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ERIE INDEMNITY CO - Quarter Report: 2021 June (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 

FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2021
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)

Pennsylvania
25-0466020
(State or other jurisdiction of(IRS Employer
incorporation or organization)Identification No.)

100 Erie Insurance Place,Erie,Pennsylvania16530
(Address of principal executive offices)(Zip Code)

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filerAccelerated filerNon-accelerated filer
Smaller reporting companyEmerging 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 23, 2021.
 
The number of shares outstanding of the registrant’s Class B Common Stock as of the latest practicable date was 2,542 at July 23, 2021.


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PART I. FINANCIAL INFORMATION

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,
2021202020212020
Operating revenue  
Management fee revenue - policy issuance and renewal services
$502,271 $483,795 $957,989 $927,545 
Management fee revenue - administrative services14,667 14,813 29,514 29,584 
Administrative services reimbursement revenue157,190 151,965 310,723 303,519 
Service agreement revenue5,902 6,446 11,981 13,108 
Total operating revenue680,030 657,019 1,310,207 1,273,756 
Operating expenses
Cost of operations - policy issuance and renewal services437,775 413,865 838,324 793,357 
Cost of operations - administrative services157,190 151,965 310,723 303,519 
Total operating expenses594,965 565,830 1,149,047 1,096,876 
Operating income85,065 91,189 161,160 176,880 
Investment income
Net investment income13,650 5,044 30,747 9,708 
Net realized investment gains (losses)2,769 6,526 3,573 (4,280)
Net impairment (losses) recoveries recognized in earnings(1)(17)86 (3,070)
Total investment income16,418 11,553 34,406 2,358 
Interest expense, net1,039 2,048 
Other expense548 258 1,067 624 
Income before income taxes99,896 102,482 192,451 178,609 
Income tax expense20,867 20,505 39,856 37,306 
Net income$79,029 $81,977 $152,595 $141,303 
Net income per share  
Class A common stock – basic$1.70 $1.76 $3.28 $3.03 
Class A common stock – diluted$1.51 $1.57 $2.92 $2.70 
Class B common stock – basic and diluted$255 $264 $491 $455 
Weighted average shares outstanding – Basic
  
Class A common stock46,188,289 46,187,808 46,188,573 46,188,299 
Class B common stock2,542 2,542 2,542 2,542 
Weighted average shares outstanding – Diluted
  
Class A common stock52,302,370 52,302,981 52,309,163 52,313,667 
Class B common stock2,542 2,542 2,542 2,542 
Dividends declared per share  
Class A common stock$1.035 $0.965 $2.070 $1.930 
Class B common stock$155.25 $144.75 $310.50 $289.50 

See accompanying notes to Financial Statements. See Note 11, "Accumulated Other Comprehensive Income (Loss)", for amounts reclassified out of accumulated other comprehensive income (loss) into the Statements of Operations. 
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ERIE INDEMNITY COMPANY
STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(in thousands)
Three months endedSix months ended
June 30,June 30,
2021202020212020
Net income$79,029 $81,977 $152,595 $141,303 
Other comprehensive income (loss), net of tax  
Change in unrealized holding gains (losses) on available-for-sale securities2,676 37,451 (6,076)5,215 
Amortization of prior service costs and net actuarial loss on pension and other postretirement plans
3,463 2,660 6,926 5,320 
Total other comprehensive income, net of tax6,139 40,111 850 10,535 
Comprehensive income$85,168 $122,088 $153,445 $151,838 
 
See accompanying notes to Financial Statements. See Note 11, "Accumulated Other Comprehensive Income (Loss)", for amounts reclassified out of accumulated other comprehensive income (loss) into the Statements of Operations.
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ERIE INDEMNITY COMPANY
STATEMENTS OF FINANCIAL POSITION
(dollars in thousands, except per share data)
June 30,December 31,
20212020
Assets(Unaudited)
Current assets:
Cash and cash equivalents$156,038 $161,240 
Available-for-sale securities20,856 17,697 
Equity securities207 19 
Receivables from Erie Insurance Exchange and affiliates, net504,013 494,637 
Prepaid expenses and other current assets59,574 52,561 
Accrued investment income6,121 6,146 
Total current assets746,809 732,300 
Available-for-sale securities, net915,942 910,539 
Equity securities93,798 94,071 
Fixed assets, net280,402 265,341 
Agent loans, net60,070 62,449 
Deferred income taxes, net17,971 12,341 
Other assets48,652 40,081 
Total assets$2,163,644 $2,117,122 
Liabilities and shareholders' equity
Current liabilities:
Commissions payable$284,234 $262,338 
Agent bonuses62,694 110,158 
Accounts payable and accrued liabilities150,346 150,706 
Dividends payable48,200 48,200 
Contract liability35,742 36,917 
Deferred executive compensation8,581 17,319 
Current portion of long-term borrowings2,064 2,031 
Total current liabilities591,861 627,669 
Defined benefit pension plans184,111 164,346 
Long-term borrowings92,795 93,833 
Contract liability18,135 18,878 
Deferred executive compensation13,773 14,904 
Other long-term liabilities17,867 9,444 
Total liabilities918,542 929,074 
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-capital16,496 16,487 
Accumulated other comprehensive loss(77,293)(78,143)
Retained earnings2,449,819 2,393,624 
Total contributed capital and retained earnings2,391,192 2,334,138 
Treasury stock, at cost; 22,110,132 shares held
(1,167,211)(1,163,670)
Deferred compensation21,121 17,580 
Total shareholders’ equity1,245,102 1,188,048 
Total liabilities and shareholders’ equity$2,163,644 $2,117,122 

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, 2021 and 2020
(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, 2020$1,992 $178 $16,487 $(78,143)$2,393,624 $(1,163,670)$17,580 $1,188,048 
Net income73,566 73,566 
Other comprehensive loss(5,289)(5,289)
Dividends declared:
Class A $1.035 per share
(47,806)(47,806)
Class B $155.25 per share
(395)(395)
Net purchase of treasury stock (1)
Deferred compensation(846)846 
Rabbi trust distribution (2)
876 (876)
Balance, March 31, 2021$1,992 $178 $16,496 $(83,432)$2,418,989 $(1,163,640)$17,550 $1,208,133 
Net income79,029 79,029 
Other comprehensive income6,139 6,139 
Dividends declared:
Class A $1.035 per share
(47,805)(47,805)
Class B $155.25 per share
(394)(394)
Net purchase of treasury stock (1)
Deferred compensation(3,668)3,668 
Rabbi trust distribution (2)
97 (97)
Balance, June 30, 2021$1,992 $178 $16,496 $(77,293)$2,449,819 $(1,167,211)$21,121 $1,245,102 


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 (3)
(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 (1)
Deferred compensation(772)772 
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 (1)
Deferred compensation(3,568)3,568 
Rabbi trust distribution (2)
704 (704)
Balance, June 30, 2020$1,992 $178 $16,487 $(106,333)$2,427,905 $(1,162,546)$16,456 $1,194,139 

(1)Net purchases of treasury stock in 2021 and 2020 include the repurchase of our Class A common stock in the open market that were subsequently distributed to satisfy stock based compensation awards.
(2)Distributions of our Class A shares were made from the rabbi trust to a retired director and an incentive compensation deferral plan participant in 2021 and to a retired director in 2020.
(3)The cumulative effect adjustment is related to the implementation of credit loss allowance accounting guidance effective January 1, 2020.

