Note 6. Fair Value

Our available-for-sale and trading securities are recorded at fair value, which is the price that would be received to sell the asset in an orderly transaction between willing market participants as of the measurement date.

Valuation techniques used to derive the fair value of our available-for-sale and trading securities are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources. Unobservable inputs reflect our own assumptions regarding fair market value for these securities. Although the majority of our prices are obtained from third party sources, we also perform an internal pricing review for securities with low trading volumes in the current market conditions. Financial instruments are categorized based upon the following characteristics or inputs to the valuation techniques:


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


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


•	Level 3 – Unobservable inputs for the asset or liability.

Estimates of fair values for our investment portfolio are obtained primarily from a nationally recognized pricing service. Our Level 1 category includes those securities valued using an exchange traded price provided by the pricing service. The methodologies used by the pricing service that support a Level 2 classification of a financial instrument include multiple verifiable, observable inputs including benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Pricing service valuations for Level 3 securities are based upon proprietary models and are used when observable inputs are not available or in illiquid markets.

In limited circumstances we adjust the price received from the pricing service when, in our judgment, a better reflection of fair value is available based upon corroborating information and our knowledge and monitoring of market conditions such as a disparity in price of comparable securities and/or non-binding broker quotes. In other circumstances, certain securities are internally priced because prices are not provided by the pricing service.

We perform continuous reviews of the prices obtained from the pricing service. This includes evaluating the methodology and inputs used by the pricing service to ensure that we determine the proper classification level of the financial instrument. Price variances, including large periodic changes, are investigated and corroborated by market data. We have reviewed the pricing methodologies of our pricing service as well as other observable inputs, such as data, and transaction volumes and believe that their prices adequately consider market activity in determining fair value. Our review process continues to evolve based upon accounting guidance and requirements.

When a price from the pricing service is not available, values are determined by obtaining non-binding broker quotes and/or market comparables. When available, we obtain multiple quotes for the same security. The ultimate value for these securities is determined based upon our best estimate of fair value using corroborating market information. Our evaluation includes the consideration of benchmark yields, reported trades, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data.

For certain structured securities in an illiquid market, there may be no prices available from a pricing service and no comparable market quotes available. In these situations, we value the security using an internally-developed, risk-adjusted discounted cash flow model.

The following table represents our consolidated fair value measurements on a recurring basis by asset class and level of input at March 31, 2013:



	Erie Insurance Group
	March 31, 2013
	Fair value measurements using:
(in millions)	Total		Quoted prices in active markets for identical assets Level 1		Observable inputs Level 2		Unobservable inputs Level 3
Indemnity
Available-for-sale securities:
States & political subdivisions	$	176	$	0	$	176	$	0
Corporate debt securities	243		0		242		1
Collateralized debt obligations	2		0		0		2
Total fixed maturities	421		0		418		3
Nonredeemable preferred stock	23		2		21		0
Common stock	26		26		0		0
Total available-for-sale securities	470		28		439		3
Other investments ⁽¹⁾	20		0		0		20
Total – Indemnity	$	490	$	28	$	439	$	23
Exchange
Available-for-sale securities:
U.S. government & agencies	$	185	$	0	$	185	$	0
States & political subdivisions	1,299		0		1,299		0
Foreign government securities	29		0		29		0
Corporate debt securities	5,974		0		5,916		58
Residential mortgage-backed securities	234		0		234		0
Commercial mortgage-backed securities	56		0		51		5
Collateralized debt obligations	46		0		32		14
Other debt securities	68		0		68		0
Total fixed maturities	7,891		0		7,814		77
Nonredeemable preferred stock	631		236		383		12
Common stock	312		312		0		0
Total available-for-sale securities	8,834		548		8,197		89
Trading securities:
Common stock	2,662		2,655		0		7
Total trading securities	2,662		2,655		0		7
Other investments ⁽¹⁾	112		0		0		112
Total – Exchange	$	11,608	$	3,203	$	8,197	$	208
Total – Erie Insurance Group	$	12,098	$	3,231	$	8,636	$	231

