10-Q 1 erie10-q03312019.htm 10-Q Document

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 March 31, 2019
 
Commission file number 0-24000
 
 
ERIE INDEMNITY COMPANY
 
 
(Exact name of registrant as specified in its charter)
 
 
PENNSYLVANIA
 
25-0466020
 
 
(State or other jurisdiction of
 
(I.R.S. Employer
 
 
incorporation or organization)
 
Identification No.)
 
 
 
100 Erie Insurance Place, Erie, Pennsylvania
 
16530
 
 
(Address of principal executive offices)
 
(Zip Code)
 
 
 
 
 
 
 
(814) 870-2000
 
 
(Registrant’s telephone number, including area code)
 
 
Not applicable
 
 
(Former name, former address and former fiscal year, if changed since last report)
 
  
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter 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 [X]   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 [X]   No [  ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer [X]            Accelerated filer [  ]        Non-accelerated filer [  ]
                                    
Smaller reporting company [  ]        Emerging growth company [  ]    
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange
Act. [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [  ]   No [X]
 
The number of shares outstanding of the registrant’s Class A Common Stock as of the latest practicable date, with no par value and a stated value of $0.0292 per share, was 46,189,068 at April 12, 2019.
 
The number of shares outstanding of the registrant’s Class B Common Stock as of the latest practicable date, with no par value and a stated value of $70 per share, was 2,542 at April 12, 2019.



 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART I. FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS

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

 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
Operating revenue
 
 

 
 

Management fee revenue - policy issuance and renewal services, net
 
$
430,983

 
$
405,978

Management fee revenue - administrative services, net
 
13,951

 
13,074

Administrative services reimbursement revenue
 
142,480

 
145,963

Service agreement revenue
 
6,692

 
7,145

Total operating revenue
 
594,106

 
572,160

 
 
 
 
 
Operating expenses
 
 
 
 
Cost of operations - policy issuance and renewal services
 
365,504

 
348,630

Cost of operations - administrative services
 
142,480

 
145,963

Total operating expenses
 
507,984

 
494,593

Operating income
 
86,122

 
77,567

 
 
 
 
 
Investment income
 
 
 
 
Net investment income
 
8,517

 
6,820

Net realized investment gains (losses)
 
2,503

 
(465
)
Net impairment losses recognized in earnings
 
(78
)
 
0

Equity in losses of limited partnerships
 
(1,147
)
 
(192
)
Total investment income
 
9,795

 
6,163

 
 
 
 
 
Interest expense, net
 
449

 
553

Other income
 
47

 
44

Income before income taxes
 
95,515

 
83,221

Income tax expense
 
20,204

 
17,463

Net income
 
$
75,311

 
$
65,758

 
 
 
 
 
 
 
 
 
 
Net income per share
 
 

 
 

Class A common stock – basic
 
$
1.62

 
$
1.41

Class A common stock – diluted
 
$
1.44

 
$
1.26

Class B common stock – basic and diluted
 
$
243

 
$
212

 
 
 
 
 
Weighted average shares outstanding – Basic
 
 

 
 

Class A common stock
 
46,188,337

 
46,187,908

Class B common stock
 
2,542

 
2,542

 
 
 
 
 
Weighted average shares outstanding – Diluted
 
 

 
 

Class A common stock
 
52,312,036

 
52,310,628

Class B common stock
 
2,542

 
2,542

 
 
 
 
 
Dividends declared per share
 
 

 
 

Class A common stock
 
$
0.90

 
$
0.84

Class B common stock
 
$
135.00

 
$
126.00

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

3


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

 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
Net income
 
$
75,311

 
$
65,758

 
 
 
 
 
Other comprehensive income (loss), net of tax
 
 

 
 

Change in unrealized holding gains (losses) on available-for-sale securities
 
5,478

 
(5,427
)
Amortization of prior service costs and net actuarial loss on pension and other postretirement plans
 
1,232

 
0

Total other comprehensive income (loss), net of tax
 
6,710

 
(5,427
)
Comprehensive income
 
$
82,021

 
$
60,331

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

4


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

 
 
 
March 31,
 
December 31,
 
 
2019
 
2018
Assets
 
(Unaudited)
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
312,045

 
$
266,417

Available-for-sale securities
 
139,994

 
402,339

Receivables from Erie Insurance Exchange and affiliates
 
456,135

 
449,873

Prepaid expenses and other current assets
 
49,997

 
36,892

Federal income taxes recoverable
 
0

 
8,162

Accrued investment income
 
4,220

 
5,263

Total current assets
 
962,391

 
1,168,946

 
 
 
 
 
Available-for-sale securities
 
534,925

 
346,184

Equity securities
 
12,410

 
11,853

Limited partnership investments
 
30,038

 
34,821

Fixed assets, net
 
144,652

 
130,832

Deferred income taxes, net
 
22,180

 
24,101

Other assets
 
92,860

 
61,590

Total assets
 
$
1,799,456

 
$
1,778,327

 
 