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,
20212020
Cash flows from operating activities
Management fee received$985,317 $937,962 
Administrative services reimbursements received301,509 279,689 
Service agreement fee received11,981 13,108 
Net investment income received18,735 18,749 
Commissions paid to agents(464,550)(448,622)
Agents bonuses paid(115,678)(100,185)
Salaries and wages paid(113,452)(100,360)
Employee benefits paid(16,567)(15,962)
General operating expenses paid(126,373)(133,422)
Administrative services expenses paid(310,617)(298,046)
Income taxes paid(40,503)(25,625)
Interest paid(2,082)(4)
Net cash provided by operating activities127,720 127,282 
Cash flows from investing activities
Purchase of investments:
Available-for-sale securities(168,671)(198,192)
Equity securities(28,408)(44,407)
Other investments(605)(622)
Proceeds from investments:
Available-for-sale securities sales59,203 68,977 
Available-for-sale securities maturities/calls99,788 58,722 
Equity securities29,856 35,684 
Other investments869 577 
Purchase of fixed assets(28,197)(37,426)
Loans to agents(2,930)(2,313)
Collections on agent loans3,584 3,577 
Net cash used in investing activities(35,511)(115,423)
Cash flows from financing activities
Dividends paid to shareholders(96,400)(89,881)
Net payments on long-term borrowings(1,011)(979)
Net cash used in financing activities(97,411)(90,860)
Net decrease in cash and cash equivalents(5,202)(79,001)
Cash and cash equivalents, beginning of period161,240 336,739 
Cash and cash equivalents, end of period$156,038 $257,738 
Supplemental disclosure of noncash transactions
Transfer of investments from limited partnerships to equity securities$$4,188 
Operating lease assets obtained in exchange for new operating lease liabilities$977 $3,440 
Liability incurred to purchase fixed assets$13,024 $814 

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 two 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 two 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 12, "Concentrations of Credit Risk".

Coronavirus ("COVID-19") pandemic
In March 2020, the outbreak of the coronavirus ("COVID-19") was declared a global pandemic. The uncertainty resulting from COVID-19 continues to evolve and the pandemic’s ultimate impact and duration remain uncertain at this time. 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.


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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, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021. For further information, refer to the financial statements and footnotes included in our Form 10-K for the year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021.

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.

Reclassifications
Certain amounts previously reported have been reclassified for comparative purposes to conform to the current period’s presentation. "Federal income taxes recoverable" is now included in "Prepaid expenses and other current assets" in the Statements of Financial Position. “Equity in earnings (losses) of limited partnerships” is now included in “Net investment income” in the Statements of Operations. The reclassifications had no effect on previously reported net income.



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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 two 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, includes variable consideration and is allocated based on the estimated standalone selling prices developed using industry information and other available information for similar services. A constraining estimate of variable consideration exists related to the potential for management fees to be returned if a policy were to be cancelled mid-term. Management fees are returned to the Exchange when policyholders cancel their insurance coverage mid-term and premiums are refunded to them. The constraining estimate is determined using the expected value method, based on both historical and current information. The estimated transaction price, as reduced by the constraint, reflects consideration expected for performance of our services. We update the transaction price and the related allocation at least annually based upon the most recent information available or more frequently if there have been significant changes in any components considered in the transaction price.

The 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). 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 a four-year period representing the time over which these services are provided. The portion of revenue not yet earned is recorded as a contract liability in the Statements of Financial Position. During the three and six months ending June 30, 2021, we recognized revenue of $10.6 million and $23.9 million, respectively, that was included in the contract liabilities balance as of December 31, 2020. During the three and six months ending June 30, 2020, we recognized revenue of $10.3 million and $23.4 million, respectively, that was included in the contract liabilities balance as of December 31, 2019. 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.


The following table disaggregates revenue by our two performance obligations:
Three months ended June 30,Six months ended June 30,
(in thousands)2021202020212020
Management fee revenue - policy issuance and renewal services$502,271 $483,795 $957,989 $927,545 
Management fee revenue - administrative services14,667 14,813 29,514 29,584 
Administrative services reimbursement revenue157,190 151,965 310,723 303,519 
Total administrative services $171,857 $166,778 $340,237 $333,103 
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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 10, "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,
20212020
(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$78,382 46,188,289 $1.70 $81,306 46,187,808 $1.76 
Dilutive effect of stock-based awards13,281 — 14,373 — 
Assumed conversion of Class B shares647 6,100,800 — 671 6,100,800 — 
Class A – Diluted EPS:
Income available to Class A stockholders on Class A equivalent shares
$79,029 52,302,370 $1.51 $81,977 52,302,981 $1.57 
Class B – Basic and diluted EPS:
Income available to Class B stockholders$647 2,542 $255 $671 2,542 $264 
Six months ended June 30,
20212020
(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$151,346 46,188,573 $3.28 $140,146 46,188,299 $3.03 
Dilutive effect of stock-based awards19,790 — 24,568 — 
Assumed conversion of Class B shares1,249 6,100,800 — 1,157 6,100,800 — 
Class A – Diluted EPS:
Income available to Class A stockholders on Class A equivalent shares
$152,595 52,309,163 $2.92 $141,303 52,313,667 $2.70 
Class B – Basic and diluted EPS:
Income available to Class B stockholders$1,249 2,542 $491 $1,157 2,542 $455 

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Note 5. Fair Value
 
Financial instruments carried at fair value
Our available-for-sale 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 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.  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 securities are valued using an exchange traded price provided by the pricing service. Pricing service valuations for Level 2 securities 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.
 
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. As of June 30, 2021, nearly all of our available-for-sale and equity securities 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 as of: 
June 30, 2021
(in thousands)TotalLevel 1Level 2Level 3
Available-for-sale securities:
Corporate debt securities$564,689 $2,461 $556,150 $6,078 
Collateralized debt obligations115,442 114,692 750 
Commercial mortgage-backed securities112,292 95,159 17,133 
Residential mortgage-backed securities93,652 90,611 3,041 
Other debt securities29,332 26,788 2,544 
U.S. Treasury21,391 21,391 
Total available-for-sale securities936,798 2,461 904,791 29,546 
Equity securities - nonredeemable preferred and common stock:
Financial services sector75,212 20,628 53,584 1,000 
Utilities sector10,470 3,594 6,876 
Energy sector2,952 957 1,995 
Consumer sector2,295 607 1,688 
Communications sector2,161 1,123 1,038 
Industrial sector915 915 
Total equity securities94,005 27,824 65,181 1,000 
Total$1,030,803 $30,285 $969,972 $30,546 


