) %
  Three months ended June 30, Six months ended June 30,
(dollars in thousands, except per share data) 2019 2018 % Change 2019 2018 % Change
  (Unaudited)    (Unaudited)   
Operating income $96,610
 $95,323
 1.3
% $182,732
 $172,890
 5.7
%
Total investment income 9,652
 6,207
 55.5
  19,447
 12,370
 57.2
 
Interest expense, net 272
 602
 (54.9)  721
 1,155
 (37.6) 
Other income 48
 58
 (17.9)  95
 102
 (7.1) 
Income before income taxes 106,038
 100,986
 5.0
  201,553
 184,207
 9.4
 
Income tax expense 18,284
 21,280
 (14.1)  38,488
 38,743
 (0.7) 
Net income $87,754
 $79,706
 10.1
% $163,065
 $145,464
 12.1
%
Net income per share - diluted $1.68
 $1.52
 10.1
% $3.12
 $2.78
 12.1
%
NM = not meaningful


Operating income increaseddecreased in both the second quarter and six months ended June 30, 2019,2020, compared to the same periods in 2018.2019, as growth in operating expenses outpaced the growth in operating revenues. Management fee revenue for policy issuance and renewal services increased 5.7% and 5.9%0.7% to $483.8 million in the second quarter and 1.8% to $927.5 million for the six months ended June 30, 2019,2020, respectively. Management fee revenue is based upon the management fee rate we charge, and the direct and affiliated assumed premiums written by the Exchange. The management fee rate was 25% for both 20192020 and 2018.2019. The direct and affiliated assumed premiums written by the Exchange increased 5.6%0.5% to $2.0 billion in the second quarter of 20192020 and increased 5.8%1.9% to $3.8$3.9 billion for the six months ended June 30, 2019,2020, compared to the same periods in 2018.2019.

Cost of operations for policy issuance and renewal services increased 6.7%2.2% to $413.9 million and 5.8%3.0% to $793.4 million in the second quarter and six months ended June 30, 2019, respectively,2020, compared to the same periods in 2018,2019, primarily due to higher commissionsagent incentives driven by direct written premium growth, personnel costs and technology investments.lower claims frequency.

Management fee revenue for administrative services increased $0.9 million4.4% to $14.2$14.8 million in the second quarter of 20192020 and increased $1.8 million5.1% to $28.1$29.6 million for the six months ended June 30, 2019,2020, compared to the same periods in 2018.2019. The administrative services reimbursement revenue and corresponding cost of operations increased both total operating revenue and total operating expenses by $146.1$152.0 million in the second quarter of 20192020 and $288.6$303.5 million for the six months ended June 30, 2019,2020, but had no net impact on operating incomeincome.

While our investment portfolio was negatively impacted by the significant disruption to financial markets in either period.
the first quarter of 2020, market conditions partially recovered in the second quarter of 2020. Total investment income increased $3.4 million and $7.1$1.9 million in the second quarter andof 2020 compared to the second quarter of 2019 primarily driven by an increase in net realized gains of $5.2 million partially offset by an increase in losses of limited partnerships of $2.7 million. Investment income decreased $17.1 million during the six months ended June 30, 2020 compared to the six months ended June 30, 2019 respectively, compared to the same periods in 2018. The increase in both periods was primarily driven by net realized gains on investmentslosses of $4.3 million, impairment losses of $3.1 million and higher net investment income.limited partnership losses of $6.0 million.

Income tax expense in the second quarter and six months ended June 30, 2019 was impacted by an income tax benefit of approximately $4.1 million as a result of settling an uncertain tax position, which reduced our effective tax rate by 3.8% and 2.0% in the second quarter and six months ended June 30, 2019, respectively.

General Conditions and Trends Affecting Our Business
Economic conditions
Unfavorable changes in economic conditions, including declining consumer confidence, inflation, high unemployment, and the threat of recession, among others, may lead the Exchange'sExchange’s customers to modify coverage, not renew policies, or even cancel policies, which could adversely affect the premium revenue of the Exchange, and consequently our management fee.  Further, unanticipated increased inflation costs including medical cost inflation, construction and auto repair cost inflation, and tort issues mayThe extent to which economic conditions could impact the estimated loss reservesExchange’s operations and future premium rates. If any of these items impactedour management fee was exacerbated with the financial condition or continuing operationsCOVID-19 pandemic. The extent and duration of the Exchange, it could have an impactimpacts to economic conditions remain uncertain as the pandemic continues to evolve. See Financial Condition, Liquidity and Capital Resources, and Part II, Item 1A. "Risk Factors" contained within this report for a discussion of the potential impacts of the COVID-19 pandemic on our financial results.operations.

Financial market volatility
Our portfolio of fixed maturity, equity security, and limited partnership investments is subject to market volatility, especially in periods of instability in the worldwide financial markets.  Over time, net investment income could also be impacted by volatility and by the general level of interest rates, which impact reinvested cash flow from the portfolio and business operations. Depending upon market conditions, which are unpredictable and remain uncertain, considerable fluctuation could exist in the fair value of our investment portfolio and reported total investment income, which could have an adverse impact on our financial condition, results of operations, and cash flows. Significant volatility has been seen in the global financial markets since the outbreak of the COVID-19 pandemic. The extent of the impact on our invested assets cannot be estimated with a high

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degree of certainty at this time given the ongoing developments of this pandemic and the related impacts on the financial markets.


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

The management fee is calculated by multiplying all direct and affiliated assumed premiums written by the Exchange by the management fee rate, which is determined by our Board of Directors at least annually.  The management fee rate was set at 25%, the maximum rate, for both 20192020 and 2018.2019.  Changes in the management fee rate can affect our revenue and net income significantly. The transaction price, including management fee revenue and administrative service reimbursement revenue, is allocated based on the estimated standalone selling prices developed using industry information and other available information for similar services. We update the transaction price allocation annually based upon the most recent information available. There wasavailable or more frequently if there have been significant changes in any components considered in the transaction price. In 2020, we are reviewing our transaction price allocation quarterly to consider the most current economic conditions related to the COVID-19 pandemic. These reviews have resulted in no material change to the allocation in 2019.allocation.

The following table presents the allocation and disaggregation of revenue for our two performance obligations: 
Three months ended June 30,Six months ended June 30,
(dollars in thousands)20202019% Change20202019% Change
(Unaudited)(Unaudited)
Policy issuance and renewal services
Direct and affiliated assumed premiums written by the Exchange$2,002,753  $1,993,593  0.5  %$3,850,431  $3,778,113  1.9  %
Management fee rate24.2 %24.2 %24.2 %24.2 %
Management fee revenue484,666  482,449  0.5  931,804  914,303  1.9  
Change in allowance for management fee returned on cancelled policies (1)
(871) (1,936) 55.0  (4,259) (2,807) (51.7) 
Management fee revenue - policy issuance and renewal services, net$483,795  $480,513  0.7  %$927,545  $911,496  1.8  %
Administrative services
Direct and affiliated assumed premiums written by the Exchange$2,002,753  $1,993,593  0.5  %$3,850,431  $3,778,113  1.9  %
Management fee rate0.8 %0.8 %0.8 %0.8 %
Management fee revenue16,022  15,949  0.5  30,803  30,225  1.9  
Change in contract liability (2)
(1,184) (1,742) 32.0  (1,183) (2,052) 42.3  
Change in allowance for management fee returned on cancelled policies (1)
(25) (12) NM(36) (27) (32.1) 
Management fee revenue - administrative services, net14,813  14,195  4.4  29,584  28,146  5.1  
Administrative services reimbursement revenue151,965  146,095  4.0  303,519  288,575  5.2  
Total revenue from administrative services$166,778  $160,290  4.0  %$333,103  $316,721  5.2  %
NM = not meaningful
 Three months ended June 30, Six months ended June 30,
(dollars in thousands)20192018% Change 20192018% Change
 (Unaudited)   (Unaudited)  
Policy issuance and renewal services         
Direct and affiliated assumed premiums written by the Exchange$1,993,593
$1,887,999
5.6
% $3,778,113
$3,570,793
5.8
%
Management fee rate24.2%24.2%   24.2%24.2%  
Management fee revenue482,449
456,896
5.6
  914,303
864,132
5.8
 
Change in allowance for management fee returned on cancelled policies (1)
(1,936)(2,324)16.7
  (2,807)(3,582)21.6
 
Management fee revenue - policy issuance and renewal services, net$480,513
$454,572
5.7
% $911,496
$860,550
5.9
%
          
Administrative services         
Direct and affiliated assumed premiums written by the Exchange$1,993,593
$1,887,999
5.6
% $3,778,113
$3,570,793
5.8
%
Management fee rate0.8%0.8%   0.8%0.8%  
Management fee revenue15,949
15,104
5.6
  30,225
28,566
5.8
 
Change in contract liability (2)
(1,742)(1,791)2.8
  (2,052)(2,165)5.2
 
Change in allowance for management fee returned on cancelled policies (1)
(12)(14)12.4
  (27)(28)3.5
 
Management fee revenue - administrative services, net14,195
13,299
6.7
  28,146
26,373
6.7
 
Administrative services reimbursement revenue146,095
146,507
(0.3)  288,575
292,470
(1.3) 
Total revenue from administrative services$160,290
$159,806
0.3
% $316,721
$318,843
(0.7)%
(1)Management fees are returned to the Exchange when policies are cancelled mid-term and unearned premiums are refunded.  We record an estimated allowance for management fees returned on mid-term policy cancellations. This estimated allowance has been allocated between the two performance obligations consistent with the revenue allocation proportion. In the three and six months ended June 30, 2020 the increase in the allowance for management fee returned on cancelled policies was driven by the potential for a greater number of mid-term cancellations as a result of the COVID-19 pandemic.

(1)Management fees are returned to the Exchange when policies are cancelled mid-term and unearned premiums are refunded.  We record an estimated allowance for management fees returned on mid-term policy cancellations. This estimated allowance has been allocated between the two performance obligations consistent with the revenue allocation proportion.