 
 
 
Liabilities and shareholders' equity
 
 
 
 
Current liabilities:
 
 
 
 
Commissions payable
 
$
253,002

 
$
241,573

Agent bonuses
 
26,129

 
103,462

Accounts payable and accrued liabilities
 
123,179

 
111,291

Dividends payable
 
41,913

 
41,910

Contract liability
 
34,116

 
33,854

Deferred executive compensation
 
10,346

 
13,107

Federal income taxes payable
 
11,946

 
0

Current portion of long-term borrowings
 
1,891

 
1,870

Total current liabilities
 
502,522

 
547,067

 
 
 
 
 
Defined benefit pension plans
 
123,270

 
116,866

Long-term borrowings
 
97,382

 
97,860

Contract liability
 
17,907

 
17,873

Deferred executive compensation
 
16,817

 
13,075

Other long-term liabilities
 
27,754

 
11,914

Total liabilities
 
785,652

 
804,655

 
 
 
 
 
Shareholders’ equity
 
 
 
 
Class A common stock, stated value $0.0292 per share; 74,996,930 shares authorized; 68,299,200 shares issued; 46,189,068 shares outstanding
 
1,992

 
1,992

Class B common stock, convertible at a rate of 2,400 Class A shares for one Class B share, stated value $70 per share; 3,070 shares authorized; 2,542 shares issued and outstanding
 
178

 
178

Additional paid-in-capital
 
16,483

 
16,459

Accumulated other comprehensive loss
 
(123,574
)
 
(130,284
)
Retained earnings
 
2,264,815

 
2,231,417

Total contributed capital and retained earnings
 
2,159,894

 
2,119,762

Treasury stock, at cost; 22,110,132 shares held
 
(1,158,779
)
 
(1,157,625
)
Deferred compensation
 
12,689

 
11,535

Total shareholders’ equity
 
1,013,804

 
973,672

Total liabilities and shareholders’ equity
 
$
1,799,456

 
$
1,778,327


See accompanying notes to Financial Statements. 

5


ERIE INDEMNITY COMPANY
STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED)
Three months ended March 31, 2019 and 2018
(dollars in thousands, except per share data)
 
Class A common stock
Class B common stock
Additional paid-in-capital
Accumulated other comprehensive income (loss)
Retained earnings
Treasury stock
Deferred compensation
Total shareholders' equity
Balance, December 31, 2018
$
1,992

$
178

$
16,459

$
(130,284
)
$
2,231,417

$
(1,157,625
)
$
11,535

$
973,672

Net income
 
 
 
 
75,311

 
 
75,311

Other comprehensive income
 
 
 
6,710

 
 
 
6,710

Dividends declared:
 
 
 
 
 
 
 
 
Class A $0.90 per share
 
 
 
 
(41,570
)
 
 
(41,570
)
Class B $135.00 per share
 
 
 
 
(343
)
 
 
(343
)
Net purchase of treasury stock (1)
 
 
24

 
 
0

 
24

Deferred compensation
 
 
 
 
 
(1,154
)
1,154

0

Balance, March 31, 2019
$
1,992

$
178

$
16,483

$
(123,574
)
$
2,264,815

$
(1,158,779
)
$
12,689

$
1,013,804



 
Class A common stock
Class B common stock
Additional paid-in-capital
Accumulated other comprehensive income (loss)
Retained earnings
Treasury stock
Deferred compensation
Total shareholders' equity
Balance, December 31, 2017
$
1,992

$
178

$
16,470

$
(156,059
)
$
2,140,853

$
(1,155,668
)
$
9,578

$
857,344

Cumulative effect adjustments (2)
 
 
 
 
(38,392
)
 
 
(38,392
)
Net income
 
 
 
 
65,758

 
 
65,758

Other comprehensive loss
 
 
 
(5,427
)
 
 
 
(5,427
)
Dividends declared:
 
 
 
 
 
 
 
 
Class A $0.84 per share
 
 
 
 
(38,799
)
 
 
(38,799
)
Class B $126.00 per share
 
 
 
 
(320
)
 
 
(320
)
Net purchase of treasury stock (1)
 
 
(9
)
 
 
0

 
(9
)
Deferred compensation
 
 
 
 
 
(1,663
)
1,663

0

Balance, March 31, 2018
$
1,992

$
178

$
16,461

$
(161,486
)
$
2,129,100

$
(1,157,331
)
$
11,241

$
840,155


(1) Net purchases of treasury stock in 2019 and 2018 include the repurchase of our Class A common stock in the open market that were subsequently distributed to satisfy stock based compensation awards. See Note 11, "Capital Stock", for additional information on treasury stock transactions.
(2) Cumulative effect adjustments are primarily related to the implementation of new revenue recognition guidance effective January 1, 2018.

See accompanying notes to Financial Statements.