(1) Other investments measured at fair value represent four real estate funds included on the balance sheet as limited partnership investments that are reported under the fair value option. These investments can never be redeemed with the funds. Instead, distributions are received when liquidation of the underlying assets of the funds occur. It is estimated that the underlying assets will generally be liquidated between 5 and 10 years from the inception of the funds. The fair value of these investments is based on the net asset value (NAV) information provided by the general partner. Fair value is based on our proportionate share of the NAV based on the most recent partners' capital statements received from the general partners, which is generally one quarter prior to our balance sheet date. These values are then analyzed to determine if they represent the NAV at our balance sheet date, with adjustment being made where appropriate. We consider observable market data and perform a review validating the appropriateness of the NAV at each balance sheet date. It is likely that all of the investments will be redeemed at a future date for an amount different than the NAV of our ownership interest in partners' capital as of March 31, 2013. During the quarter ended March 31, 2013, Indemnity made no contributions and received no distributions, and the Exchange made no contributions and received distributions totaling $0.8 million for these investments. As of March 31, 2013, the amount of unfunded commitments related to the investments was $1.5 million for Indemnity and $4.5 million for the Exchange.

Level 3 Assets – Quarterly Change:



	Erie Insurance Group
(in millions)	Beginning balance at December 31, 2012		Included in earnings ⁽¹⁾			Included in other comprehensive income		Purchases		Sales			Transfers in and (out) of Level 3 ⁽²⁾		Ending balance at March 31, 2013
Indemnity
Available-for-sale securities:
Corporate debt securities	$	1	$	0		$	0	$	0	$	0		$	0	$	1
Collateralized debt obligations	3		0			0		0		(1		)	0		2
Total fixed maturities	4		0			0		0		(1		)	0		3
Total available-for-sale securities	4		0			0		0		(1		)	0		3
Other investments	19		1			0		0		0			0		20
Total Level 3 assets – Indemnity	$	23	$	1		$	0	$	0	$	(1	)	$	0	$	23
Exchange
Available-for-sale securities:
Corporate debt securities	$	43	$	0		$	1	$	0	$	(1	)	$	15	$	58
Commercial mortgage-backed securities	0		0			0		0		0			5		5
Collateralized debt obligations	16		1			1		0		(5		)	1		14
Total fixed maturities	59		1			2		0		(6		)	21		77
Nonredeemable preferred stock	0		0			3		4		0			5		12
Total available-for-sale securities	59		1			5		4		(6		)	26		89
Trading securities:
Common stock	15		(3		)	0		0		(5		)	0		7
Total trading securities	15		(3		)	0		0		(5		)	0		7
Other investments	109		4			0		0		(1		)	0		112
Total Level 3 assets – Exchange	$	183	$	2		$	5	$	4	$	(12	)	$	26	$	208
Total Level 3 assets – Erie Insurance Group	$	206	$	3		$	5	$	4	$	(13	)	$	26	$	231


(1)	These amounts are reported in the Consolidated Statement of Operations. There is $2 million of losses included in net realized investment gains (losses) and $5 million of earnings included in equity in earnings of limited partnerships for the three months ended March 31, 2013 on Level 3 securities.


(2)	Transfers in and out of Level 3 are attributable to changes in the availability of market observable information for individual securities within the respective categories. Transfers in and out of levels are recognized at the start of the period.

We review the fair value hierarchy classifications each reporting period. Transfers between hierarchy levels may occur due to changes in the available market observable inputs. Transfers in and out of level classifications are reported as having occurred at the beginning of the quarter in which the transfers occurred.

For Indemnity, there were no Level 1 to Level 2 transfers for the three months ended March 31, 2013. Level 2 to Level 1 transfers totaled $1 million, due to trading activity levels related to one preferred stock holding, and there were no transfers between Levels 2 and 3.

For the Exchange, Level 1 to Level 2 transfers totaled $6 million and Level 2 to Level 1 transfers totaled $51 million due to trading activity levels related to one preferred stock holding and five preferred stock holdings, respectively, for the three months ended March 31, 2013. Level 2 to Level 3 transfers totaled $39 million related to seven fixed maturity holdings and one preferred stock holding. Level 3 to Level 2 transfers totaled $13 million for one fixed maturity holding. These transfers in and out of Level 3 were primarily the result of using non-binding and binding broker quotes, respectively, to determine the fair value at March 31, 2013.