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

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

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Direct and affiliated assumed premiums written by the Exchange
Direct and affiliated assumed premiums include premiums written directly by the Exchange and premiums assumed from its wholly owned property and casualty subsidiaries. Direct and affiliated assumed premiums written by the Exchange increased 5.6%0.5% to $2.0 billion in the second quarter of 2019, from $1.9 billion in2020 compared to the second quarter of 2018,2019, driven by increases in both policies in force and average premium per policy.  Year-over-year policies in force for all lines of business increased 2.7%1.1% in the second quarter of 20192020 driven by continuing strong policyholder retention, compared to 3.5%2.7% in the second quarter of 2018.2019.  The year-over-year average premium per policy for all lines of business increased 2.2% at June 30, 2020, compared to 3.4% at June 30, 2019, compared2019.

Premiums generated from new business decreased 18.6% to 2.8%$190 million in the second quarter of 2020 driven by shelter-at-home orders, changes in consumer behavior and driving patterns and mandatory business closures resulting from the COVID-19 pandemic. Year-over-year average premium per policy on new business decreased 0.4% at June 30, 2018.
Premiums2020 and new business polices written decreased 12.7% in the second quarter of 2020. In the second quarter of 2019, premiums generated from new business decreased 1.1% to $233 million in the second quarter of 2019.million. While year-over-year average premium per policy on new business increased 6.4% at June 30, 2019, new business polices written decreased 7.4% in the second quarter of 2019. Premiums generated from new business increased 7.0% to $236 million in the second quarter of 2018. Underlying this trend in new business premium was a 0.1% increase in new business policies written in the second quarter of 2018 and a year-over-year average premium per policy on new business increase of 5.3% at June 30, 2018. Premiums generated from renewal business increased 6.6%3.0% to $1.8 billion in the second quarter of 2019,2020, compared to an increase of 6.4% to $1.7 billion6.6% in the second quarter of 2018.2019.  Underlying the trend in renewal business premiums was an increase in year-over-year average premium per policy of 2.5% at June 30, 2020 compared to 2.9% at June 30, 2019, and steady policy retention ratios.  Year-over-year average premium per policy increased 2.5% at June 30, 2018.respectively. 

Personal lines – Total personal lines premiums written increased 5.6%0.7% to $1.4 billion in the second quarter of 2019, from $1.3 billion in2020 compared to the second quarter of 2018,2019, driven by an increase of 2.7%1.1% in total personal lines policies in force and an increase of 3.1%1.7% in the total personal lines year-over-year average premium per policy. The impacts of the COVID-19 pandemic, including changes in consumer behavior and driving patterns, among others, impacted new personal policies written, which decreased 10.5% in the second quarter of 2020. These impacts were experienced primarily in April and May of 2020, with declines of 23.9% and 13.4%, respectively, while in June 2020 new personal policies written increased 7.0%. In the second quarter of 2019, new personal policies written decreased by 8.9%.

Commercial lines – Total commercial lines premiums written increased 5.6%decreased 0.1% to $580$579 million in the second quarter of 2019, from $549 million in2020 compared to the second quarter of 2018,2019, driven by a 2.6%1.2% increase in total commercial lines policies in force and a 4.0%3.3% increase in the total commercial lines year-over-year average premium per policy. New commercial business polices written decreased 24.1% in the second quarter of 2020. The significant decrease in 2020 was the result of the disruptions to businesses, including mandatory business closures, and economic conditions resulting from the COVID-19 pandemic. April and May of 2020 experienced larger declines, with new commercial business policies written decreasing 36.1% and 24.2%, respectively, while June of 2020 decreased 2.7%. In the second quarter of 2019, new commercial policies written increased 1.4%.

Future trends-premium revenue – The Exchange plans to continue its efforts to grow premiums and improve its competitive position in the marketplace.  Expanding the size of its agency force through a careful agency selection process and increased market penetration in our existing operating territories is expected to contribute to future growth as existing and new agents build their books of business.

Changes in premium levels attributable to the growth in policies in force and rate changes directly affect the profitability of the Exchange and have a direct bearing on our management fee. OurThe COVID-19 pandemic may have a negative impact on the Exchange's premiums, and therefore our management fees, given recessionary economic conditions and related declines in consumer activity and demand for certain services, as well as the potential for sustained changes in driving patterns. In response to reduced exposure given lower driving activity, and to provide financial relief to policyholders as a result of the COVID-19 pandemic, the Exchange previously announced $200 million in personal and commercial auto rate reductions that will take effect at the time of policy initiations or renewal, beginning July 1, 2020. These rate reductions will reduce the Exchange's 2020 premiums written by approximately $90 million, which will result in an estimated $23 million reduction in our 2020 management fee revenue. The remaining portion of these rate reductions will impact both the Exchange's premium written and our management fee revenue in 2021. Future premiums could also be impacted by potential regulatory changes resulting from the COVID-19 pandemic.

Through a careful agency selection process, the Exchange plans to continue its effort to expand the size of its agency force to increase market penetration in existing operating territories to contribute to future growth. While our agents initially experienced business declines resulting from disruptions created by the COVID-19 pandemic, there have been no significant disruptions in their operations. The continued focus on underwriting disciplineimpacts of the COVID-19 pandemic could make it difficult for our independent agents to write new business and retain existing business and/or constrain our ability to recruit new agents.

The extent of the maturing of pricing sophistication models has contributedimpact to the Exchange's steady policy retention ratiospremiums and increased average premium per policy.our management fee cannot be estimated with a high degree of certainty at this time given the ongoing developments related to this pandemic. See also Part II. Item 1A. "Risk Factors" contained within this report.



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Policy issuance and renewal services
Three months ended June 30,Six months ended June 30,
(dollars in thousands)20202019% Change20202019% Change
(Unaudited)(Unaudited)
Management fee revenue - policy issuance and renewal services, net$483,795  $480,513  0.7  %$927,545  $911,496  1.8  %
Service agreement revenue6,446  6,907  (6.7) 13,108  13,599  (3.6) 
490,241  487,420  0.6  940,653  925,095  1.7  
Cost of policy issuance and renewal services413,865  405,005  2.2  793,357  770,509  3.0  
Operating income - policy issuance and renewal services$76,376  $82,415  (7.3) %$147,296  $154,586  (4.7) %
 Three months ended June 30, Six months ended June 30,
(dollars in thousands)20192018% Change 20192018% Change
 (Unaudited)   (Unaudited)  
Management fee revenue - policy issuance and renewal services, net$480,513
$454,572
5.7
% $911,496
$860,550
5.9
%
Service agreement revenue6,907
7,080
(2.4)  13,599
14,225
(4.4) 
 487,420
461,652
5.6
  925,095
874,775
5.8
 
Cost of policy issuance and renewal services405,005
379,628
6.7
  770,509
728,258
5.8
 
Operating income - policy issuance and renewal services$82,415
$82,024
0.5
% $154,586
$146,517
5.5
%



Policy issuance and renewal services
We allocate a portion of the management fee, which currently equates to 24.2% of the direct and affiliated assumed premiums written by the Exchange, for providing policy issuance and renewal services. This portion of the management fee is recognized as revenue when the policy is issued or renewed because it is at that time that the services we provide are substantially complete and the executed insurance policy is transferred to the customer. The increase in management fee revenue for policy issuance and renewal services was driven by the increase in the direct and affiliated assumed premiums written by the Exchange discussed previously.

Service agreement revenue
Service agreement revenue includes service charges we collect from subscribers/policyholders for providing extended payment terms on policies written and assumed by the Exchange, and late payment and policy reinstatement fees.  The service charges are fixed dollar amounts per billed installment.  The decrease in service agreement revenue for the three and six months ended 2020 reflects the continued shift to payment plans that do not incur service charges or offer a premium discount for certain payment methods.


Cost of policy issuance and renewal services
Three months ended June 30,Six months ended June 30,
(dollars in thousands)2020
2019 (1)
% Change20202019% Change
(Unaudited)(Unaudited)
Commissions:
Total commissions$278,478  $273,256  1.9  %$530,474  $516,238  2.8  %
Non-commission expense:
Underwriting and policy processing$39,891  $40,220  (0.8) %$81,243  $78,445  3.6  %
Information technology43,155  40,847  5.7  85,313  79,994  6.7  
Sales and advertising15,770  14,193  11.1  27,245  25,202  8.1  
Customer service8,631  8,319  3.8  17,210  16,336  5.4  
Administrative and other27,940  28,170  (0.8) 51,872  54,294  (4.5) 
Total non-commission expense135,387  131,749  2.8  262,883  254,271  3.4  
Total cost of policy issuance and renewal services$413,865  $405,005  2.2  %$793,357  $770,509  3.0  %
 Three months ended June 30, Six months ended June 30,
(dollars in thousands)20192018% Change 20192018% Change
 (Unaudited)   (Unaudited)  
Commissions:         
Total commissions$273,256
$261,573
4.5
% $516,238
$495,667
4.2
%
Non-commission expense: (1)
         
Underwriting and policy processing$39,760
$37,813
5.2
% $78,445
$76,407
2.7
%
Information technology40,564
34,381
18.0
  79,994
68,330
17.1
 
Sales and advertising12,392
12,981
(4.5)  25,202
27,753
(9.2) 
Customer service8,020
6,536
22.7
  16,336
14,781
10.5
 
Administrative and other31,013
26,344
17.7
  54,294
45,320
19.8
 
Total non-commission expense131,749
118,055
11.6
  254,271
232,591
9.3
 
Total cost of policy issuance and renewal services$405,005
$379,628
6.7
% $770,509
$728,258
5.8
%
(1)Three months ended June 30, 2019 amounts have been reclassified between categories to conform to the current period presentation.

(1)2018 amounts have been reclassified between categories to conform to the current period presentation.