6


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

 
 
Three Months Ended
 
 
March 31,
 
 
2019
 
2018
Cash flows from operating activities
 
 
 
 
Management fee received
 
$
433,735

 
$
418,897

Administrative services reimbursements received
 
148,308

 
150,422

Service agreement fee received
 
6,692

 
7,145

Net investment income received
 
9,112

 
8,951

Limited partnership distributions
 
1,225

 
426

Commissions paid to agents
 
(204,633
)
 
(192,803
)
Agents bonuses paid
 
(104,689
)
 
(122,607
)
Salaries and wages paid
 
(50,840
)
 
(54,668
)
Pension contributions and employee benefits paid
 
(10,875
)
 
(49,199
)
General operating expenses paid
 
(60,439
)
 
(59,033
)
Administrative services expenses paid
 
(143,046
)
 
(146,935
)
Income taxes recovered (paid)
 
138

 
(276
)
Interest paid
 
(448
)
 
(550
)
Net cash provided by (used in) operating activities
 
24,240

 
(40,230
)
 
 
 
 
 
Cash flows from investing activities
 
 
 
 
Purchase of investments:
 
 
 
 
Available-for-sale securities
 
(220,811
)
 
(77,263
)
Equity securities
 
0

 
(1,035
)
Limited partnerships
 
(9
)
 
(31
)
Proceeds from investments:
 
 
 
 
Available-for-sale securities sales
 
149,155

 
57,717

Available-for-sale securities maturities/calls
 
154,343

 
28,473

Equity securities
 
0

 
1,055

Limited partnerships
 
2,411

 
910

Purchase of fixed assets
 
(17,411
)
 
(8,691
)
Distributions on agent loans
 
(6,233
)
 
(19,310
)
Collections on agent loans
 
2,313

 
1,436

Net cash provided by (used in) investing activities
 
63,758

 
(16,739
)
 
 
 
 
 
Cash flows from financing activities
 
 
 
 
Dividends paid to shareholders
 
(41,910
)
 
(39,116
)
Net payments on long-term borrowings
 
(460
)
 
(9
)
Net cash used in financing activities
 
(42,370
)
 
(39,125
)
 
 
 
 
 
Net increase (decrease) in cash and cash equivalents
 
45,628

 
(96,094
)
Cash and cash equivalents, beginning of period
 
266,417

 
215,721

Cash and cash equivalents, end of period
 
$
312,045

 
$
119,627

 
 
 
 
 
Supplemental disclosure of noncash transactions
 
 
 
 
Operating lease assets obtained in exchange for new operating lease liabilities
 
$
32,515

 
$

  
See accompanying notes to Financial Statements.

7


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 13, "Concentrations of Credit Risk".


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 three months ended March 31, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. For further information, refer to the financial statements and footnotes included in our Form 10-K for the year ended December 31, 2018 as filed with the Securities and Exchange Commission on February 21, 2019.

8


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

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

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

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

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments-Credit Losses", which requires financial assets measured at amortized cost to be presented at the net amount expected to be collected through the use of a new forward-looking expected loss model and credit losses relating to available-for-sale debt securities to be recognized through an allowance for credit losses. ASU 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019. Early adoption for interim and annual periods beginning after December 15, 2018 is permitted. We have evaluated the impact of this guidance on our invested assets. Our investments are not measured at amortized cost, and therefore do not require the use of a new expected loss model. Our available-for-sale debt securities will continue to be monitored for credit losses which would be reflected as an allowance for credit losses rather than a reduction of the carrying value of the asset. Other financial assets subject to this guidance include our receivables from Erie Insurance Exchange and its subsidiaries and agent loans. Given the financial strength of the Exchange, demonstrated by its strong surplus position and industry ratings, it is unlikely these receivables would have significant, if any, credit loss exposure. Accordingly, we do not expect a material impact on our financial statements or related disclosures as a result of this guidance.

Other assets
Other assets include agent loans, operating lease assets and other long-term prepaid assets. Agent loans are carried at unpaid principal balance with interest recorded in investment income as earned. It is our policy to charge the loans that are in default directly to expense. We do not record an allowance for credit losses on these loans, as the majority of the loans are senior secured and historically have had insignificant default amounts.

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



9


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, is allocated based on the estimated standalone selling prices developed using industry information and other available information for similar services. We update the transaction price allocation annually based upon the most recent information available. There was no material change to the allocation in 2019.

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

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

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

A constraining estimate exists around the management fee received as consideration related to the potential for management fee to be returned if a policy were to be cancelled mid-term. Management fees are returned to the Exchange when policyholders cancel their insurance coverage mid-term and unearned premiums are refunded to them. We maintain an estimated allowance to reduce the management fee to its estimated net realizable value to account for the potential of mid-term policy cancellations based on historical cancellation rates. This estimated allowance has been allocated between the two performance obligations consistent with the revenue allocation proportions.