December 31, 2020
(in thousands)TotalLevel 1Level 2Level 3
Available-for-sale securities:
Corporate debt securities$566,425 $1,281 $559,319 $5,825 
Collateralized debt obligations110,447 110,447 
Commercial mortgage-backed securities120,201 100,739 19,462 
Residential mortgage-backed securities112,179 111,242 937 
Other debt securities18,984 18,984 
Total available-for-sale securities928,236 1,281 900,731 26,224 
Equity securities - nonredeemable preferred and common stock:
Financial services sector76,575 24,981 51,594 
Utilities sector8,742 3,957 4,785 
Energy sector2,206 676 1,530 
Consumer sector3,068 576 2,492 
Communications sector2,699 2,699 
Industrial sector800 800 
Total equity securities94,090 33,689 60,401 
Total$1,022,326 $34,970 $961,132 $26,224 


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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 – 2021 Quarterly Change:

(in thousands) 
Beginning balance at March 31, 2021
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, 2021
Available-for-sale securities:        
Corporate debt securities$5,460 $14 $37 $1,476 $(303)$1,347 $(1,953)$6,078 
Collateralized debt obligations750 750 
Commercial mortgage-backed securities 16,241 (102)(10)579 (961)2,624 (1,238)17,133 
Residential mortgage-backed securities473 (3)(224)3,030 (236)3,041 
Other debt securities521 (4)2,060 (33)2,544 
Total available-for-sale securities22,695 (91)24 4,865 (1,521)7,001 (3,427)29,546 
Nonredeemable preferred stock1,090 1,000 (1,095)1,000 
Total Level 3 securities$23,785 $(86)$24 $5,865 $(1,521)$7,001 $(4,522)$30,546 


Level 3 Assets – 2021 Year-to-Date Change:
(in thousands)Beginning balance at December 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, 2021
Available-for-sale securities:
Corporate debt securities$5,825 $20 $79 $2,258 $(673)$2,549 $(3,980)$6,078 
Collateralized debt obligations750 750 
Commercial mortgage-backed securities19,462 (197)(447)2,844 (966)3,854 (7,417)17,133 
Residential mortgage-backed securities937 (6)(476)3,030 (444)3,041 
Other debt securities(2)2,588 (42)2,544 
Total available-for-sale securities26,224 (183)(370)8,440 (2,157)9,433 (11,841)29,546 
Nonredeemable preferred stock1,000 1,090 (1,095)1,000 
Total Level 3 securities$26,224 $(178)$(370)$9,440 $(2,157)$10,523 $(12,936)$30,546 


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 
Collateralized debt obligations12 247 259 
Commercial mortgage-backed securities7,383 (34)268 6,891 (201)4,334 (575)18,066 
Total available-for-sale securities19,439 (36)1,147 7,921 (316)5,476 (10,390)23,241 
Nonredeemable preferred stock(25)820 795 
Total Level 3 securities$19,439 $(61)$1,147 $8,741 $(316)$5,476 $(10,390)$24,036 


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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 $$(511)$2,501 $(542)$8,037 $(12,898)$4,916 
Collateralized debt obligations12 247 259 
Commercial mortgage-backed securities3,321 (42)120 7,203 (287)8,891 (1,140)18,066 
Total available-for-sale securities11,645 (37)(379)9,951 (829)16,928 (14,038)23,241 
Nonredeemable preferred stock(25)820 795 
Total Level 3 securities$11,645 $(62)$(379)$10,771 $(829)$16,928 $(14,038)$24,036 
(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.


Financial instruments not carried at fair value
The following table presents the carrying values and fair values of financial instruments categorized as Level 3 in the fair value hierarchy that are recorded at carrying value as of:
June 30, 2021December 31, 2020
(in thousands)Carrying valueFair valueCarrying valueFair value
Agent loans (1)
$68,558 $72,593 $69,212 $73,854 
Long-term borrowings (2)
95,103 103,036 96,113 113,054 
(1)The discount rate used to calculate fair value at June 30, 2021 is reflective of a decrease in the BB+ financial yield curve.
(2)The discount rate used to calculate fair value at June 30, 2021 is reflective of an increase in U.S. Treasury bond yields.

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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 as of:
June 30, 2021
 (in thousands)Amortized costGross unrealized gainsGross unrealized lossesEstimated fair value
Corporate debt securities $548,975 $16,666 $952 $564,689 
Collateralized debt obligations115,087 574 219 115,442 
Commercial mortgage-backed securities109,277 3,378 363 112,292 
Residential mortgage-backed securities92,142 1,811 301 93,652 
Other debt securities28,905 462 35 29,332 
U.S. Treasury20,648 743 21,391 
Total available-for-sale securities, net$915,034 $23,634 $1,870 $936,798 


December 31, 2020
(in thousands)Amortized costGross unrealized gainsGross unrealized lossesEstimated fair value
Corporate debt securities$546,096 $21,843 $1,514 $566,425 
Collateralized debt obligations110,121 657 331 110,447 
Commercial mortgage-backed securities115,346 5,090 235 120,201 
Residential mortgage-backed securities108,840 3,373 34 112,179 
Other debt securities18,387 606 18,984 
Total available-for-sale securities, net$898,790 $31,569 $2,123 $928,236 


The amortized cost and estimated fair value of available-for-sale securities at June 30, 2021 are shown below by remaining contractual term to maturity.  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, 2021
AmortizedEstimated
(in thousands)costfair value
Due in one year or less$20,580 $20,856 
Due after one year through five years429,579 442,409 
Due after five years through ten years194,317 197,441 
Due after ten years270,558 276,092 
Total available-for-sale securities$915,034 $936,798 

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The below securities have been evaluated and determined to be temporary declines in fair value for which we expect to recover our entire principal plus interest.  The following tables present available-for-sale securities based on length of time in a gross unrealized loss position as of:
June 30, 2021
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$80,035 $584 $8,703 $368 $88,738 $952 289 
Collateralized debt obligations45,288 148 16,642 71 61,930 219 73 
Commercial mortgage-backed securities9,240 329 476 34 9,716 363 21 
Residential mortgage-backed securities29,064 301 29,064 301 46 
Other debt securities5,606 35 5,606 35 
Total available-for-sale securities$169,233 $1,397 $25,821 $473 $195,054 $1,870 436 
Quality breakdown of available-for-sale securities:
Investment grade$140,765 $1,212 $17,262 $107 $158,027 $1,319 174 
Non-investment grade28,468 185 8,559 366 37,027 551 262 
Total available-for-sale securities$169,233 $1,397 $25,821 $473 $195,054 $1,870 436 


December 31, 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$39,693 $644 $7,952 $870 $47,645 $1,514 257 
Collateralized debt obligations50,036 232 10,899 99 60,935 331 65 
Commercial mortgage-backed securities16,582 235 16,582 235 31 
Residential mortgage-backed securities8,163 34 8,163 34 13 
Other debt securities1,019 1,019 
Total available-for-sale securities$115,493 $1,154 $18,851 $969 $134,344 $2,123 370 
Quality breakdown of available-for-sale securities:
Investment grade$86,807 $561 $10,899 $99 $97,706 $660 119 
Non-investment grade28,686 593 7,952 870 36,638 1,463 251 
Total available-for-sale securities$115,493 $1,154 $18,851 $969 $134,344 $2,123 370 


Credit loss allowance on investments
As of June 30, 2021 and December 31, 2020, the current expected credit loss allowance on agent loans was $1.1 million in both periods. The current expected credit loss on available-for-sale securities was less than $0.1 million at June 30, 2021, and $0.2 million at December 31, 2020.

