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 under 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 broker/dealer quotes and/or market comparables. When available, we obtain multiple quotes for the same security. The ultimate value for these securities is determined based upon our best estimate of fair value using corroborating market information. Our evaluation includes the consideration of benchmark yields, reported trades, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data.

For certain 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 June 30, 2014:



	Erie Insurance Group
	June 30, 2014
	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	$	241	$	0	$	241	$	0
Corporate debt securities	256		0		255		1
Collateralized debt obligations	0		0		0		0
Total fixed maturities	497		0		496		1
Nonredeemable preferred stock	14		2		12		0
Common stock	12		12		0		0
Total available-for-sale securities	523		14		508		1
Other investments ⁽¹⁾	18		0		0		18
Total – Indemnity	$	541	$	14	$	508	$	19
Exchange
Available-for-sale securities:
U.S. treasury	$	31	$	0	$	31	$	0
Government sponsored enterprises	4		0		4		0
States & political subdivisions	1,519		0		1,519		0
Foreign government securities	15		0		15		0
Corporate debt securities	6,866		0		6,841		25
Residential mortgage-backed securities	146		0		146		0
Commercial mortgage-backed securities	34		0		34		0
Collateralized debt obligations	14		0		14		0
Other debt securities	72		0		72		0
Total fixed maturities	8,701		0		8,676		25
Nonredeemable preferred stock	717		303		413		1
Common stock	197		197		0		0
Total available-for-sale securities	9,615		500		9,089		26
Trading securities:
Common stock	3,377		3,362		0		15
Total trading securities	3,377		3,362		0		15
Other investments ⁽¹⁾	102		0		0		102
Total – Exchange	$	13,094	$	3,862	$	9,089	$	143
Total – Erie Insurance Group	$	13,635	$	3,876	$	9,597	$	162

(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 June 30, 2014. During the six months ended June 30, 2014, Indemnity made no contributions and received distributions totaling $1.8 million, and the Exchange made no contributions and received distributions totaling $6.9 million for these investments. As of June 30, 2014, 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 March 31, 2014		Included in earnings ⁽¹⁾		Included in other comprehensive income		Purchases		Sales			Transfers in and (out) of Level 3 ⁽²⁾		Ending balance at June 30, 2014
Indemnity
Available-for-sale securities:
Corporate debt securities	$	1	$	0	$	0	$	0	$	0		$	0	$	1
Collateralized debt obligations	0		0		0		0		0			0		0
Total fixed maturities	1		0		0		0		0			0		1
Total available-for-sale securities	1		0		0		0		0			0		1
Other investments	18		1		0		0		(1		)	0		18
Total Level 3 assets – Indemnity	$	19	$	1	$	0	$	0	$	(1	)	$	0	$	19
Exchange
Available-for-sale securities:
Corporate debt securities	$	26	$	0	$	0	$	0	$	(1	)	$	0	$	25
Collateralized debt obligations	0		0		0		0		0			0		0
Total fixed maturities	26		0		0		0		(1		)	0		25
Nonredeemable preferred stock	1		0		0		0		0			0		1
Total available-for-sale securities	27		0		0		0		(1		)	0		26
Trading securities:
Common stock	15		0		0		0		0			0		15
Total trading securities	15		0		0		0		0			0		15
Other investments	98		6		0		0		(2		)	0		102
Total Level 3 assets – Exchange	$	140	$	6	$	0	$	0	$	(3	)	$	0	$	143
Total Level 3 assets – Erie Insurance Group	$	159	$	7	$	0	$	0	$	(4	)	$	0	$	162


(1)	These amounts are reported in the Consolidated Statement of Operations. There is $7 million included in equity in earnings of limited partnerships for the three months ended June 30, 2014 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 transfers between Level 1 and Level 2 or between Level 2 and Level 3 for the three months ended June 30, 2014.

For the Exchange, Level 1 to Level 2 transfers totaled $11 million due to trading activity levels for one preferred stock holding, and there were no transfers from Level 2 to Level 1 or between Level 2 and Level 3 for the three months ended June 30, 2014.