The following table disaggregates revenue by our two performance obligations:
 
 
Three months ended March 31,
(in thousands)
 
2019
2018
Management fee revenue - policy issuance and renewal services, net
 
$
430,983

$
405,978

 
 
 
 
Management fee revenue - administrative services, net
 
13,951

13,074

Administrative services reimbursement revenue
 
142,480

145,963

Total administrative services
 
$
156,431

$
159,037




10


Note 4.  Earnings Per Share
 
Class A and Class B basic earnings per share and Class B diluted earnings per share are calculated under the two-class method. The two-class method allocates earnings to each class of stock based upon its dividend rights.  Class B shares are convertible into Class A shares at a conversion ratio of 2,400 to 1. See Note 11, "Capital Stock".

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

A reconciliation of the numerators and denominators used in the basic and diluted per-share computations is presented as follows for each class of common stock: 
 
 
Three months ended March 31,
 
 
2019
 
2018
(dollars in thousands, except per share data)
 
Allocated net income (numerator)
 
Weighted shares (denominator)
 
Per-share amount
 
Allocated net income (numerator)
 
Weighted shares (denominator)
 
Per-share amount
Class A – Basic EPS:
 
 
 
 
 
 
 
 
 
 
 
 
Income available to Class A stockholders
 
$
74,694

 
46,188,337

 
$
1.62

 
$
65,220

 
46,187,908

 
$
1.41

Dilutive effect of stock-based awards
 
0

 
22,899

 

 
0

 
21,920

 

Assumed conversion of Class B shares
 
617

 
6,100,800

 

 
538

 
6,100,800

 

Class A – Diluted EPS:
 
 
 
 
 
 
 
 
 
 
 
 
Income available to Class A stockholders on Class A equivalent shares
 
$
75,311

 
52,312,036

 
$
1.44

 
$
65,758

 
52,310,628

 
$
1.26

Class B – Basic and diluted EPS:
 
 
 
 
 
 
 
 
 
 
 
 
Income available to Class B stockholders
 
$
617

 
2,542

 
$
243

 
$
538

 
2,542

 
$
212


 
 
 
 
 
 
 
 
 
 
 
 
 

11


Note 5. Fair Value
 
Financial instruments carried at fair value
Our available-for-sale debt securities and equity securities are recorded at fair value, which is the price that would be received to sell the asset in an orderly transaction between willing market participants as of the measurement date.
 
Valuation techniques used to derive the fair value of our available-for-sale debt securities and equity securities are based upon observable and unobservable inputs.  Observable inputs reflect market data obtained from independent sources.  Unobservable inputs reflect our own assumptions regarding fair market value for these securities.  Although virtually all of our prices are obtained from third party sources, we also perform an internal pricing review on outliers. The outlier review includes securities with price changes that vary from current market conditions or independent third party price sources. Financial instruments are categorized based upon the following characteristics or inputs to the valuation techniques:
 
Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.

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

Level 3 – Unobservable inputs for the asset or liability.
 
Estimates of fair values for our investment portfolio are obtained primarily from a nationally recognized pricing service.  Our Level 1 category includes those securities 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 market data, and transaction volumes and believe that the prices adequately consider market activity in determining fair value. 
 
When a price from the pricing service is not available, values are determined by obtaining broker/dealer quotes and/or market comparables.  When available, we obtain multiple quotes for the same security.  The ultimate value for these securities is determined based upon our best estimate of fair value using corroborating market information.  Our evaluation includes the consideration of benchmark yields, reported trades, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data.




12


The following tables present our fair value measurements on a recurring basis by asset class and level of input: 
 
 
At March 31, 2019
 
 
Fair value measurements using:
(in thousands)
 
Total
 
Quoted prices in
active markets for identical assets
Level 1
 
Observable inputs
Level 2
 
Unobservable inputs
Level 3
Available-for-sale securities:
 
 
 
 
 
 
 
 
U.S. Treasury (1)
 
$
279,956

 
$
0

 
$
279,956

 
$
0

States & political subdivisions (1)
 
27,452

 
0

 
27,452

 
0

Corporate debt securities
 
233,017

 
0

 
221,494

 
11,523

Residential mortgage-backed securities
 
6,571

 
0

 
5,656

 
915

Commercial mortgage-backed securities
 
48,144

 
0

 
46,962

 
1,182

Collateralized debt obligations
 
63,932

 
0

 
63,932

 
0

Other debt securities
 
15,847

 
0

 
15,847

 
0

Total available-for-sale securities
 
674,919

 
0

 
661,299

 
13,620

Equity securities:
 
 
 
 
 
 
 
 
Nonredeemable preferred stock - financial services sector
 
12,410

 
1,966

 
10,444

 
0

Total equity securities
 
12,410

 
1,966

 
10,444

 
0

Total
 
$
687,329

 
$
1,966

 
$
671,743

 
$
13,620


 
 
At December 31, 2018
 
 
Fair value measurements using:
(in thousands)
 
Total
 
Quoted prices in
active markets for identical assets
Level 1
 
Observable inputs
Level 2
 
Unobservable inputs
Level 3
Available-for-sale securities:
 