Net investment income
Investment income (loss), net of expenses, was generated from the following portfolios:
Three months ended June 30,Six months ended June 30,
(in thousands)2021202020212020
Available-for-sale securities$5,790 $5,670 $11,987 $11,458 
Equity securities1,116 901 2,318 1,757 
Limited partnerships (1)
6,151 (2,329)15,197 (6,034)
Cash equivalents and other935 1,115 1,912 3,089 
Total investment income13,992 5,357 31,414 10,270 
Less: investment expenses342 313 667 562 
Investment income, net of expenses$13,650 $5,044 $30,747 $9,708 
(1)Equity in earnings (losses) of limited partnerships includes both realized gains (losses) and unrealized valuation changes. Our limited partnership investments are included in the line item "Other assets" in the Statements of Financial Position. We have made no new limited partnership commitments since 2006, and the balance of limited partnership investments is expected to decline over time as additional distributions are received.
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Realized investment gains (losses)
Realized gains (losses) on investments were as follows:
Three months ended June 30,Six months ended June 30,
(in thousands)2021202020212020
Available-for-sale securities:  
Gross realized gains$1,075 $1,721 $2,998 $2,795 
Gross realized losses(678)(1,366)(1,118)(1,825)
Net realized gains on available-for-sale securities397 355 1,880 970 
Equity securities (1)
2,371 6,170 1,692 (5,252)
Miscellaneous
Net realized investment gains (losses)$2,769 $6,526 $3,573 $(4,280)
(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 held at the reporting date is calculated as follows:
Three months ended June 30,Six months ended June 30,
(in thousands)2021202020212020
Equity securities:
Net gains (losses) recognized during the period (1)
$2,371 $6,170 $1,692 $(5,252)
Less: net gains (losses) recognized on securities sold128 1,357 (293)(2,157)
Net unrealized gains (losses) recognized on securities held at reporting date$2,243 $4,813 $1,985 $(3,095)
(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 impairment (losses) recoveries recognized in earnings
Impairments on available-for-sale securities and agent loans were as follows:
Three months ended June 30,Six months ended June 30,
(in thousands)2021202020212020
Available-for-sale securities:
Intent to sell$— $— $— $(2,242)
Credit (impaired) recovered(1)(17)86 (658)
Total available-for-sale securities(1)(17)86 (2,900)
Agent loans - expected credit losses— — — (170)
Net impairment (losses) recoveries recognized in earnings$(1)$(17)$86 $(3,070)
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Note 7.  Borrowing Arrangements
 
Bank line of credit
As of June 30, 2021, 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, 2021, a total of $99.1 million remains available under the facility due to $0.9 million outstanding letters of credit, which reduce the availability for letters of credit to $24.1 million.  We had no borrowings outstanding on our line of credit as of June 30, 2021.  Investments with a fair value of $123.4 million were pledged as collateral on the line at June 30, 2021. The investments pledged as collateral have no trading restrictions and are reported as available-for-sale securities and cash and cash equivalents as of June 30, 2021. 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, 2021.

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 $122.6 million were pledged as collateral for the facility and are reported as available-for-sale securities and cash and cash equivalents as of June 30, 2021. 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, 2021.

The remaining unpaid balance from the Credit Facility is reported at carrying value, net of unamortized loan origination and commitment fees, as long-term borrowings on our Statements of Financial Position. 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
2021$1,021 
20222,109 
20232,226 
20242,302 
20252,449 
Thereafter84,996 

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Note 8.  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)2021202020212020
Service cost for benefits earned$13,260 $10,874 $26,520 $21,747 
Interest cost on benefits obligation9,206 9,394 18,412 18,789 
Expected return on plan assets(12,568)(12,353)(25,137)(24,706)
Prior service cost amortization357 335 714 671 
Net actuarial loss amortization4,026 3,031 8,053 6,062 
Pension plan cost (1)
$14,281 $11,281 $28,562 $22,563 
(1)The components of pension plan costs other than the service cost component are included in the line item "Other expense" in the Statements of Operations after reimbursements from the Exchange and its subsidiaries.


Note 9.  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. For the three months ended June 30, 2021 and 2020, our effective tax rate was 20.9% and 20.0%, respectively, and for the six months ended June 30, 2021 and 2020, our effective tax rate was 20.7% and 20.9%, respectively. Impacting our effective tax rate in the second quarter of 2020 was the reversal of a valuation allowance generated in the first quarter of 2020 by the financial market volatility resulting from the COVID-19 pandemic, which decreased our effective tax rate by 0.9%.


Note 10.  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 no shares of Class B common stock converted into Class A common stock during the six months ended June 30, 2021 and the year ended December 31, 2020. 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 no shares repurchased under this program during the six months ended June 30, 2021 and the year ended December 31, 2020. We had approximately $17.8 million of repurchase authority remaining under this program at June 30, 2021.
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Note 11.  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, 2021June 30, 2020
(in thousands)Before TaxIncome TaxNetBefore TaxIncome TaxNet
Investment securities:
AOCI (loss), beginning of period (1)
$18,306 $3,845 $14,461 $(27,761)$$(27,761)
OCI before reclassifications (1)
3,783 795 2,988 40,364 2,646 37,718 
Realized investment gains(397)(84)(313)(355)(75)(280)
Impairment losses17 13 
OCI3,387 711 2,676 40,026 2,575 37,451 
AOCI, end of period (1)
$21,693 $4,556 $17,137 $12,265 $2,575 $9,690 
Pension and other postretirement plans:
AOCI (loss), beginning of period$(123,917)$(26,024)$(97,893)$(150,233)$(31,550)$(118,683)
Amortization of prior service costs357 75 282 336 70 266 
Amortization of net actuarial loss 4,027 846 3,181 3,031 637 2,394 
OCI4,384 921 3,463 3,367 707 2,660 
AOCI (loss), end of period$(119,533)$(25,103)$(94,430)$(146,866)$(30,843)$(116,023)
Total
AOCI (loss), beginning of period$(105,611)$(22,179)$(83,432)$(177,994)$(31,550)$(146,444)
Investment securities3,387 711 2,676 40,026 2,575 37,451 
Pension and other postretirement plans4,384 921 3,463 3,367 707 2,660 
OCI7,771 1,632 6,139 43,393 3,282 40,111 
AOCI (loss), end of period$(97,840)$(20,547)$(77,293)$(134,601)$(28,268)$(106,333)
Six months endedSix months ended
June 30, 2021June 30, 2020
(in thousands)Before TaxIncome TaxNetBefore TaxIncome TaxNet
Investment securities:
AOCI, beginning of period$29,384 $6,171 $23,213 $5,664 $1,189 $4,475 
OCI (loss) before reclassifications(5,725)(1,202)(4,523)4,671 981 3,690 
Realized investment gains(1,880)(395)(1,485)(970)(204)(766)
Impairment (recoveries) losses(86)(18)(68)2,900 609 2,291 
OCI (loss)(7,691)(1,615)(6,076)6,601 1,386 5,215 
AOCI, end of period$21,693 $4,556 $17,137 $12,265 $2,575 $9,690 
Pension and other postretirement plans:
AOCI (loss), beginning of period$(128,300)$(26,944)$(101,356)$(153,600)$(32,257)$(121,343)
Amortization of prior service costs714 150 564 672 141 531 
Amortization of net actuarial loss8,053 1,691 6,362 6,062 1,273 4,789 
OCI8,767 1,841 6,926 6,734 1,414 5,320 
AOCI (loss), end of period$(119,533)$(25,103)$(94,430)$(146,866)$(30,843)$(116,023)
Total
AOCI (loss), beginning of period$(98,916)$(20,773)$(78,143)$(147,936)$(31,068)$(116,868)
Investment securities(7,691)(1,615)(6,076)6,601 1,386 5,215 
Pension and other postretirement plans8,767 1,841 6,926 6,734 1,414 5,320 
OCI 1,076 226 850 13,335 2,800 10,535 
AOCI (loss), end of period$(97,840)$(20,547)$(77,293)$(134,601)$(28,268)$(106,333)
(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.
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Note 12. 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". Net management fee amounts and other reimbursements due from the Exchange and its affiliates were $504.0 million and $494.6 million at June 30, 2021 and December 31, 2020, respectively, which includes a current expected credit loss allowance of $0.6 million in both periods.