Level 3 Assets – Year-to-Date Change:




	Erie Insurance Group
(in millions)	Beginning balance at December 31, 2013		Included in earnings ⁽¹⁾		Included in other comprehensive income			Purchases		Sales			Transfers in and (out) of Level 3 ⁽²⁾			Ending balance at June 30, 2014
Indemnity
Available-for-sale securities:
Corporate debt securities	$	1	$	0	$	0		$	0	$	0		$	0		$	1
Collateralized debt obligations	1		0		0			0		(1		)	0			0
Total fixed maturities	2		0		0			0		(1		)	0			1
Total available-for-sale securities	2		0		0			0		(1		)	0			1
Other investments	18		2		0			0		(2		)	0			18
Total Level 3 assets – Indemnity	$	20	$	2	$	0		$	0	$	(3	)	$	0		$	19
Exchange
Available-for-sale securities:
Corporate debt securities	$	26	$	0	$	0		$	0	$	(1	)	$	0		$	25
Collateralized debt obligations	5		1		(1		)	0		(3		)	(2		)	0
Total fixed maturities	31		1		(1		)	0		(4		)	(2		)	25
Nonredeemable preferred stock	0		0		0			1		0			0			1
Total available-for-sale securities	31		1		(1		)	1		(4		)	(2		)	26
Trading securities:
Common stock	15		0		0			0		0			0			15
Total trading securities	15		0		0			0		0			0			15
Other investments	98		11		0			0		(7		)	0			102
Total Level 3 assets – Exchange	$	144	$	12	$	(1	)	$	1	$	(11	)	$	(2	)	$	143
Total Level 3 assets – Erie Insurance Group	$	164	$	14	$	(1	)	$	1	$	(14	)	$	(2	)	$	162


(1)	These amounts are reported in the Consolidated Statement of Operations. There is $1 million included in net realized investment gains (losses) and $13 million included in equity in earnings of limited partnerships for the six months ended June 30, 2014 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.

For Indemnity, there were no transfers between Level 1 and Level 2 or between Level 2 and Level 3 for the six months ended June 30, 2014.

For the Exchange, Level 1 to Level 2 transfers totaled $14 million due to trading activity levels for two preferred stock holdings, and there were no transfers from Level 2 to Level 1 for the six months ended June 30, 2014. There were no Level 2 to Level 3 transfers, and Level 3 to Level 2 transfers totaled $2 million for one fixed maturity holding as a result of using observable market data to determine the fair value at June 30, 2014.

Quantitative and Qualitative Disclosures about Unobservable Inputs



	Erie Insurance Group
	June 30, 2014
(dollars in millions)	Fair value		No. of holdings	Valuation techniques	Unobservable input	Range	Weighted average
Indemnity
Corporate debt securities ⁽¹⁾	$	1	1	Market approach	Non-binding broker quote	114
Collateralized debt obligations ⁽²⁾	0		1	Income approach	Projected maturity date	Dec 2014
					Repayment at maturity	1%
					Discount rate	15%
Other investments ⁽⁴⁾	18		2
Total Level 3 assets – Indemnity	$	19	4

Exchange
Corporate debt securities ⁽¹⁾⁽³⁾	$	25	7	Market approach	Non-binding broker quote	109-117	111
					Comparable transaction EBITDA multiples	8.0 - 12.1x	8.0x
					Comparable security yield	6%
Collateralized debt obligations ⁽²⁾	0		2	Income approach	Projected maturity date	Dec 2014 - Oct 2035
					Repayment at maturity	1 - 100%	64%
					Discount rate	15 - 18%	17%

Nonredeemable preferred stock ⁽⁵⁾	1		1	Market approach	Comparable company price-to-sales ratio	12.0 - 22.0x	19.0x
Common stock ⁽³⁾	15		4	Market approach	Comparable transaction EBITDA multiples	8.0 - 12.1x	8.0x
					Discount for lack of marketability	5 - 30%	10%
Other investments ⁽⁴⁾	102		4
Total Level 3 assets – Exchange	$	143	18
Total Level 3 assets – Erie Insurance Group	$	162	22

(1)

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. When a non-binding broker quote was the only input available, it was considered unobservable.

(2)

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, 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.

(3)

Common stock investments and Corporate debt securities – The unobservable inputs used in the fair value measurement of direct private equity common stock investments and certain corporate debt 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.


(4)	Other investments – Other investments represent certain limited partnerships that are recorded at fair value and are based upon net asset value (NAV) provided by the general partner where the unobservable inputs are not reasonably available to us.