 
 
 
 
 
 
 
U.S. Treasury (1)
 
$
208,412

 
$
0

 
$
208,412

 
$
0

States & political subdivisions (1)
 
159,023

 
0

 
159,023

 
0

Corporate debt securities
 
249,947

 
0

 
237,370

 
12,577

Residential mortgage-backed securities
 
4,609

 
0

 
4,609

 
0

Commercial mortgage-backed securities
 
46,515

 
0

 
46,515

 
0

Collateralized debt obligations
 
64,239

 
0

 
64,239

 
0

Other debt securities
 
15,778

 
0

 
15,778

 
0

Total available-for-sale securities
 
748,523

 
0

 
735,946

 
12,577

Equity securities:
 
 
 
 
 
 
 
 
Nonredeemable preferred stock - financial services sector
 
11,853

 
1,809

 
10,044

 
0

Total equity securities
 
11,853

 
1,809

 
10,044

 
0

Other limited partnership investments (2)
 
3,206

 

 

 

Total
 
$
763,582

 
$
1,809

 
$
745,990

 
$
12,577


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

13


The following table presents our fair value measurements on a recurring basis by pricing source:
 
 
At March 31, 2019
(in thousands)
 
Total
 
Level 1
 
Level 2
 
Level 3
Available-for-sale securities:
 
 
 
 
 
 
 
 
Priced via pricing services
 
$
673,729

 
$
0

 
$
661,299

 
$
12,430

Priced via market comparables/broker quotes
 
125

 
0

 
0

 
125

Priced via internal modeling
 
1,065

 
0

 
0

 
1,065

Total available-for-sale securities
 
674,919

 
0

 
661,299

 
13,620

Equity securities priced via pricing services
 
12,410

 
1,966

 
10,444

 
0

Total
 
$
687,329

 
$
1,966

 
$
671,743

 
$
13,620



Quantitative and Qualitative Disclosures about Unobservable Inputs

The following table presents quantitative information about the significant unobservable inputs utilized in the fair value measurements of Level 3 assets. Level 3 securities where cost is the best estimate of fair value totaled $1.1 million at March 31, 2019 and are excluded from the table below. When a non-binding broker quote was the only input available, the security was classified within Level 3. The quantitative detail of the unobservable inputs is neither provided nor reasonably available to us and therefore has not been included in the table below. These investments totaled $0.1 million at March 31, 2019 and $12.6 million at December 31, 2018. The weighted average is calculated based on estimated fair value.
 
 
At March 31, 2019
(dollars in thousands)
 
Fair
value
Valuation techniques
Unobservable input
Range
(basis points)
Weighted
average
(basis points)
Impact of increase in input on estimated fair value
 
 
 
 
 



Corporate debt securities - bank loans
 
$
11,373

Market approach
Market residual yield (1)
-186 - +1,479
+33
Decrease
Commercial mortgage-backed securities
 
1,057

Market approach
Credit spread (2)
+42 - +275
+181
Decrease
(1)
Values for bank loans classified as Level 3 are determined by our pricing vendor based on model yield curves adjusted for observable inputs. The market residual yield represents a net adjustment to the model yield curve for unobservable input factors.
(2)
Values for commercial mortgage-backed securities classified as Level 3 include adjustments to the base spread over the appropriate U.S. Treasury yield assuming no prepayments until penalty provisions have expired.


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

Level 3 Assets – Year-to-Date Change:
(in thousands)
 
Beginning balance at December 31, 2018
 
Included in earnings(1)
 
Included
in other comprehensive
income
 
Purchases
 
Sales
 
Transfers into Level 3(2)
 
Transfers out of Level 3(2)
 
Ending balance at March 31, 2019
Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate debt securities
 
$
12,577

 
$
11

 
$
268

 
$
734

 
$
(431
)
 
$
4,813

 
$
(6,449
)
 
$
11,523

Residential mortgage-backed securities
 
0

 
0

 
0

 
921

 
(6
)
 
0

 
0

 
915

Commercial mortgage-backed securities
 
0

 
(2
)
 
0

 
478

 
0

 
706

 
0

 
1,182

Total Level 3 available-for-sale securities
 
$
12,577

 
$
9

 
$
268

 
$
2,133

 
$
(437
)
 
$
5,519

 
$
(6,449
)
 
$
13,620




14


Level 3 Assets – Year-to-Date Change:
(in thousands)
 
Beginning balance at December 31, 2017
 
Included in earnings(1)
 
Included
in other
comprehensive
income
 
Purchases
 
Sales
 
Transfers into Level 3(2)
 
Transfers out of Level 3(2)
 
Ending balance at March 31, 2018
Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate debt securities
 
$
7,879

 
$
(9
)
 
$
5

 
$
0

 
$
(493
)
 
$
2,412

 
$
(3,485
)
 
$
6,309

Collateralized debt obligations
 
2,200

 
0

 
7

 
0

 
0

 
0

 
(2,207
)
 
0

Total Level 3 available-for-sale securities
 
$
10,079

 
$
(9
)
 
$
12

 
$
0

 
$
(493
)
 
$
2,412

 
$
(5,692
)
 
$
6,309

 
(1)
These amounts are reported in the Statements of Operations as net investment income and net realized investment gains (losses) for the each of the periods presented above.
(2)
Transfers into and/or (out) of Level 3 are primarily attributable to the availability of market observable information and the re-evaluation of the observability of pricing inputs.
 