Commissions – Commissions increased $11.7$5.2 million in the second quarter of 20192020 and $20.6$14.2 million for the six months ended June 30, 2019, compared to the same respective periods in 2018. The increases were primarily driven by the growth in direct and affiliated assumed premiums written by the Exchange of 5.6% in the second quarter of 2019 and 5.8% for the six months ended June 30, 2019, partially offset by lower agent incentive costs related to less profitable growth,2020 compared to the same periods in 2018.2019, primarily driven by increases in agent incentive compensation. The estimated agent incentive payouts at June 30, 20192020 are based on actual underwriting results for the two prior years and current year-to-date actual results and forecasted results for the remainder of 2019.2020. Therefore, fluctuations in the current quarter underwriting results can impact the estimated incentive payout on a quarter-to-quarter basis. The Exchange experienced a significant decrease in automobile claims frequency and related loss expense beginning in March 2020 that continued through the second quarter of 2020 driven by the impacts of the COVID-19 pandemic. If a sustained period of lower claims frequency and loss expenses occurs, our agent compensation could increase related to the profitability component of the agent incentive bonuses. While lower than historical comparative periods, the Exchange's claims frequency began to trend upward in June
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2020. Growth in direct and affiliated assumed premiums written by the Exchange of 0.5% in the second quarter of 2020 and 1.9% for the six months ended June 30, 2020 also contributed to the increase in commission expenses compared to the same periods in 2019.

Non-commission expense – Non-commission expense increased $13.7$3.6 million in the second quarter of 20192020 compared to the second quarter of 2018.2019. Information technology costs increased $6.2$2.3 million driven by increases in hardware and software costs primarily due to increasedsupport remote work capabilities for our employees and professional fees. Customer serviceSales and advertising costs increased $1.5 million primarily due to increased personnel costs. Administrative and other expenses increased $4.7$1.6 million primarily driven by an increasea new program to support agent charitable giving in long-term incentive plan cost due to a higher company stock price during the second quarter of 2019 comparedresponse to the second quarter of 2018.COVID-19 pandemic. Personnel costs in all expense categories forincreased slightly as increases in salaries and wages resulting from higher vacation accruals were partially offset by lower medical expenses due to the second quarter of 2019 were impacted by additional bonuses awarded to all employees of approximately $1.1 million.COVID-19 pandemic.

Non-commission expense increased $21.7$8.6 million forin the six months ended June 30, 20192020 compared to the same period in 2018.2019. Information technology costs increased $11.7$5.3 million primarily due to increases in hardware and software costs, professional fees, and personnel costs. Underwriting and policy processing expense increased professional fees. Administrative$2.8 million primarily due to increases in personnel costs. Sales and other expensesadvertising costs increased $9.0$2.0 million primarily driven by an increasepersonnel costs and a new program to support agent charitable giving in long-term incentive plan cost dueresponse to a higherthe COVID-19 pandemic. Administrative and other costs decreased $2.4 million primarily driven by the change in the company stock price, which experienced a lower increase during the six months ended June 30, 20192020 compared to the six months ended June 30, 2018. Personnelsame period in 2019. Increased personnel costs in all expense categories were impacted by additional bonuses awarded to allincluded higher vacation accruals as employees of approximately $1.1 million fortook less vacation in the first six months ended June 30, 2019 and $4.8 million foras a result of the six months ended June 30, 2018.COVID-19 pandemic.

Administrative services
Three months ended June 30,Six months ended June 30,
(dollars in thousands)20202019% Change20202019% Change
(Unaudited)(Unaudited)
Management fee revenue - administrative services, net$14,813  $14,195  4.4  %$29,584  $28,146  5.1  %
Administrative services reimbursement revenue151,965  146,095  4.0  303,519  288,575  5.2  
Total revenue allocated to administrative services166,778  160,290  4.0  333,103  316,721  5.2  
Administrative services expenses
Claims handling services131,474  127,296  3.3  263,777  251,495  4.9  
Investment management services8,353  8,402  (0.6) 17,410  17,185  1.3  
Life management services12,138  10,397  16.7  22,332  19,895  12.2  
Operating income - administrative services$14,813  $14,195  4.4  %$29,584  $28,146  5.1  %
 Three months ended June 30, Six months ended June 30,
(dollars in thousands)20192018% Change 20192018% Change
 (Unaudited)   (Unaudited)  
Management fee revenue - administrative services, net$14,195
$13,299
6.7
% $28,146
$26,373
6.7
%
Administrative services reimbursement revenue146,095
146,507
(0.3)  288,575
292,470
(1.3) 
Total revenue allocated to administrative services160,290
159,806
0.3
  316,721
318,843
(0.7) 
Administrative services expenses         
Claims handling services127,296
127,544
(0.2)  251,495
255,649
(1.6) 
Investment management services8,402
8,485
(1.0)  17,185
16,773
2.5
 
Life management services10,397
10,478
(0.8)  19,895
20,048
(0.8) 
Operating income - administrative services$14,195
$13,299
6.7
% $28,146
$26,373
6.7
%



Administrative services
We allocate a portion of the management fee, which currently equates to 0.8% of the direct and affiliated assumed premiums written by the Exchange, to the administrative services. This portion of the management fee is recognized as revenue over a four-year period representing the time over which the services are provided. We also report reimbursed costs as revenues, which are recognized monthly as services are provided. The administrative services expenses we incur and the related reimbursements we receive are recorded gross in the Statements of Operations.

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

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Total investment income
A summary of the results of our investment operations is as follows:
  Three months ended June 30, Six months ended June 30,
(dollars in thousands) 20192018 % Change 20192018 % Change
  (Unaudited)    (Unaudited)   
Net investment income $8,030
$7,104
 13.0% $16,547
$13,924
 18.8
%
Net realized investment gains (losses) 1,302
(32) NM  3,805
(497) NM
 
Net impairment losses recognized in earnings (84)(646) 87.1  (162)(646) 75.0
 
Equity in earnings (losses) of limited partnerships 404
(219) NM  (743)(411) (80.8) 
Total investment income $9,652
$6,207
 55.5% $19,447
$12,370
 57.2
%

Three months ended June 30,Six months ended June 30,
(dollars in thousands)20202019% Change20202019% Change
(Unaudited)(Unaudited)
Net investment income$7,373  $8,030  (8.2) %$15,742  $16,547  (4.9) %
Net realized investment gains (losses)6,526  1,302  NM(4,280) 3,805  NM
Net impairment losses recognized in earnings(17) (84) (79.1) (3,070) (162) NM
Equity in (losses) earnings of limited partnerships(2,329) 404  NM(6,034) (743) NM
Total investment income$11,553  $9,652  19.7  %$2,358  $19,447  (87.9) %
NM = not meaningful


Net investment income
Net investment income primarily includes interest and dividends on our fixed maturity and equity security portfolios, net of investment expenses. Net investment income increased $0.9decreased by $0.7 million in the second quarter of 20192020 and increased $2.6$0.8 million for the six months ended June 30, 2019,2020, compared to the same periods in 2018.2019. The results from both periods were primarily due to increaseddecreased income generated from cash and cash equivalents driven by lower rates and earned on agent loans, bothinvested balances, somewhat offset by increased preferred stock dividends resulting from higher balances and rates. Those earnings were somewhat offset by decreased income on fixed maturities driven by lower average invested balances.

Net realized investment gains (losses)
A breakdown of our net realized investment gains (losses) is as follows: 
Three months ended June 30,Six months ended June 30,
(in thousands)2020201920202019
Securities sold:(Unaudited)(Unaudited)
Available-for-sale securities$355  $1,239  $970  $3,157  
Equity securities(1,840) 0  (2,528) 0  
Equity securities change in fair value8,010  63  (2,724) 648  
Miscellaneous1  0  2  0  
Net realized investment gains (losses)$6,526  $1,302  $(4,280) $3,805  
  Three months ended June 30, Six months ended June 30,
(in thousands) 2019 2018 2019 2018
Securities sold: (Unaudited) (Unaudited)
Fixed maturities $1,239
 $(66) $3,157
 $(411)
Equity securities 0
 0
 0
 (59)
Equity securities change in fair value (1)
 63
 (68) 648
 (129)
Miscellaneous 0
 102
 0
 102
Net realized investment gains (losses) (2)
 $1,302
 $(32) $3,805
 $(497)

(1)The fair value of our equity portfolio is based upon exchange traded prices provided by a nationally recognized pricing service.
(2)See Part I, Item 1. "Financial Statements - Note 6, Investments, of Notes to Financial Statements" contained within this report for additional disclosures regarding net realized investment gains (losses).


Market value adjustments of equity securities are recognized in net realized investment gains (losses) in the Statements of Operations. While net realized gains of $6.5 million in the second quarter of 2020 reflected a partial financial market recovery, net realized losses of $4.3 million for the six months ended June 30, 2020 reflect an overall decrease as a result of the COVID-19 pandemic driven by the significant volatility in the first quarter of 2020. Net realized gains during the second quarter and six months ended June 30, 2019 were primarily driven by gains from sales of fixed maturityavailable-for-sale securities.

Net realizedimpairment losses recognized in earnings
Improvements in market conditions during the second quarter of 2020 resulted in lower impairment losses. Net impairment losses recognized on available-for-sale securities during the six months ended June 30, 2020 include $2.2 million of securities in an unrealized loss position where we had intent to sell prior to recovery of our amortized cost basis and $0.7 million of credit impairment losses. The remaining impairments include the change in the current expected credit loss allowance related to our agent loans. The COVID-19 pandemic's impact on financial markets contributed to higher impairment losses on our available-for-sale securities during the first six months of 2020 compared to the same period in 2019.

Equity in (losses) earnings of limited partnerships
Limited partnership results for both the second quarter and six months ended June 2018, while driven by sales activity and market value adjustments, were offset somewhat by miscellaneous gains.


Net impairment losses recognized in earnings
Net impairment losses were $0.1 million and $0.6 million in30, 2020 compared to the second quarters of 2019quarter and 2018, respectively, and $0.2 million and $0.6 million for the six months ended June 30, 2019 and 2018, respectively. Impairments in all periods included securities in an unrealized loss position where we determined the loss was other-than-temporary based on credit factors. The 2018 periods also included securities in an unrealized loss position with intentwere due primarily to sell prior to expected recovery of our amortized cost basis.