(5)	Nonredeemable preferred stock - The unobservable input used in the fair value measurement of a private nonredeemable preferred stock security is the price to sales ratio for comparable publicly traded companies.

Securities valued using unobservable inputs shown above totaled $162 million at June 30, 2014. In total, Level 3 assets represent less than 1.2% of the total assets measured at fair value on a recurring basis for the Erie Insurance Group.

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



	Erie Insurance Group
	December 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	$	243	$	0	$	243	$	0
Corporate debt securities	282		0		281		1
Collateralized debt obligations	1		0		0		1
Total fixed maturities	526		0		524		2
Nonredeemable preferred stock	25		2		23		0
Common stock	25		25		0		0
Total available-for-sale securities	576		27		547		2
Other investments ⁽¹⁾	18		0		0		18
Total – Indemnity	$	594	$	27	$	547	$	20
Exchange
Available-for-sale securities:
U.S. government & agencies	$	172	$	0	$	172	$	0
States & political subdivisions	1,470		0		1,470		0
Foreign government securities	15		0		15		0
Corporate debt securities	6,211		0		6,185		26
Residential mortgage-backed securities	156		0		156		0
Commercial mortgage-backed securities	47		0		47		0
Collateralized debt obligations	16		0		11		5
Other debt securities	75		0		75		0
Total fixed maturities	8,162		0		8,131		31
Nonredeemable preferred stock	621		242		379		0
Common stock	198		198		0		0
Total available-for-sale securities	8,981		440		8,510		31
Trading securities:
Common stock	3,202		3,187		0		15
Total trading securities	3,202		3,187		0		15
Other investments ⁽¹⁾	98		0		0		98
Total – Exchange	$	12,281	$	3,627	$	8,510	$	144
Total – Erie Insurance Group	$	12,875	$	3,654	$	9,057	$	164

(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, 2013. During the year ended December 31, 2013, Indemnity made no contributions and received distributions totaling $2.4 million, and the Exchange made no contributions and received distributions totaling $21.7 million for these investments. As of December 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 March 31, 2013		Included in earnings ⁽¹⁾		Included in other comprehensive income			Purchases		Sales			Transfers in and (out) of Level 3 ⁽²⁾			Ending balance at June 30, 2013
Indemnity
Available-for-sale securities:
Corporate debt securities	$	1	$	0	$	0		$	0	$	0		$	0		$	1
Collateralized debt obligations	2		0		0			0		(1		)	0			1
Total fixed maturities	3		0		0			0		(1		)	0			2
Total available-for-sale securities	3		0		0			0		(1		)	0			2
Other investments	20		0		0			0		0			0			20
Total Level 3 assets – Indemnity	$	23	$	0	$	0		$	0	$	(1	)	$	0		$	22
Exchange
Available-for-sale securities:
Corporate debt securities	58		0		(1		)	1		(2		)	(23		)	33
Commercial mortgage-backed securities	5		0		0			0		(1		)	0			4
Collateralized debt obligations	14		1		(1		)	0		(2		)	0			12
Total fixed maturities	77		1		(2		)	1		(5		)	(23		)	49
Nonredeemable preferred stock	12		2		(1		)	0		(6		)	0			7
Total available-for-sale securities	89		3		(3		)	1		(11		)	(23		)	56
Trading securities:
Common stock	7		0		0			0		0			0			7
Total trading securities	7		0		0			0		0			0			7
Other investments	112		2		0			0		(1		)	0			113
Total Level 3 assets – Exchange	$	208	$	5	$	(3	)	$	1	$	(12	)	$	(23	)	$	176
Total Level 3 assets – Erie Insurance Group	$	231	$	5	$	(3	)	$	1	$	(13	)	$	(23	)	$	198


(1)	These amounts are reported in the Consolidated Statement of Operations. There is $3 million included in net realized investment gains (losses) and $2 million included in equity in earnings of limited partnerships for the three months ended June 30, 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.

For Indemnity, there were no transfers between Level 1 and Level 2 or between Level 2 and Level 3 for the three months ended June 30, 2013.

For the Exchange, there were no transfers between Level 1 and Level 2 or from Level 2 to Level 3 for the three months ended June 30, 2013. Level 3 to Level 2 transfers totaled $23 million for three fixed maturity holdings. These transfers out of Level 3 were primarily the result of using observable market data to determine the fair value at June 30, 2013.