Note 13.  Commitments and Contingencies

In 2020, we entered into an agreement with a bank for the establishment of a loan participation program for agent loans. The maximum amount of loans to be funded through this program is $100 million. We have committed to fund a minimum of 30% of each loan executed through this program. As of June 30, 2021, the total loans executed under this agreement totaled $22.5 million, of which our portion of the loans is $8.7 million. Additionally, we have agreed to guarantee a portion of the funding provided by the other participants in the program in the event of default. As of June 30, 2021, our maximum potential amount of future payments on the guaranteed portion is $2.6 million. All loan payments under the participation program are current as of June 30, 2021.

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 14.  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
 
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, 2020, as contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 25, 2021.
 
 
INDEX
 Page Number
 

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

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


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

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

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

By virtue of its legal structure as a reciprocal insurer, the Exchange does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services. 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 2020 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
In March 2020, the outbreak of the coronavirus ("COVID-19") was declared a global pandemic. The uncertainty resulting from the COVID-19 pandemic continues to evolve and the pandemic’s ultimate impact and duration remain uncertain at this time.

The impact the COVID-19 pandemic has on the premiums written by the Exchange, our sole customer, affects our management fee revenue. The uncertainty of the ongoing impacts of the COVID-19 pandemic will likely continue until such time as the spread of the virus is contained. In response to reduced driving conditions in 2020 resulting from the COVID-19 pandemic, the Exchange implemented $200 million in personal and commercial auto rate reductions, which became effective in the third quarter of 2020. These rate reductions resulted in a decrease to Exchange's written premiums of approximately $55 million and $110 million for the three and six months ended June 30, 2021, respectively, and a corresponding decrease in our management fee revenue of approximately $14 million and $28 million for the three and six months ending June 30, 2021, respectively. There may also be other market and/or regulatory pressures that could impact the Exchange’s operations. While financial markets remained generally strong in the first half of 2021, we could experience future losses and/or impairments to the portfolio if future development of the pandemic impacts market conditions. Additionally, we continued to incur increased agent incentive costs as claim frequency, while increasing in 2021, remains lower than pre-pandemic levels resulting in improved agent profitability the first half of 2021. 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 Financial Condition and Liquidity and Capital Resources contained within this report, as well as Part I. Item 1A. "Risk Factors" related to COVID-19 as included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021.

We have a dedicated internal committee comprised of management from various finance disciplines reviewing our risk positions and emerging trends 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 March 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 dedicated team responsible for the development and implementation of a return to office plan. Some employees began returning to our offices in July 2021. Additional employees will return to our offices in phases, assuming the pandemic does not worsen.
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Financial Overview
Three months ended June 30,Six months ended June 30,
(dollars in thousands, except per share data)20212020% Change20212020% Change
(Unaudited)(Unaudited)
Operating income$85,065 $91,189 (6.7)%$161,160 $176,880 (8.9)%
Total investment income16,418 11,553 42.1 34,406 2,358 NM
Interest expense, net1,039 NM2,048 NM
Other expense548 258 NM1,067 624 71.0 
Income before income taxes99,896 102,482 (2.5)192,451 178,609 7.8 
Income tax expense20,867 20,505 1.8 39,856 37,306 6.8 
Net income$79,029 $81,977 (3.6)%$152,595 $141,303 8.0 %
Net income per share – diluted$1.51 $1.57 (3.6)%$2.92 $2.70 8.0 %
NM = not meaningful


Operating income decreased in both the second quarter and six months ended June 30, 2021, compared to the same periods in 2020, as growth in operating expenses outpaced the growth in operating revenues. Management fee revenue for policy issuance and renewal services increased 3.8% to $502.3 million in the second quarter of 2021 and 3.3% to $958.0 million for the six months ended June 30, 2021, 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 2021 and 2020. The direct and affiliated assumed premiums written by the Exchange increased 3.4% to $2.1 billion in the second quarter of 2021 and increased 2.6% to $3.9 billion for the six months ended June 30, 2021 compared to the same periods in 2020.

Cost of operations for policy issuance and renewal services increased 5.8% to $437.8 million and 5.7% to $838.3 million in the second quarter and six months ended June 30, 2021, compared to the same periods in 2020, due to higher commissions driven by direct and affiliated assumed written premium growth, personnel costs and technology investments.

Management fee revenue for administrative services decreased 1.0% to $14.7 million and 0.2% to $29.5 million in the second quarter and six months ended June 30, 2021, compared to the same periods in 2020. The administrative services reimbursement revenue and corresponding cost of operations increased both total operating revenue and total operating expenses by $157.2 million in the second quarter of 2021 and $310.7 million for the six months ended June 30, 2021, but had no net impact on operating income.

Total investment income increased $4.9 million and $32.0 million in the second quarter and six months ended June 30, 2021, compared to the same periods in 2020. The results from both periods were primarily due to increases in net investment income. Investment results in 2020 were impacted by the significant financial market volatility resulting from the COVID-19 pandemic.

General Conditions and Trends Affecting Our Business
Economic conditions
Unfavorable changes in economic conditions, including declining consumer confidence, inflation, high unemployment, and the threat of recession, among others, may lead the Exchange’s customers to modify coverage, not renew policies, or even cancel policies, which could adversely affect the premium revenue of the Exchange, and consequently our management fee.  As the COVID-19 pandemic continues to evolve, the extent and duration of the impacts to economic conditions remain uncertain. See Financial Condition and Liquidity and Capital Resources contained within this report, as well as Part I. Item 1A. "Risk Factors" related to COVID-19 included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021 for a discussion of the potential impacts of the COVID-19 pandemic on our operations.