Equity in earnings (losses) of limited partnerships
The components of equity in earnings (losses) of limited partnerships are as follows:
  Three months ended June 30, Six months ended June 30,
(in thousands) 2019 2018 2019 2018
  (Unaudited) (Unaudited)
Private equity $187
 $(270) $(1,008) 66
Mezzanine debt (51) 27
 (56) 105
Real estate 268
 24
 321
 (582)
Equity in earnings (losses) of limited partnerships $404
 $(219) $(743) (411)

Limited partnership earnings pertain to investments in U.S. and foreign private equity, mezzanine debt, and real estate partnerships.  Valuation adjustments are recorded to reflect the changes in fair value of the underlying investments held by the limited partnerships.  These adjustments are recorded as a component of equity in earnings (losses) of limited partnerships in the Statements of Operations.

Limited partnership earnings tend to be cyclical based upon market conditions, the age of the partnership, and the nature of the investments.  Generally, limited partnership earnings are recorded on a quarter lag from financial statements we receive from our general partners.  As a consequence, earnings from limited partnerships reported at June 30, 2019 reflect investment valuation changes resulting from the financial markets and the economy in the fourth quarter of 2018 and the first quarter of 2019.

Limited partnership investments generated gains of $0.4 million andincreased losses of $0.2 million in the second quarters of 2019 and 2018, respectively, and losses of $0.7 million and $0.4 million in the six months ended June 30, 2019 and 2018, respectively. The real estate and private equity sectors generated higher earnings in the second quarter of 2019 compared to the second quarter of 2018. Losses generated for the six months ended June 2019 were primarily in the private equity sector, partially offset by earnings from real estate investments while losses for the six months ended June 2018 were primarily in the real estate sector.

Financial condition of Erie Insurance Exchange
Serving in the capacity of attorney-in-fact for the Exchange, we are dependent on the growth and financial condition of the Exchange, who is our sole customer. The strength of the Exchange and its wholly owned subsidiaries is rated annually by A.M. Best Company. Higher ratings of insurance companies generally indicateCompany through assessing its 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. The Exchange and each of its property and casualty subsidiaries are rated A+ "Superior". On June 24, 2019,, the outlook for the financial strength rating was affirmed as stable.According to A.M. Best, this second highest financial strength rating, categorywhich 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
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meet obligations to policyholders over the long term. On July 8, 2020, the outlook for the financial strength rating was affirmed as stable.As of December 31, 2018,2019, only approximately 12% of insurance groups, in which the Exchange is included, are rated A+ or higher, and the Exchange is included in that group.higher.

The financial statements of the Exchange are prepared in accordance with statutory accounting principles prescribed by the Commonwealth of Pennsylvania. Financial statements prepared under statutory accounting principles focus on the solvency of the insurer and generally provide a more conservative approach than under U.S. generally accepted accounting principles. Statutory direct written premiums of the Exchange and its wholly owned property and casualty subsidiaries grew 5.8%1.9% to
$3.8 $3.9 billion for the six months ended June 30, 2019 from $3.6 billion for2020 compared to the six months ended June 30, 2018.2019. These premiums, along with investment income, are the major sources of cash that support the operations of the Exchange. Policyholders’ surplus determined under statutory accounting principles was $9.4 billion at June 30, 2020, $9.5 billion at December 31, 2019, and $9.0 billion at June 30, 2019, $8.6 billion at December 31, 2018, and $8.8 billion at June 30, 2018.2019. The Exchange and its wholly owned property and casualty subsidiaries' year-over-year policy retention ratio continues to be high at 89.9% at June 30, 2020, 90.0% at December 31, 2019, and 90.2% at June 30, 2019, 90.1% at December 31, 2018,2019.

We have prepared our financial statements considering the financial strength of the Exchange based on its AM Best rating and 89.8% at June 30, 2018.strong level of surplus. We are monitoring risks related to the COVID-19 pandemic on an ongoing basis and believe that the Exchange falls within defined risk tolerances. However, see Part II. Item 1A. "Risk Factors" for possible outcomes that could impact that determination.


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FINANCIAL CONDITION
 
The financial market conditions resulting from the COVID-19 pandemic partially recovered in the second quarter of 2020 which resulted in a favorable impact on our investment portfolio; however, we could experience further reductions in the market value of our investment portfolio as long as market conditions remain volatile in response to the developments of this pandemic and the related economic impacts.

Investments
Our investment portfolio is managed with the objective of maximizing after-tax returns on a risk-adjusted basis. The following table presents the carrying value of our investments as of: 
 
Distribution
(dollars in thousands)June 30, 2020% to totalDecember 31, 2019% to total
(Unaudited)  
Fixed maturities$804,825  83 %$730,701  82 %
Equity securities:
Preferred stock73,973  8  64,752  7  
Common stock1,416  0  2,381  0  
Limited partnerships15,463  2  26,775  3  
Agent loans (1)
65,450  7  67,696  8  
Other investments2,046  0  1,430  0  
Total investments$963,173  100 %$893,735  100 %
(1)The current portion of investmentsagent loans is included with prepaid expenses and other current assets in the Statements of Financial Position.

  Carrying value at   Carrying value at  
(dollars in thousands) June 30, 2019 % to total December 31, 2018 % to total
  (Unaudited)  
  
Fixed maturities $689,108
 87% $748,523
 88%
Equity securities:        
Preferred stock 12,445
 2
 11,853
 1
Limited partnerships:        
Private equity 26,793
 3
 28,271
 3
Mezzanine debt 1,053
 0
 1,152
 0
Real estate 2,498
 0
 5,398
 1
Other investments (1)
 61,478
 8
 58,394
 7
Total investments $793,375
 100% $853,591
 100%
(1)Other investments primarily include agent loans. Agent loans are included with other assets in the Statements of Financial Position.


We continually review our investment portfolio to evaluate positions that might incur other-than-temporary declines in value. We record impairment write-downs on investments in instances where the fair value of the investment is substantially below cost, and we conclude that the decline in fair value is other-than-temporary, which includes consideration for intent to sell.  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 our review of investment valuation are the length of time the fair value is below cost and the amount the fair value is below cost.
We individually analyze all positions with emphasis on those that have, in our opinion, declined significantly below cost.  In compliance with current impairment guidance for available-for-sale debt securities, we perform further analysis to determine if a credit-related impairment has occurred.  Some of the factors considered in determining whether a debt security is credit impaired include potential for the default of interest and/or principal, level of subordination, collateral of the issue, compliance with financial covenants, credit ratings and industry conditions.  We have the intent to sell all credit-impaired debt securities; therefore, the entire amount of the impairment charges are included in earnings and no impairments are recorded in other comprehensive income.  We believe our investment valuation philosophy and accounting practices result in appropriate and timely measurement of fair value and recognition of impairment.

Fixed maturities
Under our investment strategy, we maintain a fixed maturity portfolio that is of high quality and well diversified within each market sector.  This investment strategy also achieves a balanced maturity schedule.  Our fixed maturity portfolio is managed with the goal of achieving reasonable returns while limiting exposure to risk. As part of a rebalancing of our portfolio, we began selling off our municipal bond portfolio in the fourth quarter of 2018. The proceeds were reinvested in U.S. Treasury and corporate debt securities.

Fixed maturities classified as available-for-sale are carried at fair value with unrealized gains and losses, net of deferred taxes, included in shareholders’ equity.  Net unrealized gains on fixed maturities, net of deferred taxes, amounted to $1.0totaled $9.8 million at June 30, 2019,2020, compared to net unrealized lossesgains of $7.0$4.5 million at December 31, 2018.


2019.

The following table presents a breakdown of the fair value of our fixed maturity portfolio by industry sector and rating: rating as of:
(in thousands)
June 30, 2020 (1)
AAAAAABBBNon- investment
grade		Fair
value
 (Unaudited)
Basic materials$0  $0  $3,300  $1,152  $6,948  $11,400  
Communications0  8,910  8,696  8,305  16,928  42,839  
Consumer0  3,256  19,773  56,455  32,864  112,348  
Diversified0  0  0  1,057  497  1,554  
Energy0  4,207  4,707  14,016  11,848  34,778  
Financial0  1,021  59,803  100,623  10,389  171,836  
Industrial0  0  10,182  10,271  12,490  32,943  
Structured securities (2)
126,862  174,840  24,716  8,752  0  335,170  
Technology0  3,140  10,197  14,073  7,976  35,386  
Utilities0  0  3,923  16,815  5,833  26,571  
Total$126,862  $195,374  $145,297  $231,519  $105,773  $804,825  
(1)(1)Ratings are supplied by S&P, Moody’s, and Fitch.  The table is based upon the lowest rating for each security.
(2)Structured securities include residential and commercial mortgage-backed securities, collateralized debt obligations, and asset-backed securities.





35
  At June 30, 2019
(in thousands) (Unaudited)
Industry Sector AAA AA A BBB 
Non- investment
grade
 
Fair
value
Basic materials $0
 $0
 $0
 $3,042
 $7,790
 $10,832
Communications 0
 4,995
 0
 8,650
 16,629
 30,274
Consumer 0
 3,096
 10,264
 44,387
 28,815
 86,562
Diversified 0
 0
 0
 1,048
 463
 1,511
Energy 0
 0
 5,126
 8,215
 9,814
 23,155
Financial 0
 4,087
 52,454
 64,853
 7,692
 129,086
Government-municipal 359
 3,001
 0
 0
 0
 3,360
Industrial 0
 0
 998
 13,284
 15,590
 29,872
Structured securities (2)
 75,864
 92,057
 8,806
 1,271
 0
 177,998
Technology 0
 2,996
 6,163
 12,673
 7,379
 29,211
U.S. Treasury 0
 151,094
 0
 0
 0
 151,094
Utilities 0
 0
 2,740
 11,155
 2,258
 16,153
Total $76,223
 $261,326
 $86,551
 $168,578
 $96,430
 $689,108
(1)
Ratings are supplied by S&P, Moody’s, and Fitch.  The table is based upon the lowest rating for each security.Table of Contents
(2)Structured securities include residential mortgage-backed securities, commercial mortgage-backed securities, collateralized debt obligations, and asset-backed securities.