Level 3 Assets – Year-to-Date 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 June 30, 2013
Indemnity
Available-for-sale securities:
Corporate debt securities	$	1	$	0		$	0		$	0	$	0		$	0		$	1
Collateralized debt obligations	3		0			0			0		(2		)	0			1
Total fixed maturities	4		0			0			0		(2		)	0			2
Total available-for-sale securities	4		0			0			0		(2		)	0			2
Other investments	19		1			0			0		0			0			20
Total Level 3 assets – Indemnity	$	23	$	1		$	0		$	0	$	(2	)	$	0		$	22
Exchange
Available-for-sale securities:
Corporate debt securities	$	43	$	0		$	(1	)	$	1	$	(2	)	$	(8	)	$	33
Commercial mortgage-backed securities	0		0			(1		)	0		(1		)	6			4
Collateralized debt obligations	16		1			0			0		(7		)	2			12
Total fixed maturities	59		1			(2		)	1		(10		)	0			49
Nonredeemable preferred stock	0		0			3			4		0			0			7
Total available-for-sale securities	59		1			1			5		(10		)	0			56
Trading securities:
Common stock	15		(3		)	0			0		(5		)	0			7
Total trading securities	15		(3		)	0			0		(5		)	0			7
Other investments	109		7			0			0		(3		)	0			113
Total Level 3 assets – Exchange	$	183	$	5		$	1		$	5	$	(18	)	$	0		$	176
Total Level 3 assets – Erie Insurance Group	$	206	$	6		$	1		$	5	$	(20	)	$	0		$	198


(1)	These amounts are reported in the Consolidated Statement of Operations. There is $(2) million of losses included in net realized investment (losses) and $8 million included in equity in earnings of limited partnerships for the six months ended June 30, 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.

For Indemnity, there were no Level 1 to Level 2 transfers for the six months ended June 30, 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 $5 million and Level 2 to Level 1 transfers totaled $44 million due to trading activity levels related to one preferred stock holding and five preferred stock holdings, respectively, for the six months ended June 30, 2013. Level 2 to Level 3 transfers totaled $18 million for five fixed maturity holdings and Level 3 to Level 2 transfers totaled $18 million for two fixed maturity holdings. 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 June 30, 2013.

The following table presents our consolidated fair value measurements on a recurring basis by pricing source at June 30, 2014:



	Erie Insurance Group
(in millions)	June 30, 2014
	Total		Level 1		Level 2		Level 3
Indemnity
Fixed maturities:
Priced via pricing services	$	496	$	0	$	496	$	0
Priced via market comparables/broker quotes ⁽¹⁾	1		0		0		1
Priced via internal modeling	0		0		0		0
Total fixed maturities	497		0		496		1
Nonredeemable preferred stock:
Priced via pricing services	12		2		10		0
Priced via market comparables/broker quotes ⁽¹⁾	2		0		2		0
Total nonredeemable preferred stock	14		2		12		0
Common stock:
Priced via pricing services	12		12		0		0
Total common stock	12		12		0		0
Other investments:
Priced via unobservable inputs ⁽²⁾	18		0		0		18
Total other investments	18		0		0		18
Total – Indemnity	$	541	$	14	$	508	$	19
Exchange
Fixed maturities:
Priced via pricing services	$	8,646	$	0	$	8,646	$	0
Priced via market comparables/broker quotes ⁽¹⁾	48		0		30		18
Priced via internal modeling	7		0		0		7
Total fixed maturities	8,701		0		8,676		25
Nonredeemable preferred stock:
Priced via pricing services	679		303		376		0
Priced via market comparables/broker quotes ⁽¹⁾	37		0		37		0
Priced via internal modeling	1		0		0		1
Total nonredeemable preferred stock	717		303		413		1
Common stock:
Priced via pricing services	3,559		3,559		0		0
Priced via internal modeling	15		0		0		15
Total common stock	3,574		3,559		0		15
Other investments:
Priced via unobservable inputs ⁽²⁾	102		0		0		102
Total other investments	102		0		0		102
Total – Exchange	$	13,094	$	3,862	$	9,089	$	143
Total – Erie Insurance Group	$	13,635	$	3,876	$	9,597	$	162


(1)	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 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 six months ended June 30, 2014.