Financial market volatility
Our portfolio of fixed maturity and equity security investments is subject to market volatility especially in periods of instability in the worldwide financial markets. Over time, net investment income could also be impacted by volatility and by the general level of interest rates, which impact reinvested cash flow from the portfolio and business operations. Depending upon market conditions, which are unpredictable and remain uncertain, considerable fluctuation could 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 was seen in the global financial markets at the onset of the COVID-19 pandemic and pandemic related events may create future volatility. The extent of the impact on our invested assets 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 financial markets.
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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 2021 and 2020.  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, includes variable consideration and is allocated based on the estimated standalone selling prices developed using industry information and other available information for similar services. We update the transaction price and the related allocation at least annually based upon the most recent information available or more frequently if there have been significant changes in any components considered in the transaction price. Our current transaction price allocation review resulted in a minor change in the allocation percentages between the two performance obligations. The change in allocation will not have a material impact on our financial statements.

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)20212020% Change20212020% Change
(Unaudited)(Unaudited)
Policy issuance and renewal services
Direct and affiliated assumed premiums written by the Exchange
$2,070,557 $2,002,753 3.4 %$3,948,739 $3,850,431 2.6 %
Management fee rate24.3 %24.2 %24.3 %24.2 %
Management fee revenue503,146 484,666 3.8 959,544 931,804 3.0 
Change in estimate for management fee returned on cancelled policies (1)
(875)(871)(0.4)(1,555)(4,259)63.5 
Management fee revenue - policy issuance and renewal services$502,271 $483,795 3.8 %$957,989 $927,545 3.3 %
Administrative services
Direct and affiliated assumed premiums written by the Exchange
$2,070,557 $2,002,753 3.4 %$3,948,739 $3,850,431 2.6 %
Management fee rate0.7 %0.8 %0.7 %0.8 %
Management fee revenue14,494 16,022 (9.5)27,641 30,803 (10.3)
Change in contract liability (2)
168 (1,184)NM1,875 (1,183)NM
Change in estimate for management fee returned on cancelled policies (1)
(25)NM(2)(36)95.8 
Management fee revenue - administrative services14,667 14,813 (1.0)29,514 29,584 (0.2)
Administrative services reimbursement revenue
157,190 151,965 3.4 310,723 303,519 2.4 
Total revenue from administrative services
$171,857 $166,778 3.0 %$340,237 $333,103 2.1 %
NM = not meaningful
(1)A constraining estimate of variable consideration exists related to the potential for management fees to be returned if a policy were to be cancelled mid-term. Management fees are returned to the Exchange when policies are cancelled mid-term and unearned premiums are refunded. 
(2)Management fee revenue - administrative services is recognized over time as the services are provided. See Part I, Item 1. "Financial Statements - Note 3, Revenue, of Notes to Financial Statements" contained within this report.

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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 3.4% to $2.1 billion in the second quarter of 2021 compared to the second quarter of 2020, primarily driven by increases in homeowners and commercial multi-peril premiums written.  Year-over-year policies in force for all lines of business increased 3.6% in the second quarter of 2021 compared to 1.1% in the second quarter of 2020.  The year-over-year average premium per policy for all lines of business decreased 1.5% at June 30, 2021 compared to an increase of 2.2% at June 30, 2020. The year-over-year average premium per policy at June 30, 2021 was impacted by the rate reductions for our personal and commercial auto policies that became effective in the third quarter of 2020.

Premiums generated from new business increased 38.4% to $263 million in the second quarter of 2021. While year-over-year average premium per policy on new business decreased 2.7% at June 30, 2021, new business policies written increased 33.4 % in the second quarter of 2021. Premiums generated from new business decreased 18.6% to $190 million in the second quarter of 2020. Year-over-year average premium per policy on new business decreased 0.4% at June 30, 2020 and new business policies written decreased 12.7% in the second quarter of 2020, primarily due to the shelter-at-home orders and mandatory business closures resulting from the COVID-19 pandemic. Premiums generated from renewal business decreased 0.3% to $1.8 billion in the second quarter of 2021 compared to the second quarter of 2020.  Underlying the trend in renewal business premiums was a decrease in year-over-year average premium per policy of 1.2% at June 30, 2021, driven by the rate reductions for our personal and commercial auto policies that became effective in the third quarter of 2020, compared to an increase of 2.5% at June 30, 2020. 

Personal lines – Total personal lines premiums written increased 2.0% to $1.5 billion in the second quarter of 2021, compared to 0.7% in the second quarter of 2020. While total personal lines year-over-year average premium per policy decreased 2.1% at June 30, 2021, total personal lines policies in force increased 3.6% in the second quarter of 2021.

Commercial lines – Total commercial lines premiums written increased 6.8% to $619 million in the second quarter of 2021, compared to a decrease of 0.1% in the second quarter of 2020, driven by a 3.4% increase in total commercial lines policies in force and a 0.1% increase in total commercial lines year-over-year average premium per policy.

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

Changes in premium levels attributable to the growth in policies in force and rate changes directly affect the profitability of the Exchange and have a direct bearing on our management fee. Future premiums could be impacted by changes resulting from the COVID-19 pandemic, including potential regulatory changes and inflationary trends, among others. Longer-term, increased driving activity may result in future rate increases due to higher claims frequencies and severity. See also Part I. Item 1A. "Risk Factors" related to COVID-19 included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021.


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Policy issuance and renewal services
Three months ended June 30,Six months ended June 30,
(dollars in thousands)20212020% Change20212020% Change
(Unaudited)(Unaudited)
Management fee revenue - policy issuance and renewal services$502,271$483,7953.8 %$957,989$927,5453.3 %
Service agreement revenue5,9026,446(8.4)11,98113,108(8.6)
508,173490,2413.7 969,970940,6533.1 
Cost of policy issuance and renewal services
437,775413,8655.8 838,324793,3575.7 
Operating income - policy issuance and renewal services
$70,398$76,376(7.8)%$131,646$147,296(10.6)%


Policy issuance and renewal services
The management fee revenue allocated for providing policy issuance and renewal services was 24.3% and 24.2% of the direct and affiliated assumed premiums written by the Exchange for both the three and six months ended June 30, 2021 and 2020, respectively.  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 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)20212020% Change20212020% Change
(Unaudited)(Unaudited)
Commissions:
Total commissions$293,220$278,4785.3 %$554,601$530,4744.5 %
Non-commission expense:
Underwriting and policy processing$43,181$39,8918.2 %$83,769$81,2433.1 %
Information technology46,07643,1556.8 92,48185,3138.4 
Sales and advertising14,59015,770(7.5)25,53327,245(6.3)
Customer service9,1318,6315.8 17,92917,2104.2 
Administrative and other31,57727,94013.0 64,01151,87223.4 
Total non-commission expense144,555135,3876.8 283,723262,8837.9 
Total cost of policy issuance and renewal services
$437,775$413,8655.8 %$838,324$793,3575.7 %


Commissions – Commissions increased $14.7 million in the second quarter of 2021 and $24.1 million for the six months ended June 30, 2021 compared to the same periods in 2020, primarily driven by the growth in direct and affiliated assumed written premium, primarily in lines of business that pay a higher commission rate. To a lesser extent, there was also an increase in agent incentive compensation for the second quarter and six months ended June 30, 2021 compared to the second quarter and six months ending June 30, 2020. The estimated agent incentive payouts at June 30, 2021 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 2021. Lower claims frequency and related loss expense since the onset of the COVID-19 pandemic impacted agent compensation related to the profitability component in all periods.