Equity Securitiessecurities
Equity securities consist of nonredeemable preferred and common stock and are carried at fair value in the Statements of Financial Position with all changes in unrealized gains and losses reflected in the Statements of Operations. All

The following table presents an analysis of the fair value of our nonredeemable preferred and common stock was invested in the financialsecurities by sector at both June 30, 2019 and December 31, 2018.as of:

Limited partnerships
Investments in limited partnerships have decreased from December 31, 2018 to June 30, 2019.  Changes in partnership values are a function of contributions and distributions, adjusted for market value changes in the underlying investments. The decrease in limited partnership investments was primarily due to net distributions received from the partnerships. We have made no new limited partnership commitments since 2006, and the balance of limited partnership investments is expected to continue to decrease over time as additional distributions are received. The results from our limited partnerships are based upon financial statements received from our general partners, which are generally received on a quarter lag.  As a result, the market values and earnings recorded during 2019 reflect the partnership activity experienced in the fourth quarter of 2018 and the first quarter of 2019.
(in thousands)June 30, 2020December 31, 2019
Preferred stockCommon stockPreferred stockCommon stock
(Unaudited)
Communication$2,478  $1.416  $1,052  $2,381  
Consumer2,599  0  508  0  
Energy1,035  0  1,881  0  
Financial services60,149  0  53,513  0  
Industrial0  0  980  0  
Utilities7,712  0  6,818  0  
Total$73,973  $1,416  $64,752  $2,381  

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LIQUIDITY AND CAPITAL RESOURCES
 
We continue to monitor the sufficiency of our liquidity and capital resources given the potential impact of the COVID-19 pandemic. We did not see a significant impact on our sources or uses of cash in the first half of 2020. However, we may experience future reductions in our management fee revenue if the Exchange’s premium growth is constrained. Also, future disruptions in the markets could occur which may affect our liquidity position. There is potential that the funding requirements for our costs of operations will increase related to agent compensation and technology costs, among others. If our normal operating and investing cash activities were to become insufficient to meet future funding requirements, we believe we have sufficient access to liquidity through our cash position, liquid marketable securities and our $100 million line of credit that does not expire until October 2023. See broader discussions of potential risks to our operations in the Operating Overview and Part II. Item 1A. "Risk Factors" contained within this report.

Sources and Uses of Cash
Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet the short- and long-term cash requirements of its business operations and growth needs.  Our liquidity requirements have been met primarily by funds generated from management fee revenue and income from investments.  Cash provided from these sources is used primarily to fund the costs of our management operations including commissions, salaries and wages, pension plans, share repurchases, dividends to shareholders, and the purchase and development of information technology.  We expect that our operating cash needs will be met by funds generated from operations.

Volatility in the financial markets presents challenges to us as we do occasionally access our investment portfolio as a source of cash.  Some of our fixed income investments, despite being publicly traded, aremay be illiquid.  Volatility in these markets could impair our ability to sell certain fixed income securities or cause such securities to sell at deep discounts. Additionally, our limited partnership investments are significantly less liquid.  We believe we have sufficient liquidity to meet our needs from sources other than the liquidation of securities.securities, even if market volatility persists throughout 2020.
 
Cash flow activities
The following table provides condensed cash flow information for the six months ended June 30:
(in thousands) 2019 2018(in thousands)20202019
 (Unaudited)(Unaudited)(Unaudited)
Net cash provided by operating activities $114,416
 $41,593
Net cash provided by operating activities$127,282  $114,416  
Net cash provided by (used in) investing activities 42,215
 (5,653)
Net cash (used in) provided by investing activitiesNet cash (used in) provided by investing activities(115,423) 42,215  
Net cash used in financing activities (84,786) (53,249)Net cash used in financing activities(90,860) (84,786) 
Net increase (decrease) in cash and cash equivalents $71,845
 $(17,309)
Net (decrease) increase in cash and cash equivalentsNet (decrease) increase in cash and cash equivalents$(79,001) $71,845  
 
 
Net cash provided by operating activities was $127.3 million in the first six months of 2020, compared to $114.4 million in the first six months of 2019,2019. Increased cash provided by operating activities in the six months of 2020 was primarily due to an increase of $35.0 million in management fee received driven by growth in direct and affiliated assumed premiums written by the Exchange and a decrease in income taxes paid of $14.2 million driven by lower taxable income compared to $41.6the same period in 2019. Offsetting the increase in cash provided by operating activities was a decrease in administrative services reimbursement received of $16.7 million and an increase in cash paid for agent commissions of $14.0 million due to higher scheduled commissions driven by premium growth in the six months of 2020 compared to the same period in 2019.

Net cash used in investing activities was $115.4 million in the first six months of 2018.  This change was primarily due to the fact that we had no pension contribution coupled with lower bonuses paid to agents in the first six months of 2019. In 2018, our Board approved an $80 million accelerated pension contribution, of which $40 million was contributed in January 2018 and $40 million in April 2018. We are reimbursed approximately 58% of the net periodic benefit cost of the pension plans from the Exchange and its subsidiaries, which includes pension benefits for employees performing administrative services and their allocated share of costs for employees in departments that support the administrative functions. Cash paid for agent bonuses decreased $18.1 million in the first six months of 2019,2020, compared to the first six months of 2018, due to less profitable underwriting results.

Netnet cash provided by investinginvestment activities wasof $42.2 million in the first six months of 2019, compared to cash used of $5.7 millionsame period in the first six months of 2018.2019. In the first six months of 2019, we generated more proceeds were generated from investment activity. The higher proceedssales and maturities/calls, which were somewhat offset by higher purchases of available-for-sale securities and fixeddue to portfolio rebalancing compared to the same period in 2020. Fixed asset purchases due to constructionincreased $3.2 million over the prior year driven by increases in progresstechnology investments, partially offset by decreases in costs related to the home office expansion. Also impacting our future investing activities are limited partnership commitments, which totaled $9.9 million at June 30, 2019, and will be funded as required byWe have a commitment for the partnerships’ agreements.  Of this amount, the total remaining commitment to fund limited partnerships that invest in private equity securities was $4.4 million and mezzanine debt securities was $5.5 million. Additionally, we have committed to incur future costs related to the construction of the building that will serve as part of our principal headquarters,headquarters. Of the total expected cost of $114 million, which is expected to cost $100 million and is beingwas funded primarily by the senior secured draw term loan credit facility, of the same amount. As of June 30, 2019, $71.6$100.5 million of costs have been paid related to this project.as of June 30, 2020.

Net cash used in financing activities totaled $90.9 million in the first six months of 2020, compared to $84.8 million in the first six months of 2019, compared to $53.2 million in the first six months of 2018.2019. The increase in cash used was due to dividends paid to shareholders and principal payments on the senior secured draw term loan credit facility, which commenced January 1, 2019.shareholders. Dividends paid to shareholders totaled $89.9 million in the first six months of 2020 and $83.8 million in the first six months of 2019 and $78.2 million in the first six months of 2018.2019. We increased both our Class A and Class B shareholder regular quarterly dividends by 7.1%7.2% for 2019,2020, compared to 2018.2019.  There are no regulatory restrictions on the payment of dividends to our shareholders. Future financing activities willalso include the principal payments
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due annually over the term of the senior secured draw term loan credit facility, of which $0.9$1.0 million will be paid during the remainder of 2019. Financing activities in the first six months of 2018 were impacted by the final $25 million draw on the senior secured draw term loan credit facility.2020.

There were no repurchases of our Class A nonvoting common stock in the first six months of 20192020 and 20182019 in conjunction with our stock repurchase program. In 2011, our Board of Directors approved a continuation of the current stock repurchase

program of $150 million with no time limitation.  This repurchase authority includes, and is not in addition to, any unspent amounts remaining under the prior authorization.  We had approximately $17.8 million of repurchase authority remaining under this program at June 30, 2019,2020, based upon trade date.

InDuring the first six months ended June 30, 2020, we purchased 26,410 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $4.6 million. Of this amount, we purchased 1,787 shares for $0.3 million, or $165.82 per share, for stock-based awards in conjunction with our equity compensation plan. We purchased 3,216 shares for $0.5 million, or $162.53 per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The remaining 21,407 shares were purchased at a total cost of $3.8 million, or $178.34 per share, to fund the rabbi trust for the incentive compensation deferral plan. All shares were delivered as of June 30, 2020.

During the six months ended June 30, 2019, we purchased 11,964 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $2.0 million. Of this amount, we purchased 3,246 shares for $0.4 million, or $132.35 per share, for stock-based awards in conjunction with our equity compensation plan, for which the shares were delivered to plan participants in January 2019.plan. We purchased 4,465 shares for $0.9 million, or $190.59 per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The shares were transferred to the rabbi trust in February and May 2019. The remaining 4,253 shares were purchased at a total cost of $0.7 million, or $175.64 per share, to fund the rabbi trust for the incentive compensation deferral plan. The shares were transferred to the rabbi trust in February, March and May 2019.
In the first six months of 2018, we purchased 22,247 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $2.6 million. Of this amount, we purchased 5,830 shares for $0.7 million, or $117.39 per share, for stock-based awards in conjunction with our equity compensation plan, for which theAll shares were delivered to plan participants in January and May 2018. We purchased 4,576 shares for $0.5 million, or $115.69 per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The shares were transferred to the rabbi trust in March and May 2018. The remaining 11,841 shares were purchased at a total costas of $1.4 million, or $119.14 per share, to fund the rabbi trust for the incentive compensation deferral plan. The shares were transferred to the rabbi trust in March and May 2018.June 30, 2019.

Capital Outlook
We regularly prepare forecasts evaluating the current and future cash requirements for both normal and extreme risk events.events, including the current COVID-19 pandemic.  Should an extreme risk event result in a cash requirement exceeding normal cash flows, we have the ability to meet our future funding requirements through various alternatives available to us.