Quantitative and Qualitative Disclosures about Unobservable Inputs



	Erie Insurance Group
	March 31, 2013
(dollars in millions)	Fair value		No. of holdings	Valuation techniques	Unobservable input	Range	Weighted average
Indemnity
Corporate debt securities	$	1	1	Market approach	Non-binding broker quote	114.84
Collateralized debt obligations	2		2	Income approach	Projected maturity date	Sep 2014
					Repayment at maturity	42 - 100%	81.7%
					Discount rate	7.5 - 15.0%	9.9%
					Projected LIBOR rate	0.29%
Total Level 3 assets – Indemnity	$	3	3

Exchange
Corporate debt securities	58		11	Market approach	Non-binding broker quote	101.5 - 115.50	108.62
					Comparable transaction EBITDA multiples	6.7 - 17.1x	8.0x
					Comparable security yield	6.00%
Commercial mortgage-backed securities	5		1	Market approach	Non-binding broker quote	102.63
Collateralized debt obligations	11		4	Income approach	Projected maturity date	Sep 2014 - Oct 2035
					Repayment at maturity	42 - 100%	88.1%
					Discount rate	7.0 - 15.0%	8.9%
					Projected LIBOR rate	0.29%

	3		3	Market approach	Non-binding broker quote	15 - 64	51.6
Nonredeemable preferred stock	12		2	Market approach	Non-binding broker quote	104.00
					Comparable transaction EBITDA multiples	6.7 - 17.1x	8.0x
Common stock	7		3	Market approach	Comparable transaction EBITDA multiples	6.7 - 17.1x	8.0x
					Discount for lack of marketability	5 - 30%	30%
Total Level 3 assets – Exchange	$	96	24
Total Level 3 assets – Erie Insurance Group	$	99	27

Securities valued using unobservable inputs shown above totaled $99 million at March 31, 2013. Other investments representing certain limited partnerships recorded at fair value of $132 million are also included in Level 3 within our consolidated fair value measurements. These values are based upon net asset value (NAV) information provided by the general partner. In total, Level 3 assets represent less than 1.9% of the assets measured at fair value on a recurring basis for the Erie Insurance Group.

Collateralized-debt-obligation securities – The unobservable inputs used in the fair value measurement of certain collateralized-debt-obligation securities are the repayment at maturity of underlying collateral available to pay note holders, the projected maturity of the underlying security, an expectation that the London Inter-Bank Offer Rates (“LIBOR”) do not change until maturity and a discount rate appropriate for the security. Significant changes in any of those inputs in isolation would result in a significantly higher or lower fair value measurement. Generally, a change in the assumption used for the performance of the underlying collateral is accompanied by an opposite change in the maturity and a directionally opposite change in the discount rate used to value the security. LIBOR assumptions are independent of collateral performance.

Corporate debt securities, Commercial mortgage-backed securities and Nonredeemable preferred stock – When a non-binding broker quote was the only input available, it was considered unobservable.

Corporate debt securities – The unobservable input used in the fair value measurement of certain corporate debt securities is the likelihood of repayment by the underlying entity when there is no market for trading these securities. When available, we obtain non-binding broker quotes to value such securities.

Common stock investments, Nonredeemable preferred stock and Corporate debt securities – The unobservable inputs used in the fair value measurement of direct private equity common stock investments, certain corporate debt securities and certain nonredeemable preferred securities are comparable private transaction earnings before interest, taxes, depreciation and amortization (“EBITDA”) multiples, the average EBITDA multiple for comparable publicly traded companies and the amount of discount applied to the price due to the illiquidity of the securities being valued. Significant changes in any of those inputs in isolation could result in a significantly higher or lower fair value measurement.