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Non-commission expense – Non-commission expense increased $9.2 million in the second quarter of 2021 compared to the second quarter of 2020. Underwriting and policy processing expense increased $3.3 million primarily due to increased personnel costs and underwriting report costs. Information technology costs increased $2.9 million primarily due to increased hardware and software costs as well as increased personnel costs. Administrative and other costs increased $3.6 million primarily driven by increased building and equipment depreciation and professional fees compared to the same period in 2020. Personnel costs in all expense categories for the second quarter of 2021 were impacted by higher medical costs compared to the prior year as the COVID-19 pandemic reduced elective procedures in 2020.

Non-commission expense increased $20.8 million in the six months ended June 30, 2021 compared to the same period of 2020. Underwriting and policy processing expense increased $2.5 million primarily due to increased underwriting report costs and personnel costs. Information technology costs increased $7.2 million primarily due to increased hardware and software costs and personnel costs. Administrative and other costs increased $12.1 million primarily driven by increased personnel costs and professional fees compared to the same period in 2020. Personnel costs in all expense categories were impacted by higher pension costs and higher medical costs compared to the prior year as the COVID-19 pandemic reduced elective procedures in 2020.


Administrative services
Three months ended June 30,Six months ended June 30,
(dollars in thousands)20212020% Change20212020% Change
(Unaudited)(Unaudited)
Management fee revenue - administrative services$14,667$14,813(1.0)%$29,514$29,584(0.2)%
Administrative services reimbursement revenue
157,190151,9653.4 310,723303,5192.4 
Total revenue allocated to administrative services
171,857166,7783.0 340,237333,1032.1 
Administrative services expenses
Claims handling services
135,192131,4742.8 267,662263,7771.5 
Investment management services
9,6898,35316.0 19,40317,41011.5 
Life management services
12,30912,1381.4 23,65822,3325.9 
Operating income - administrative services
$14,667$14,813(1.0)%$29,514$29,584(0.2)%


Administrative services
The management fee revenue allocated to administrative services was 0.7% and 0.8% of the direct and affiliated assumed premiums written by the Exchange for both the three and six months ended June 30, 2021 and 2020, respectively. 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)20212020% Change20212020% Change
(Unaudited)(Unaudited)
Net investment income$13,650 $5,044 NM$30,747 $9,708 NM
Net realized investment gains (losses)2,769 6,526 (57.6)%3,573 (4,280)NM
Net impairment (losses) recoveries recognized in earnings(1)(17)NM86 (3,070)NM
Total investment income$16,418 $11,553 42.1 %$34,406 $2,358 NM
NM = not meaningful


Net investment income
Net investment income includes interest and dividends on our fixed maturity and equity security portfolios and the results of our limited partnership investments, net of investment expenses. Net investment income increased $8.6 million in the second quarter of 2021 and $21.0 million for the six months ended June 30, 2021, compared to the same periods in 2020. The results from both periods were primarily due to equity in earnings of limited partnerships of $6.2 million and $15.2 million for the three and six months ended June 30, 2021, respectively, compared to equity in losses of limited partnerships of $2.3 million and $6.0 million, respectively, for the same periods in 2020. We have made no new limited partnership commitments since 2006, and the balance of limited partnership investments is expected to decline over time as additional distributions are received.

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)2021202020212020
Securities sold:(Unaudited)(Unaudited)
Available-for-sale securities$397 $355 $1,880 $970 
Equity securities392 (1,840)899 (2,528)
Equity securities change in fair value1,979 8,010 793 (2,724)
Miscellaneous
Net realized investment gains (losses)$2,769 $6,526 $3,573 $(4,280)


Net realized gains during the second quarter of 2021 were primarily driven by market value adjustments on equity securities while net realized gains for the six months ended June 30, 2021 were primarily due to disposals of available-for-sale securities. Net realized gains during the second quarter of 2020 were primarily driven by increases in the fair value of equity securities while net realized losses for the six months ended June 30, 2020 were driven by the significant financial market volatility resulting from the COVID-19 pandemic.

Net impairment (losses) recoveries recognized in earnings
Net impairment losses during the second quarter of 2021 and net impairment recoveries for the six months ended June 30, 2021 were on credit impaired available-for-sale securities. Net impairment losses in 2020 were primarily due to the COVID-19 pandemic's impact on financial markets on our available-for-sale securities.


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Financial condition of Erie Insurance Exchange
Serving in the capacity of attorney-in-fact for the Exchange, we are dependent on the growth and financial condition of the Exchange, who is our sole customer. The strength of the Exchange and its wholly owned subsidiaries is rated annually by A.M. Best Company through assessing its financial stability and ability to pay claims. The ratings are generally based upon factors relevant to policyholders and are not directed toward return to investors. The Exchange and each of its property and casualty subsidiaries are rated A+ "Superior", the second highest financial strength rating, which is assigned to companies that have achieved superior overall performance when compared to the standards established by A.M. Best and have a superior ability to meet obligations to policyholders over the long term. On July 27, 2021, the outlook for the financial strength rating was affirmed as stable. As of December 31, 2020, only approximately 12% of insurance groups, in which the Exchange is included, are rated A+ or higher.

The financial statements of the Exchange are prepared in accordance with statutory accounting principles prescribed by the Commonwealth of Pennsylvania. Financial statements prepared under statutory accounting principles focus on the solvency of the insurer and generally provide a more conservative approach than under U.S. generally accepted accounting principles. Statutory direct written premiums of the Exchange and its wholly owned property and casualty subsidiaries grew 2.6% to $3.9 billion in the first six months of 2021 compared to the first six months of 2020. 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 $11.7 billion at June 30, 2021, $10.7 billion at December 31, 2020, and $9.4 billion at June 30, 2020. 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, 2021, December 31, 2020 and June 30, 2020.

We have prepared our financial statements considering the financial strength of the Exchange based on its A.M. Best rating and strong level of surplus. 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 I. Item 1A. "Risk Factors" related to COVID-19 included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021 for possible outcomes that could impact that determination.

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FINANCIAL CONDITION
 
Investments
Our investment portfolio is managed with the objective of maximizing after-tax returns on a risk-adjusted basis. The following table presents the carrying value of our investments as of: 
 
(dollars in thousands)June 30, 2021% to totalDecember 31, 2020% to total
(Unaudited)  
Fixed maturities$936,798 83 %$928,236 84 %
Equity securities:
Preferred stock93,798 94,071 
Common stock207 19 
Agent loans (1)
68,558 69,212 
Other investments28,845 14,325 
Total investments$1,128,206 100 %$1,105,863 100 %
(1)The current portion of agent loans is included with prepaid expenses and other current assets in the Statements of Financial Position.


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

Fixed maturities are carried at fair value with unrealized gains and losses, net of deferred taxes, included in shareholders’ equity. Net unrealized gains on fixed maturities, net of deferred taxes, totaled $17.2 million at June 30, 2021, compared to net unrealized gains of $23.3 million at December 31, 2020.