Outside of our normal operating and investing cash activities, future funding requirements could be met through: 1) cash and cash equivalents, which total approximately $338.3$257.7 million at June 30, 2019,2020, 2) a $100 million bank revolving line of credit, and 3) liquidation of unpledged assets held in our investment portfolio, including preferred and common stock and investment grade bonds, which totaled approximately $387.3$532.3 million at June 30, 2019.2020.  Volatility in the financial markets could impair our ability to sell certain fixed income securities or cause such securities to sell at deep discounts.  Additionally, we have the ability to curtail or modify discretionary cash outlays such as those related to shareholder dividends and share repurchase activities.

As of June 30, 2019,2020, we have access to a $100 million bank revolving line of credit with a $25 million letter of credit sublimit that expires on October 30, 2023. As of June 30, 2019,2020, a total of $99.1 million remains available under the facility due to
$0.9 $0.9 million outstanding letters of credit, which reduce the availability for letters of credit to $24.1 million.  We had no borrowings outstanding on our line of credit as of June 30, 2019.2020. Investments with a fair value of $109.3$124.4 million were pledged as collateral on the line at June 30, 2019.2020. The investments pledged as collateral have no trading restrictions and are reported as available-for-sale securities and cash and cash equivalents and available-for-sale securities in the Statements of Financial Position.  The banks require compliance with certain covenants, which include leverage ratios and debt restrictions.  We were in compliance with our bank covenants at June 30, 2019.2020.

Off-Balance Sheet Arrangements and Contractual Obligations
Off-balance sheet arrangements include those with unconsolidated entities that may have a material current or future effect on our financial condition or results of operations, including material variable interests in unconsolidated entities that conduct certain activities. We have no material off-balance sheet obligations. As of June 30, 2019,2020, there were no material changes to our future contractual obligations as previously reported in our Annual Report on Form 10-K for the year ended December 31, 2018 other than a $36.1 million contract for software, services and maintenance that was executed in June 2019 that will be paid over the contract term2019.

38
Table of three years. This contract will be included in "Other commitments" in the Contractual Obligations table.Contents


CRITICAL ACCOUNTING ESTIMATES
 
We make estimates and assumptions that have a significant effect on the amounts and disclosures reported in the financial statements.  The most significant estimates relate to investment valuation and retirement benefit plans for employees.  While management believes its estimates are appropriate, the ultimate amounts may differ from estimates provided.  Our most critical accounting estimates are described in Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" for the year ended December 31, 20182019 of our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on February 21, 2019.27, 2020.  See Part I, Item 1. "Financial Statements - Note 5, Fair Value, of Notes to Financial Statements" contained within this report for additional information on our valuation of investments.



ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Our exposure to market risk is primarily related to fluctuations in prices and interest rates.  Quantitative and qualitative disclosures about market risk resulting from changes in prices, interest rates, and other risk exposures for the year ended December 31, 20182019 are included in Item 7A. "Quantitative and Qualitative Disclosures About Market Risk", of our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on February 21, 201927, 2020.
.

Although the components of the investment portfolio have changed,While there have beenwere no material changes to our reported market risks during the six months ended June 30, 2019.  2020, there were significant disruptions in the financial markets during the first quarter of 2020 that have affected prices for many securities due to increased economic uncertainty resulting from the COVID-19 pandemic. While increased economic uncertainty remains, market conditions partially recovered in the second quarter of 2020, including improved liquidity and tightening of credit spreads.

For a recent discussion of conditions surrounding our investment portfolio, see the "Operating Overview", "Results of Operations", and "Financial Condition" discussions contained in Part I, Item 2. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" contained within this report.


ITEM 4.CONTROLS AND PROCEDURES
ITEM 4. CONTROLS AND PROCEDURES
 
We carried out an evaluation, with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.
 
Our management evaluated, with the participation of the Chief Executive Officer and Chief Financial Officer, any change in our internal control over financial reporting and determined there has been no change in our internal control over financial reporting during the six months ended June 30, 20192020 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


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PART II. OTHER INFORMATION

ITEM 1.LEGAL PROCEEDINGS
ITEM 1. LEGAL PROCEEDINGS

State Court Lawsuit Against Erie Indemnity Company
Erie Indemnity Company (“Indemnity”("Indemnity") was named as a defendant in a complaint filed on August 1, 2012 by alleged subscribers of the Erie Insurance Exchange (the “Exchange”"Exchange") in the Court of Common Pleas Civil Division of Fayette County, Pennsylvania captioned Erie Insurance Exchange, an unincorporated association, by Joseph S. Sullivan and Anita Sullivan, Patricia R. Beltz, and Jenna L. DeBord, trustees ad litem v. Erie Indemnity Co. (the “"Sullivan”" lawsuit).

As subsequently amended, the complaint alleges that, beginning on September 1, 1997, Indemnity retained “Service Charges”"Service Charges" (installment fees) and “Added"Added Service Charges”Charges" (late fees and policy reinstatement charges) on policies written by Exchange and its insurance subsidiaries, which allegedly should have been paid to Exchange, in the amount of approximately $308 million. In addition to their claim for monetary relief on behalf of Exchange, Plaintiffs seek an accounting of all so-called intercompany transactions between Indemnity and Exchange from 1996 to date. Plaintiffs allege that Indemnity breached its contractual, fiduciary, and equitable duties by retaining Service Charges and Added Service Charges that should have been retained by Exchange. Plaintiffs bring these same claims under three separate derivative-type theories. First, Plaintiffs purport to bring suit as members of Exchange on behalf of Exchange. Second, Plaintiffs purport to bring suit as trustees ad litem on behalf of Exchange. Third, Plaintiffs purport to bring suit on behalf of Exchange pursuant to Rule 1506 of the Pennsylvania Rules of Civil Procedure, which allows shareholders to bring suit derivatively on behalf of a corporation or similar entity.

Indemnity filed a motion in the state court in November 2012 seeking dismissal of the lawsuit. On December 19, 2013, the court granted Indemnity’s motion in part, holding that the Pennsylvania Insurance Holding Company Act “provides"provides the [Pennsylvania Insurance] Department with special competence to address the subject matter of plaintiff’s claims”claims" and referring “all issues”"all issues" in the Sullivan lawsuit to the Pennsylvania Insurance Department (the “Department”"Department") for “its"its views and any determination.”" The court stayed all further proceedings and reserved decision on all other grounds for dismissal raised by Indemnity. Plaintiffs sought reconsideration of the court’s order, and on January 13, 2014, the court entered a revised order affirming its prior order and clarifying that the Department “shall"shall decide any and all issues within its jurisdiction.”" On January 30, 2014, Plaintiffs asked the court to certify its order to permit an immediate appeal to the Superior Court of Pennsylvania and to stay any proceedings in the Department pending completion of any appeal. On February 18, 2014, the court issued an order denying Plaintiffs’ motion. On March 20, 2014, Plaintiffs filed a petition for review with the Superior Court, which was denied by the Superior Court on May 5, 2014.

The Sullivan matter was assigned to an Administrative Judge within the Department for determination. The parties agreed that an evidentiary hearing was not required, entered into a stipulated record, and submitted briefing to the Department. Oral argument was held before the Administrative Judge on January 6, 2015. On April 29, 2015, the Department issued a declaratory opinion and order: (1) finding that the transactions between Exchange and Indemnity in which Indemnity retained or received revenue from installment and other service charges from Exchange subscribers complied with applicable insurance laws and regulations and that Indemnity properly retained charges paid by Exchange policyholders for certain installment premium payment plans, dishonored payments, policy cancellations, and policy reinstatements; and (2) returning jurisdiction over the matter to the Fayette County Court of Common Pleas.

On May 26, 2015, Plaintiffs appealed the Department’s decision to the Pennsylvania Commonwealth Court. Oral argument was held before the Commonwealth Court en banc on December 9, 2015. On January 27, 2016, the Commonwealth Court issued an opinion vacating the Department’s ruling and directing the Department to return the case to the Court of Common Pleas, essentially holding that the primary jurisdiction referral of the trial court was improper at this time because the allegations of the complaint do not implicate the special competency of the Department.

On February 26, 2016, Indemnity filed a petition for allowance of appeal to the Pennsylvania Supreme Court seeking further review of the Commonwealth Court opinion. On March 14, 2016, Plaintiffs filed an answer opposing Indemnity’s petition for allowance of appeal; and, on March 28, 2016, Indemnity sought permission to file a reply brief in further support of its petition for allowance of appeal. On August 10, 2016, the Pennsylvania Supreme Court denied Indemnity’s petition for allowance of appeal; and the Sullivan lawsuit returned to the Court of Common Pleas of Fayette County.

On September 12, 2016, Plaintiffs filed a motion to stay the Sullivan lawsuit pending the outcome of the Federal Court Lawsuit they filed against Indemnity and former and current Directors of Indemnity on July 8, 2016. (See below.) Indemnity filed an opposition to Plaintiff’s motion to stay on September 19, 2016; and filed amended preliminary objections seeking dismissal of the Sullivan lawsuit on September 20, 2016. The motion to stay and the amended preliminary objections remain pending. On June 27, 2018, Plaintiffs filed a motion for a status conference in the Sullivan lawsuit.

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On July 30, 2018, the Court held a status conference and thereafter lifted the stay of proceedings. On September 28, 2018, Indemnity filed a Motion to Enforce the Federal Judgment in the Beltz II lawsuit, seeking dismissal of the Sullivan lawsuit with prejudice. On October 26, 2018, Plaintiffs filed an opposition to that Motion; and Indemnity filed a reply in further support on November 5, 2018. Oral argument was held on Indemnity’s Motion to Enforce the Federal Judgment on November 20, 2018.2018 and on July 30, 2019. The Motion to Enforce the Federal Judgment remains pending.

Indemnity believes that it continues to have meritorious legal and factual defenses to the Sullivan lawsuit and intends to vigorously defend against all allegations and requests for relief.