The change in unrealized gains or losses included in other comprehensive income related to Level 3 securities held at the reporting date is as follows:
 
 
Three months ended March 31,
(in thousands)
 
2019
 
2018
Available-for-sale securities:
 
 
 
 
Corporate debt securities
 
$
157

 
$
10

Residential mortgage-backed securities
 
0

 

Commercial mortgage-backed securities
 
4

 

Net unrealized gains on Level 3 securities held at reporting date
 
$
161

 
$
10



Financial instruments disclosed, but not carried at fair value
The following table presents the carrying values and fair value measurements, which are categorized as Level 3 in the fair value hierarchy, of financial instruments disclosed, but not carried at fair value:
 
 
At March 31, 2019
 
At December 31, 2018
(in thousands)
 
Carrying value
 
Fair value
 
Carrying value
 
Fair value
Agent loans
 
$
61,926

 
$
61,487

 
$
58,006

 
$
54,110

Long-term borrowings
 
99,273

 
95,958

 
99,730

 
94,057




15


Note 6.  Investments
 
Available-for-sale securities
The following tables summarize the cost and fair value of our available-for-sale securities. See also Note 5, "Fair Value" for additional fair value disclosures. 
 
 
At March 31, 2019
 (in thousands)
 
Amortized
cost
 
Gross unrealized gains
 
Gross unrealized losses
 
Estimated fair value
Available-for-sale securities:
 
 
 
 
 
 
 
 
U.S. Treasury (1)
 
$
279,553

 
$
503

 
$
100

 
$
279,956

States & political subdivisions (1)
 
26,931

 
521

 
0

 
27,452

Corporate debt securities
 
235,546

 
985

 
3,514

 
233,017

Residential mortgage-backed securities
 
6,513

 
67

 
9

 
6,571

Commercial mortgage-backed securities
 
48,120

 
273

 
249

 
48,144

Collateralized debt obligations
 
64,432

 
17

 
517

 
63,932

Other debt securities
 
15,752

 
95

 
0

 
15,847

Total available-for-sale securities
 
$
676,847

 
$
2,461

 
$
4,389

 
$
674,919

 
 
 
At December 31, 2018
(in thousands)
 
Amortized
cost
 
Gross unrealized gains
 
Gross unrealized losses
 
Estimated fair value
Available-for-sale securities:
 
 
 
 
 
 
 
 
U.S. Treasury (1)
 
$
208,610

 
$
18

 
$
216

 
$
208,412

States & political subdivisions (1)
 
157,003

 
2,020

 
0

 
159,023

Corporate debt securities
 
259,362

 
139

 
9,554

 
249,947

Residential mortgage-backed securities
 
4,603

 
38

 
32

 
4,609

Commercial mortgage-backed securities
 
47,022

 
80

 
587

 
46,515

Collateralized debt obligations
 
65,039

 
30

 
830

 
64,239

Other debt securities
 
15,756

 
33

 
11

 
15,778

Total available-for-sale securities
 
$
757,395

 
$
2,358

 
$
11,230

 
$
748,523

(1)
In the fourth quarter of 2018, we began selling off our municipal bonds as part of a portfolio rebalancing. We intend to sell the remaining municipal bonds in the second quarter of 2019. We have currently invested proceeds from these sales primarily in U.S. Treasuries.


The amortized cost and estimated fair value of available-for-sale securities at March 31, 2019 are shown below by remaining contractual term to maturity.  Mortgage-backed securities are allocated based upon stated maturity dates.  Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. 
 
 
At March 31, 2019
 
 
Amortized
 
Estimated
(in thousands)
 
cost
 
fair value
Due in one year or less
 
$
123,334

 
$
123,200

Due after one year through five years
 
320,044

 
319,564

Due after five years through ten years
 
133,675

 
132,586

Due after ten years
 
99,794

 
99,569

Total available-for-sale securities (1)
 
$
676,847

 
$
674,919

(1)
The contractual maturities of our municipal bond portfolio are included in the table. However, given our intent to sell this portfolio, municipal bond securities are classified as current assets in our Statements of Financial Position.



16


Available-for-sale securities in a gross unrealized loss position are as follows.  Data is provided by length of time for securities in a gross unrealized loss position. 
 