The following table presents a breakdown of the fair value of our fixed maturity portfolio by industry sector and rating as of:
(in thousands)
June 30, 2021 (1)
AAAAAABBBNon- investment
grade
Fair
value
 (Unaudited)
Basic materials$$$3,225 $2,125 $9,248 $14,598 
Communications8,792 8,511 17,656 17,837 52,796 
Consumer3,198 21,798 66,610 44,033 135,639 
Diversified1,045 624 1,669 
Energy4,176 7,881 19,251 11,952 43,260 
Financial1,019 64,308 115,182 15,604 196,113 
Industrial10,061 16,524 22,583 49,168 
Structured securities (2)
165,284 132,377 35,852 17,204 350,717 
Technology5,230 7,864 22,275 12,438 47,807 
U.S. Treasury21,391 21,391 
Utilities3,843 16,307 3,490 23,640 
Total
$170,514 $170,953 $163,343 $294,179 $137,809 $936,798 
(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.


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Equity securities
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.

The following table presents an analysis of the fair value of our nonredeemable preferred and common stock securities by sector as of:
(in thousands)June 30, 2021December 31, 2020
Preferred stockCommon stockPreferred stockCommon stock
(Unaudited)
Communications$2,161 $$2,699 $
Consumer2,295 3,068 
Energy2,745 207 2,187 19 
Financial services75,212 76,575 
Industrial 915 800 
Utilities10,470 8,742 
Total
$93,798 $207 $94,071 $19 
 
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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 2021. 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. 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 contained within this report and Part I. Item 1A. "Risk Factors" related to COVID-19 included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021.

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, may be illiquid.  Volatility in these markets could impair our ability to sell certain fixed income securities or cause such securities to sell at deep discounts. We believe we have sufficient liquidity to meet our needs from sources other than the liquidation of securities, even if market volatility persists throughout 2021 and beyond.
 
Cash flow activities
The following table provides condensed cash flow information for the six months ended June 30:
(in thousands)20212020
(Unaudited)(Unaudited)
Net cash provided by operating activities$127,720 $127,282 
Net cash used in investing activities(35,511)(115,423)
Net cash used in financing activities(97,411)(90,860)
Net decrease in cash and cash equivalents$(5,202)$(79,001)
 
 
Net cash provided by operating activities was $127.7 million in the first six months of 2021, compared to $127.3 million in the first six months of 2020. Increased cash provided by operating activities in the six months of 2021 was primarily due to an increase in management fees received driven by growth in direct and affiliated assumed premiums written by the Exchange of $47.4 million and an increase in administrative service reimbursements received of $21.8 million. Partially offsetting the increase in cash provided by operating activities was an increase in cash paid for agent commissions and agent bonuses of $15.9 million and $15.5 million, respectively, due to higher scheduled commission driven by premium growth, and increases in income taxes and salaries and wages paid of $14.9 million and $13.1 million, respectively, in the first six months of 2021 compared to the same period in 2020.

Net cash used in investing activities was $35.5 million in the first six months of 2021, compared to $115.4 million in the same period in 2020. In the first half of 2021, net cash used in investing activities was primarily driven by fixed asset purchases, as purchases of investments were offset by proceeds from sales and and maturities/calls of investments. Net cash used in investing activities in the first half of 2020 was primarily due to purchases of available-for-sale securities exceeding the proceeds generated from investment sales and maturities/calls of available-for-sale securities.

Net cash used in financing activities totaled $97.4 million in the first half of 2021, compared to $90.9 million in the first half of 2020. The increase in cash used in the first half of 2021, compared to the same period in 2020, was due to dividends paid to shareholders. We increased both our Class A and Class B shareholder regular quarterly dividends by 7.3% for 2021, compared to 2020.  There are no regulatory restrictions on the payment of dividends to our shareholders.

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There were no repurchases of our Class A nonvoting common stock in the first six months of 2021 and 2020 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, 2021, based upon trade date.

During the six months ended June 30, 2021, we purchased 23,558 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $4.7 million. Of this amount, we purchased 978 shares for $0.2 million, or $242.01 per share, for stock-based awards in conjunction with our equity compensation plan. We purchased 2,603 shares for $0.6 million, or $227.05 per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The remaining 19,977 shares were purchased at a total cost of $3.9 million, or $196.35 per share, to fund the rabbi trust for the incentive compensation deferral plan. All shares were delivered as of June 30, 2021.

During the 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.

Capital Outlook
We regularly prepare forecasts evaluating the current and future cash requirements for both normal and extreme risk 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 $156.0 million at June 30, 2021, 2) a $100 million bank revolving line of credit, and 3) liquidation of unpledged assets held in our investment portfolio, including preferred stock and investment grade bonds, which totaled approximately $655.7 million at June 30, 2021.  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, 2021, 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, 2021, a total of $99.1 million remains available under the facility due to $0.9 million outstanding letters of credit, which reduce the availability for letters of credit to $24.1 million.  We had no borrowings outstanding on our line of credit as of June 30, 2021. Investments with a fair value of $123.4 million were pledged as collateral on the line at June 30, 2021. The investments pledged as collateral have no trading restrictions and are reported as available-for-sale securities and cash and cash equivalents 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, 2021.

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, 2021, there were no material changes to our future contractual obligations as previously reported in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021.

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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, 2020 of our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on February 25, 2021.  See Part I, Item 1. "Financial Statements - Note 5, Fair Value, of Notes to Financial Statements" contained within this report for additional information on our valuation of investments.


ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Our exposure to market risk is primarily related to fluctuations in 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, 2020 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 25, 2021.

Significant volatility was seen in the global financial markets at the onset of the COVID-19 pandemic and pandemic related events may create future volatility; however, there have been no material changes that impact our portfolio or reshape our periodic investment reviews of asset allocations during the six months ended June 30, 2021. For a recent discussion of conditions surrounding our investment portfolio, see the "Operating Overview", "Results of Operations", and "Financial Condition" discussions contained in Part I, Item 2. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" contained within this report.


ITEM 4.    CONTROLS AND PROCEDURES
 
We carried out an evaluation, with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.
 
Our management evaluated, with the participation of the Chief Executive Officer and Chief Financial Officer, any change in our internal control over financial reporting and determined there has been no change in our internal control over financial reporting during the six months ended June 30, 2021 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

As disclosed in our prior periodic reports, all material litigation pending against the Company has been concluded.  There is currently no substantive disclosure for this item.

ITEM 1A.    RISK FACTORS
 
There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021.


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

Issuer Purchases of Equity Securities
In 2011, our Board of Directors approved a continuation of the current stock repurchase program, authorizing repurchases for a total of $150 million with no time limitation.  This repurchase authority included, and was not in addition to, any unspent amounts remaining under the prior authorization. There were no repurchases of our Class A common stock under this program during the six months ending June 30, 2021. We had approximately $17.8 million of repurchase authority remaining under this program at June 30, 2021.

During the quarter ending June 30, 2021, we purchased 19,038 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $3.6 million. We purchased 189 shares for $40 thousand, or $212.89 per share, in May 2021 and 17,403 shares for $3.3 million, or $190.74 per share, in June 2021 to fund the rabbi trust for the incentive compensation deferral plan. The shares were transferred to the rabbi trust in May and June 2021. The remaining 1,446 shares were purchased in May 2021 at a total cost of $0.3 million, or $212.89 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 2021.
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ITEM 6.    EXHIBITS
Exhibit  
Number Description of Exhibit
31.1* 
   
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 29, 2021By:/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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