Federal Court Lawsuit Against Erie Indemnity Company and Directors
On February 6, 2013, a lawsuit was filed in the United States District Court for the Western District of Pennsylvania, captioned Erie Insurance Exchange, an unincorporated association, by members Patricia R. Beltz, Joseph S. Sullivan and Anita Sullivan, and Patricia R. Beltz, on behalf of herself and others similarly situate v. Richard L. Stover; J. Ralph Borneman, Jr.; Terrence W. Cavanaugh; Jonathan Hirt Hagen; Susan Hirt Hagen; Thomas B. Hagen; C. Scott Hartz; Claude C. Lilly, III; Lucian L. Morrison; Thomas W. Palmer; Martin P. Sheffield; Elizabeth H. Vorsheck; and Robert C. Wilburn (the “"BeltzBeltz"” lawsuit), by alleged policyholders of Exchange who are also the plaintiffs in the Sullivan lawsuit. The individuals named as defendants in the Beltz lawsuit were the then-current Directors of Indemnity.

As subsequently amended, the Beltz lawsuit asserts many of the same allegations and claims for monetary relief as in the Sullivan lawsuit. Plaintiffs purport to sue on behalf of all policyholders of Exchange, or, alternatively, on behalf of Exchange itself. Indemnity filed a motion to intervene as a Party Defendant in the Beltz lawsuit in July 2013, and the Directors filed a motion to dismiss the lawsuit in August 2013. On February 10, 2014, the court entered an order granting Indemnity’s motion to intervene and permitting Indemnity to join the Directors’ motion to dismiss; granting in part the Directors’ motion to dismiss; referring the matter to the Department to decide any and all issues within its jurisdiction; denying all other relief sought in the Directors’ motion as moot; and dismissing the case without prejudice. To avoid duplicative proceedings and expedite the Department’s review, the Parties stipulated that only the Sullivan action would proceed before the Department and any final and non-appealable determinations made by the Department in the Sullivan action will be applied to the Beltz action.

On March 7, 2014, Plaintiffs filed a notice of appeal to the United States Court of Appeals for the Third Circuit. Indemnity filed a motion to dismiss the appeal on March 26, 2014. On November 17, 2014, the Third Circuit deferred ruling on Indemnity’s motion to dismiss the appeal and instructed the parties to address that motion, as well as the merits of Plaintiffs’ appeal, in the parties’ briefing. Briefing was completed on April 2, 2015. In light of the Department’s April 29, 2015 decision in Sullivan, the Parties then jointly requested that the Beltz appeal be voluntarily dismissed as moot on June 5, 2015. The Third Circuit did not rule on the Parties’ request for dismissal and instead held oral argument as scheduled on June 8, 2015. On July 16, 2015, the Third Circuit issued an opinion and judgment dismissing the appeal. The Third Circuit found that it lacked appellate jurisdiction over the appeal, because the District Court’s February 10, 2014 order referring the matter to the Department was not a final, appealable order.

On July 8, 2016, the Beltz plaintiffs filed a new action labeled as a “Verified"Verified Derivative And Class Action Complaint”Complaint" in the United States District Court for the Western District of Pennsylvania. The action is captioned Patricia R. Beltz, Joseph S. Sullivan, and Anita Sullivan, individually and on behalf of all others similarly situated, and derivatively on behalf of Nominal Defendant Erie Insurance Exchange v. Erie Indemnity Company; Kaj Ahlmann; John T. Baily; Samuel P. Black, III; J. Ralph Borneman, Jr.; Terrence W. Cavanaugh; Wilson C. Cooney; LuAnn Datesh; Patricia A. Goldman; Jonathan Hirt Hagen; Thomas B. Hagen; C. Scott Hartz; Samuel P. Katz; Gwendolyn King; Claude C. Lilly, III; Martin J. Lippert; George R. Lucore; Jeffrey A. Ludrof; Edmund J. Mehl; Henry N. Nassau; Thomas W. Palmer; Martin P. Sheffield; Seth E. Schofield; Richard L. Stover; Jan R. Van Gorder; Elizabeth A. Hirt Vorsheck; Harry H. Weil; and Robert C. Wilburn (the “"Beltz IIII"” lawsuit). The individual defendants are all present or former Directors of Indemnity (the “Directors”"Directors").

The allegations of the Beltz II lawsuit arise from the same fundamental, underlying claims as the Sullivan and prior Beltz litigation, i.e., that Indemnity improperly retained Service Charges and Added Service Charges. The Beltz II lawsuit alleges that the retention of the Service Charges and Added Service Charges was improper because, for among other reasons, that retention constituted a breach of the Subscriber’s Agreement and an Implied Covenant of Good Faith and Fair Dealing by Indemnity, breaches of fiduciary duty by Indemnity and the other defendants, conversion by Indemnity, and unjust enrichment by defendants Jonathan Hirt Hagen, Thomas B. Hagen, and Elizabeth A. Hirt Vorsheck, at the expense of Exchange. The Beltz II lawsuit requests, among other things, that a judgment be entered against the Defendants certifying the action as a class action pursuant to Rule 23 of the Federal Rules of Civil Procedure; declaring Plaintiffs as representatives of the Class and Plaintiffs’ counsel as counsel for the Class; declaring the conduct alleged as unlawful, including, but not limited to, Defendants’ retention of the Service Charges and Added Service Charges; enjoining Defendants from continuing to retain the Service Charges and Added Service Charges; and awarding compensatory and punitive damages and interest.

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On September 23, 2016, Indemnity filed a motion to dismiss the Beltz II lawsuit. On September 30, 2016, the Directors filed their own motions to dismiss the Beltz II lawsuit. On July 17, 2017, the Court granted Indemnity’s and the Directors’ motions to dismiss the Beltz II lawsuit, dismissing the case in its entirety. The Court ruled that “the"the Subscriber’s Agreement does not govern the separate and additional charges at issue in the Complaint”Complaint" and, therefore, dismissed the breach of contract claim against Indemnity for failure to state a claim. The Court also ruled that the remaining claims, including the claims for breach of fiduciary duty against Indemnity and the Directors, are barred by the applicable statutes of limitation or fail to state legally cognizable claims. On August 14, 2017, Plaintiffs filed a notice of appeal to the United States Court of Appeals for the Third Circuit.

On May 10, 2018, the United States Court of Appeals for the Third Circuit affirmed the District Court’s dismissal of the Beltz II lawsuit. On May 24, 2018, Plaintiffs filed a petition seeking rehearing of their appeal before the Third Circuit. The Third Circuit denied that petition on June 14, 2018.

Federal Court Lawsuit Against Erie Indemnity Company and Directors
On December 28, 2017 a lawsuit was filed in the United States District Court for the Western District of Pennsylvania captioned Lynda Ritz, individually and on behalf of all others similarly situated and derivatively on behalf of Nominal Defendant Erie Insurance Exchange v. Erie Indemnity Company, J. Ralph Borneman, Jr., Terrence W. Cavanaugh, Eugene C. Connell, LuAnn Datesh, Jonathan Hirt Hagen, Thomas B. Hagen, C. Scott Hartz, Brian A. Hudson, Sr., Claude C. Lilly, III, George R. Lucore, Thomas W. Palmer, Martin P. Sheffield, Richard L. Stover, Elizabeth A. Hirt Vorsheck, and Robert C. Wilburn, and Erie Insurance Exchange (Nominal Defendant) (the “
Ritz” lawsuit). The individual named as Plaintiff is alleged to be a policyholder (subscriber) of the Erie Insurance Exchange (the “Exchange”). With the exception of Terrence W. Cavanaugh and Robert C. Wilburn, the individuals named as Defendants comprise the current Board of Directors of Indemnity. Messrs. Cavanaugh and Wilburn are former Directors of Indemnity (the “Directors”).

The Complaint alleges that since at least 2007, Erie Indemnity Company has taken “unwarranted and excessive” management fees as compensation for its services under the Subscriber’s Agreement.  Count I of the Complaint purports to allege a claim for breach of alleged fiduciary duties against Indemnity and the Directors on behalf of Plaintiff and a putative class of subscribers.  Count II purports to allege a claim for breach of alleged fiduciary duties against Indemnity and the Directors on behalf of Exchange.  Count III purports to allege a claim for breach of contract and an alleged implied covenant of good faith and fair dealing against Indemnity on behalf of Plaintiff and a putative class.  Count IV purports to allege a claim of unjust enrichment against several Directors.

The Complaint seeks compensatory and punitive damages and requests the Court to enjoin Indemnity from continuing to retain excessive management fees; and order such other relief as may be appropriate.

On March 5, 2018, Indemnity filed a motion to dismiss the Ritz lawsuit. The Directors also filed their own motions to dismiss the Ritz lawsuit on March 5, 2018. Plaintiff filed her responses to both motions on April 26, 2018; and Indemnity and the Directors filed their replies in support of their motions on May 25, 2018. On February 4, 2019, the Court granted Indemnity’s and the Directors’ motions to dismiss the Ritz suit in its entirety, with prejudice, on the basis that all of the alleged claims in the Ritz suit are barred and precluded as a matter of law by the judgment entered in favor of Indemnity and the Directors in the Beltz II suit.

On March 4, 2019, Plaintiff filed a Motion for Reconsideration of the Court’s ruling dismissing the suit with prejudice. On April 5, 2019, Indemnity and the Directors filed their opposition to the Motion for Reconsideration. The Motion for Reconsideration was denied on May 13, 2019. Plaintiff declined to appeal the dismissal of the Ritz lawsuit.

For additional information on contingencies, see Part I, Item 1. "Financial Statements - Note 14, Commitments and Contingencies, of Notes to Financial Statements".

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ITEM 1A.RISK FACTORS
ITEM 1A. RISK FACTORS
 
There have been no material changes fromOur business involves various risks and uncertainties, including, but not limited to those discussed in this section. The risks and uncertainties described in the risk factors previously disclosedbelow, or any additional risk outside of those discussed below, could have a material adverse effect on our business, financial condition, operating results, cash flows, or liquidity if they were to develop into actual events. This information should be considered carefully together with the other information contained in this report and in other reports and materials we file periodically with the Securities and Exchange Commission ("SEC").