 
At March 31, 2019
 
 
Less than 12 months
 
12 months or longer
 
Total
(dollars in thousands)
 
Fair
value
 
Unrealized losses
 
Fair
value
 
Unrealized losses
 
Fair
 value
 
Unrealized losses
 
No. of holdings
Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
 
$
0

 
$
0

 
$
11,748

 
$
100

 
$
11,748

 
$
100

 
4

Corporate debt securities
 
82,879

 
1,647

 
94,393

 
1,867

 
177,272

 
3,514

 
471

Residential mortgage-backed securities
 
1,208

 
4

 
388

 
5

 
1,596

 
9

 
2

Commercial mortgage-backed securities
 
9,491

 
17

 
19,023

 
232

 
28,514

 
249

 
27

Collateralized debt obligations
 
59,394

 
468

 
3,231

 
49

 
62,625

 
517

 
45

Other debt securities
 
100

 
0

 
0

 
0

 
100

 
0

 
1

Total available-for-sale securities
 
$
153,072

 
$
2,136

 
$
128,783

 
$
2,253

 
$
281,855

 
$
4,389

 
550

Quality breakdown of available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment grade
 
$
77,871

 
$
534

 
$
94,217

 
$
807

 
$
172,088

 
$
1,341

 
124

Non-investment grade
 
75,201

 
1,602

 
34,566

 
1,446

 
109,767

 
3,048

 
426

Total available-for-sale securities
 
$
153,072

 
$
2,136

 
$
128,783

 
$
2,253

 
$
281,855

 
$
4,389

 
550


 
 
At December 31, 2018
 
 
Less than 12 months
 
12 months or longer
 
Total
(dollars in thousands)
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
 
No. of
holdings
Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
 
$
129,474

 
$
19

 
$
11,656

 
$
197

 
$
141,130

 
$
216

 
7

Corporate debt securities
 
157,300

 
6,866

 
86,586

 
2,688

 
243,886

 
9,554

 
635

Residential mortgage-backed securities
 
777

 
6

 
1,618

 
26

 
2,395

 
32

 
3

Commercial mortgage-backed securities
 
17,624

 
175

 
16,997

 
412

 
34,621

 
587

 
30

Collateralized debt obligations
 
55,246

 
826

 
1,248

 
4

 
56,494

 
830

 
39

Other debt securities
 
8,213

 
11

 
0

 
0

 
8,213

 
11

 
7

Total available-for-sale securities
 
$
368,634

 
$
7,903

 
$
118,105

 
$
3,327

 
$
486,739

 
$
11,230

 
721

Quality breakdown of available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment grade
 
$
242,821

 
$
1,295

 
$
98,118

 
$
1,641

 
$
340,939

 
$
2,936

 
147

Non-investment grade
 
125,813

 
6,608

 
19,987

 
1,686

 
145,800

 
8,294

 
574

Total available-for-sale securities
 
$
368,634

 
$
7,903

 
$
118,105

 
$
3,327

 
$
486,739

 
$
11,230

 
721

 
 
The above securities have been evaluated and determined to be temporary impairments for which we expect to recover our entire principal plus interest.  The primary components of this analysis include a general review of market conditions and financial performance of the issuer along with the extent and duration at which fair value is less than cost.  Any securities that we intend to sell or will more likely than not be required to sell before recovery are included in other-than-temporary impairments, which are recognized in earnings.


17


Net investment income
Investment income, net of expenses, was generated from the following portfolios:
 
 
Three months ended March 31,
(in thousands)
 
2019
 
2018
Fixed maturities (1)
 
$
6,161

 
$
6,110

Equity securities
 
141

 
142

Cash equivalents and other
 
2,465

 
1,008

Total investment income
 
8,767

 
7,260

Less: investment expenses
 
250

 
440

Investment income, net of expenses
 
$
8,517

 
$
6,820


(1)
Includes interest earned on note receivable from Erie Family Life Insurance Company of $0.4 million for the three months ended March 31, 2018. The note was repaid in full in December 2018.
 

Realized investment gains (losses)
Realized gains (losses) on investments were as follows:
 
 
Three months ended March 31,
(in thousands)
 
2019
 
2018
Available-for-sale securities:
 
 

 
 

Gross realized gains
 
$
2,258

 
$
340

Gross realized losses
 
(340
)
 
(685
)
Net realized gains (losses) on available-for-sale securities
 
1,918

 
(345
)
Equity securities
 
585

 
(120
)
Net realized investment gains (losses)
 
$
2,503

 
$
(465
)

 
The portion of net unrealized gains and losses recognized during the reporting period, related to equity securities still held at the reporting date, is calculated as follows:
 
 
Three months ended March 31,
(in thousands)
 
2019
 
2018
Equity securities:
 
 
 
 
Net gains (losses) recognized during the period
 
$
585

 
$
(120
)
Less: net losses recognized on securities sold
 
0

 
(34
)
Net unrealized gains (losses) recognized on securities held at reporting date
 
$
585

 
$
(86
)


Other-than-temporary impairments on available-for-sale securities recognized in earnings were $0.1 million for the three months ended March 31, 2019. There were no other-than-temporary impairments on available-for-sale securities recognized in earnings for the three months ended March 31, 2018. We have the intent to sell all credit-impaired available-for-sale debt securities; therefore, the entire amount of the impairment charges were included in earnings and no non-credit impairments were recognized in other comprehensive income. 