The following table represents our consolidated fair value measurements on a recurring basis by asset class and level of input at December 31, 2012:



	Erie Insurance Group
	December 31, 2012
	Fair value measurements using:
(in millions)	Total		Quoted prices in active markets for identical assets Level 1		Observable inputs Level 2		Unobservable inputs Level 3
Indemnity
Available-for-sale securities:
States & political subdivisions	$	185	$	0	$	185	$	0
Corporate debt securities	261		0		260		1
Commercial mortgage-backed securities	3		0		3		0
Collateralized debt obligations	3		0		0		3
Total fixed maturities	452		0		448		4
Nonredeemable preferred stock	29		4		25		0
Common stock	26		26		0		0
Total available-for-sale securities	507		30		473		4
Other investments ⁽¹⁾	19		0		0		19
Total – Indemnity	$	526	$	30	$	473	$	23
Exchange
Available-for-sale securities:
U.S. government & agencies	$	191	$	0	$	191	$	0
States & political subdivisions	1,321		0		1,321		0
Foreign government securities	16		0		16		0
Corporate debt securities	5,777		0		5,734		43
Residential mortgage-backed securities	231		0		231		0
Commercial mortgage-backed securities	67		0		67		0
Collateralized debt obligations	49		0		33		16
Other debt securities	55		0		55		0
Total fixed maturities	7,707		0		7,648		59
Nonredeemable preferred stock	631		199		432		0
Common stock	314		314		0		0
Total available-for-sale securities	8,652		513		8,080		59
Trading securities:
Common stock	2,417		2,402		0		15
Total trading securities	2,417		2,402		0		15
Other investments ⁽¹⁾	109		0		0		109
Total – Exchange	$	11,178	$	2,915	$	8,080	$	183
Total – Erie Insurance Group	$	11,704	$	2,945	$	8,553	$	206

(1) Other investments measured at fair value represent four real estate funds included on the balance sheet as limited partnership investments that are reported under the fair value option. These investments can never be redeemed with the funds. Instead, distributions are received when liquidation of the underlying assets of the funds occur. It is estimated that the underlying assets will generally be liquidated between 5 and 10 years from the inception of the funds. The fair value of these investments is based on the net asset value (NAV) information provided by the general partner. Fair value is based on our proportionate share of the NAV based on the most recent partners' capital statements received from the general partners, which is generally one quarter prior to our balance sheet date. These values are then analyzed to determine if they represent the NAV at our balance sheet date, with adjustment being made where appropriate. We consider observable market data and perform a review validating the appropriateness of the NAV at each balance sheet date. It is likely that all of the investments will be redeemed at a future date for an amount different than the NAV of our ownership interest in partners' capital as of December 31, 2012. During the year ended December 31, 2012, Indemnity made contributions totaling $0.2 million and received distributions totaling $0.3 million, and the Exchange made contributions totaling $0.7 million and received distributions totaling $4.7 million for these investments. As of December 31, 2012, the amount of unfunded commitments related to the investments was $1.5 million for Indemnity and $4.5 million for the Exchange.

Level 3 Assets – Quarterly Change:



	Erie Insurance Group
(in millions)	Beginning balance at December 31, 2011		Included in earnings ⁽¹⁾		Included in other comprehensive income		Purchases		Sales			Transfers in and (out) of Level 3 ⁽²⁾		Ending balance at March 31, 2012
Indemnity
Available-for-sale securities:
Corporate debt securities	$	0	$	0	$	0	$	0	$	0		$	1	$	1
Collateralized debt obligations	4		0		0		0		0			0		4
Total fixed maturities	4		0		0		0		0			1		5
Total available-for-sale securities	4		0		0		0		0			1		5
Other investments ⁽³⁾	17		0		0		0		0			0		17
Total Level 3 assets – Indemnity	$	21	$	0	$	0	$	0	$	0		$	1	$	22
Exchange
Available-for-sale securities:
States & political subdivisions	$	4	$	0	$	1	$	0	$	0		$	0	$	5
Corporate debt securities	12		0		0		0		0			14		26
Collateralized debt obligations	29		0		0		0		(4		)	2		27
Other debt securities	5		0		0		0		0			0		5
Total fixed maturities	50		0		1		0		(4		)	16		63
Nonredeemable preferred stock	5		0		1		0		0			0		6
Total available-for-sale securities	55		0		2		0		(4		)	16		69
Trading securities:
Common stock	12		2		0		0		0			0		14
Total trading securities	12		2		0		0		0			0		14
Other investments ⁽³⁾	102		1		0		1		(1		)	0		103
Total Level 3 assets – Exchange	$	169	$	3	$	2	$	1	$	(5	)	$	16	$	186
Total Level 3 assets – Erie Insurance Group	$	190	$	3	$	2	$	1	$	(5	)	$	17	$	208


(1)	These amounts are reported in the Consolidated Statement of Operations. There is $2 million of earnings included in net realized investment gains (losses) and $1 million of earnings included in equity in earnings of limited partnerships for the three months ended March 31, 2012 on Level 3 securities.