The risk factors listed below should be read in conjunction with the risk factors included in our Annual Report on Form 10-K for the fiscal year ended December 31, 20182019 as filed with the SecuritiesSEC on February 27, 2020. These risk factors address risks specific to the COVID-19 pandemic and Exchange Commissionrelated economic conditions. While we believe the risk factors in our Form 10-K filed with the SEC on February 21, 201927, 2020 generally address the risks of a pandemic on our business, we have included these disclosures to provide additional details specific to the COVID-19 pandemic.
.

Serving as the attorney-in-fact in the reciprocal insurance exchange structure results in the Exchange being our sole customer. We have an interest in the growth and financial condition of the Exchange as our earnings are largely generated from management fees based on the direct and affiliated assumed premiums written by the Exchange. If the impacts of the COVID-19 pandemic impair the Exchange’s ability to grow or its financial condition, it could have a material adverse effect on our business, financial condition, results of operations, or cash flows.

On March 11, 2020, the World Health Organization declared the outbreak of COVID-19 a global pandemic. The significant volatility in the financial markets, economic disruption and uncertainty resulting from the COVID-19 pandemic that began in the first quarter of 2020 continues to evolve and the pandemic’s ultimate impact and duration remain highly uncertain at this time. Efforts to contain the spread of the virus included the closure of nonessential businesses and stay at home orders. The resulting effects, including a decline in consumer activity, lower demand for certain services, high unemployment, and payroll declines may cause customers to modify coverages, not renew or cancel policies, which may have a negative impact on the Exchange’s written premiums, and therefore our management fees. While certain coverage modifications were experienced in the first half of 2020, primarily related to reduced usage/mileage in the private passenger automobile line of business, the modifications did not result in a material impact to the Exchange’s written premiums, however, the extent and duration of the effects on future customer demand and buying practices remains uncertain. A specific action taken by the Exchange both in response to changes in exposure as less driving occurs and to provide financial relief to the policyholders will result in a certain reduction to Exchange written premiums. In a Form 8-K filed with the SEC on April 9, 2020, the Exchange and its subsidiaries announced an estimated $200 million in personal and commercial auto rate reductions effective beginning July 1, 2020 at the time of new policy issuance or policy renewal. The estimated impact of these rate reductions on 2020 premiums written by the Exchange is a reduction of approximately $90 million, which will result in an estimated $23 million reduction in our management fee revenue. The remaining reduction will impact both the Exchanges’ written premium and our management fee revenue in 2021. An additional action taken by the Exchange that does not impact Indemnity was the announcement of a policyholder dividend to be paid directly to personal and commercial auto policyholders equal to approximately 30% of their premium for two months. Longer term, there could be sustained changes in driving patterns if working remotely becomes more common and accepted, potentially having a negative impact on premium revenues.

The Exchange is represented by independent agencies that serve as its sole distribution channel. The economic impact of the pandemic on independent agents’ business operations or systems capabilities could make it difficult for independent agents to write new business and retain existing business and/or constrain the ability to recruit new agents, thereby impeding premium growth. Additionally, if independent agents are not able to work remotely or are affected by an outbreak of the virus, this could adversely impact their operations and their ability to write new business and provide service to existing policyholders. More broadly, independent agents may face challenges sustaining their own business operations and financial conditions as small businesses faced with deteriorating economic conditions that could result in business closure thereby reducing the agency force of the Exchange. Further, the COVID-19 pandemic could be an accelerant to shifting consumer behaviors toward increased digital interactions.

The unknown risks related to the COVID-19 pandemic may cause additional uncertainty in the process of estimating loss and loss adjustment expense reserves. For example, the behavior of claimants and policyholders may change in unexpected ways, the disruption to the court system may impact the timing and amounts of claims settlements, and the actions taken by governmental bodies, both legislative and regulatory, in reaction to COVID-19 and their related impacts are hard to predict. As a result, the Exchange's estimated level of loss and loss adjustment expense reserves may change.

The Exchange’s financial condition could be impacted by delays in collecting premiums from customers due to economic hardships. Potential regulatory actions including temporary suspension of policy cancellations for the nonpayment of premiums
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and relaxing due dates for premium payments could also have a negative impact to the Exchange. If there were legislative action to retroactively mandate coverage irrespective of terms, exclusions or other conditions included in business interruption policies that would otherwise preclude coverage, this would have a significant impact on the financial condition, results of operations and cash flows of the Exchange.

The Exchange and its subsidiaries have been named as defendants in a number of pandemic-related lawsuits and, therefore, are subject to the risks and uncertainties of such litigation. There is also a risk that the Exchange could suffer reputational harm if any actions taken are not viewed as sufficient responses to the pandemic by customers or consumer organizations.

While the Exchange’s investment portfolio was negatively impacted by the significant disruption to financial markets in the first quarter of 2020 as a result of the COVID-19 pandemic, market conditions partially recovered in the second quarter of 2020. The value of the Exchange’s invested assets could be adversely impacted and there is potential for further impairments on its investment portfolio as long as market conditions remain volatile in response to the developments of this pandemic and the related economic impacts.

The duration and extent of the impact on the Exchange’s business, financial condition, results of operations and cash flows cannot be estimated with a high degree of certainty at this time given the ongoing developments of this pandemic and the related impacts on the economy and financial markets.

The effect of the COVID-19 pandemic on our operations, the business operations of our customers and/or independent agents, or our third-party vendor operations, could have a material adverse effect on our business, financial condition, results of operations, or cash flows.

If the COVID-19 pandemic results in conditions that constrain the Exchange’s ability to grow its written premiums, our management fee revenue could be negatively impacted. We expect that certain expenses within our cost of operations will increase as a result of the pandemic, including but not limited to agent compensation, technology costs, and potentially healthcare costs, among others. Our agent incentive bonuses include a profitability component. If claims frequency and loss expenses continue to decline, the profitability component of our agent incentive bonuses will continue to improve, increasing our agent compensation costs. Technology costs may increase as a result of supporting remote work capabilities for our employees. There is a potential for increased healthcare costs for treatments of the COVID-19 virus if a significant number of our employees and/or their dependents were to become infected. Also, future pension costs could increase as a result of a lower discount rate or investment returns related to the adverse market conditions caused by the COVID-19 pandemic.

Our business continuity plans were implemented upon the outbreak of this pandemic, including transitioning the vast majority of our employees and third-party contractors to remote work capabilities. We have had no significant interruption to our core business processes or systems to date. We have processes in place with our critical third-party vendors to understand impacts on their business and their business continuity plans. We have had no significant interruption to any third-party vendor business processes or systems to date. No significant challenges have been identified in our, or our third-party vendor’s ongoing business continuity plans, however if future challenges were to arise, this could result in an adverse effect on our business, financial condition, results of operations or cash flows. Also, while we have not experienced any delays in internal initiatives to date, future challenges could arise that impact the timing and execution of certain initiatives. Having shifted to remote working arrangements, we also face a heightened risk of cybersecurity attacks or data security incidents and are more dependent on internet and telecommunications access and capabilities. If we experience difficulties with technology, data and network security, outsourcing relationships or cloud-based technology, our ability to conduct our business could be negatively impacted.

Indemnity’s workforce providing services for the Exchange are largely concentrated in Erie, Pennsylvania. If a significant outbreak affects the labor force in this area, or if a significant operating function had a high level of infections at one time, it could impact the policy acquisition, underwriting, claims and/or support services provided to the policyholders of the Exchange and/or our independent agents.

With the increasing number of COVID-19 related disputes, there is a risk that Indemnity could become subject to pandemic related litigation. It is also possible that changes in economic conditions and steps taken by federal, state and local governments in response to COVID-19 could require an increase in taxes at the federal, state and local levels, which would adversely impact our results of operations.

While Indemnity’s investment portfolio was negatively impacted by the significant disruption to financial markets in the first quarter of 2020 as a result of the COVID-19 pandemic, market conditions partially recovered in the second quarter of 2020. The value of our invested assets could be adversely impacted and there is potential for further impairments in our investment
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portfolio as long as market conditions remain volatile in response to the developments of this pandemic and the related economic impacts.

The duration and extent of the impact on our business, financial condition, results of operations and cash flows cannot be estimated with a high degree of certainty at this time given the ongoing developments of this pandemic and the related impacts on the economy and financial markets.


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

Issuer Purchases of Equity Securities
In 2011,, our Board of Directors approved a continuation of the current stock repurchase program, authorizing repurchases for a total of $150$150 million with no time limitation.  This repurchase authority included, and was not in addition to, any unspent amounts remaining under the prior authorization. There were no repurchases of our Class A common stock under this program during the quartersix months ending June 30, 2019.2020. We had approximately $17.8 million of repurchase authority remaining under this program at June 30, 2019.2020.

During the quarter ending June 30, 2019,2020, we purchased 2,23919,456 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $0.4$3.6 million. We purchased 45 shares for $8 thousand, or $172.12 per share, in May 2020 and 17,818 shares for $3.3 million, or $198.01$184.42 per share, in June 2020 to fund the rabbi trust for the outside director deferred stock compensation plan and the incentive compensation deferral plan. The shares were transferred to the rabbi trust in May 2019.and June 2020. The remaining 1,593 shares were purchased in May 2020 at a total cost of $0.3 million, or $172.12 per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The shares were transferred to the rabbi trust in May 2020.

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ITEM 6. EXHIBITS
ITEM 6.ExhibitEXHIBITS

NumberDescription of Exhibit
Exhibit
Number31.1*Description of Exhibit
10.1*
10.2*
Appendix B to Deferred Compensation Plan of Erie Indemnity Company (As Amended and Restated Effective as of January 1, 2019).
31.1*
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*
32*
101.INS*Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH*Inline XBRL Taxonomy Extension Schema Document.
101.CAL*Inline XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF*Inline XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB*Inline XBRL Taxonomy Extension Label Linkbase Document.
101.PRE*Inline XBRL Taxonomy Extension Presentation Linkbase Document.
104*Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).


* Filed herewith.


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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:July 25, 201930, 2020By:/s/ Timothy G. NeCastro
Timothy G. NeCastro, President & CEO
By:/s/ Gregory J. Gutting
Gregory J. Gutting, Executive Vice President & CFO

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