(2)	Transfers in and out of Level 3 are attributable to changes in the availability of market observable information for individual securities within the respective categories. Transfers in and out of levels are recognized at the start of the period.


(3)	The other investments reported as Level 3 assets represent four real estate funds which were previously presented with our limited partnerships reported under the equity method of accounting and therefore were not included in our fair value measurements table. This table has been adjusted to reflect the appropriate fair value of these assets during the first quarter of 2012.

For Indemnity, there were no transfers between Levels 1 and 2 for the three months ended March 31, 2012. Level 2 to Level 3 transfers totaled $1 million related to one fixed maturity holding, primarily as the result of using non-binding broker quotes to determine the fair value at March 31, 2012, and there were no Level 3 to Level 2 transfers.

For the Exchange, there were no transfers between Levels 1 and 2 for the three months ended March 31, 2012. Level 2 to Level 3 transfers totaled $16 million related to five fixed maturity holdings, primarily as the result of using non-binding broker quotes to determine the fair value at March 31, 2012, and there were no Level 3 to Level 2 transfers.

The following table sets forth our consolidated fair value measurements on a recurring basis by pricing source at March 31, 2013:



	Erie Insurance Group
(in millions)	March 31, 2013
	Total		Level 1		Level 2		Level 3
Indemnity
Fixed maturities:
Priced via pricing services	$	404	$	0	$	404	$	0
Priced via market comparables/non-binding broker quotes ⁽¹⁾	15		0		14		1
Priced via unobservable inputs	2		0		0		2
Total fixed maturities	421		0		418		3
Nonredeemable preferred stock:
Priced via pricing services	21		2		19		0
Priced via market comparables/non-binding broker quotes ⁽¹⁾	2		0		2		0
Priced via unobservable inputs	0		0		0		0
Total nonredeemable preferred stock	23		2		21		0
Common stock:
Priced via pricing services	26		26		0		0
Priced via market comparables/non-binding broker quotes ⁽¹⁾	0		0		0		0
Priced via unobservable inputs	0		0		0		0
Total common stock	26		26		0		0
Other investments:
Priced via unobservable inputs ⁽²⁾	20		0		0		20
Total other investments	20		0		0		20
Total – Indemnity	$	490	$	28	$	439	$	23
Exchange
Fixed maturities:
Priced via pricing services	$	7,724	$	0	$	7,724	$	0
Priced via market comparables/non-binding broker quotes ⁽¹⁾	147		0		90		57
Priced via unobservable inputs	20		0		0		20
Total fixed maturities	7,891		0		7,814		77
Nonredeemable preferred stock:
Priced via pricing services	604		236		368		0
Priced via market comparables/non-binding broker quotes ⁽¹⁾	20		0		15		5
Priced via unobservable inputs	7		0		0		7
Total nonredeemable preferred stock	631		236		383		12
Common stock:
Priced via pricing services	2,967		2,967		0		0
Priced via market comparables/non-binding broker quotes ⁽¹⁾	0		0		0		0
Priced via unobservable inputs	7		0		0		7
Total common stock	2,974		2,967		0		7
Other investments:
Priced via unobservable inputs ⁽²⁾	112		0		0		112
Total other investments	112		0		0		112
Total – Exchange	$	11,608	$	3,203	$	8,197	$	208
Total – Erie Insurance Group	$	12,098	$	3,231	$	8,636	$	231


(1)	All broker quotes obtained for securities were non-binding. When a non-binding broker quote was the only price available, the security was classified as Level 3.


(2)	Other investments measured at fair value represent four real estate funds included on the balance sheet as limited partnership investments that are reported under the fair value option. The fair value of these investments is based on the net asset value (NAV) information provided by the general partner.

There were no assets measured at fair value on a nonrecurring basis during the three months ended March 31, 2013.