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


18


Equity in losses of limited partnerships by method of accounting were as follows:
 
 
Three months ended March 31,
(in thousands)
 
2019
 
2018
Equity in (losses) earnings of limited partnerships - equity method
 
$
(1,147
)
 
$
195

Change in fair value of limited partnerships - fair value option
 
0

 
(387
)
Equity in losses of limited partnerships
 
$
(1,147
)
 
$
(192
)


The following table summarizes limited partnership investments by sector:
(in thousands)
 
At March 31, 2019
 
At December 31, 2018
Private equity
 
$
26,691

 
$
28,271

Mezzanine debt
 
1,118

 
1,152

Real estate
 
2,229

 
2,192

Real estate - fair value option
 
0

 
3,206

Total limited partnership investments
 
$
30,038

 
$
34,821



See also Note 14, "Commitments and Contingencies" for investment commitments related to limited partnerships.
 
 
 
 
 
 
Note 7.  Leases

Lease assets and liabilities recorded on our Statement of Financial Position were as follows:
(in thousands)
 
March 31, 2019
Operating lease assets
 
$
28,611

 
 
 
Operating lease liabilities - current
 
$
12,466

Operating lease liabilities - long-term
 
16,589

Total operating lease liabilities
 
$
29,055



We currently have leases for real estate, technology equipment, copiers, and vehicles. Our largest operating lease asset at March 31, 2019 of $16.2 million is for office space leased from the Exchange, including the home office. Under this lease, rent is based on rental rates of like property and all operating expenses are the responsibility of the tenant (Indemnity). The lease agreement expires December 31, 2021.

Operating lease costs for the three months ended March 31, 2019 were $3.6 million. Of this amount, the Exchange and its subsidiaries reimbursed us $1.5 million, which represents the allocated share of lease costs supporting administrative services activities.


Note 8.  Borrowing Arrangements
 
Bank line of credit
As of March 31, 2019, 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 March 31, 2019, 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 March 31, 2019.  Investments with a fair value of $109.4 million were pledged as collateral on the line at March 31, 2019. The investments pledged as collateral have no trading restrictions and are reported as cash and cash equivalents and available-for-sale securities in the Statements of Financial Position as of March 31, 2019. 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 March 31, 2019.

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.

19


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 $115.0 million were pledged as collateral for the facility and are reported as cash and cash equivalents and available-for-sale securities in the Statements of Financial Position as of March 31, 2019. 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 March 31, 2019.
 
The remaining unpaid balance from the Credit Facility is reported at carrying value on our Statements of Financial Position, net of unamortized loan origination and commitment fees. See Note 5, "Fair Value" for the estimated fair value of these borrowings.
 
Annual principal payments
The following table sets forth future principal payments:
(in thousands)
 
 
Year
 
Principal payments
2019
$
1,410

2020
 
1,953

2021
 
2,040

2022
 
2,130

2023
 
2,225

Thereafter
 
89,782



Note 9.  Postretirement Benefits
 
Pension plans
Our pension plans consist of a noncontributory defined benefit pension plan covering substantially all employees and an unfunded supplemental employee retirement plan for certain members of executive and senior management. Although we are the sponsor of these postretirement plans and record the funded status of these plans, the Exchange and its subsidiaries reimburse us for approximately 59% 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 March 31,
(in thousands)
 
2019
 
2018
Service cost for benefits earned
 
$
8,463

 
$
9,513

Interest cost on benefits obligation
 
9,827

 
8,846

Expected return on plan assets
 
(11,871
)
 
(12,815
)
Prior service cost amortization
 
349

 
338

Net actuarial loss amortization
 
1,278

 
3,202

Pension plan cost (1)
 
$
8,046

 
$
9,084

 
(1)
The components of pension plan costs other than the service cost component are included in the line item "Other income" in the Statements of Operations after reimbursements from the Exchange and its subsidiaries.


Note 10.  Income Taxes

Income tax expense is provided on an interim basis based upon our estimate of the annual effective income tax rate, adjusted each quarter for discrete items. For the three months ended March 31, 2019 and 2018, our effective tax rate is 21.2% and 21.0%, respectively.



20


Note 11.  Capital Stock
 
Class A and B common stock
Holders of Class B shares may, at their option, convert their shares into Class A shares at the rate of 2,400 Class A shares per Class B share.  There were no shares of Class B common stock converted into Class A common stock during the three months ended March 31, 2019 and the year ended December 31, 2018. 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 three months ended March 31, 2019 and the year ended December 31, 2018. We had approximately $17.8 million of repurchase authority remaining under this program at March 31, 2019.
 
During the three months ended March 31, 2019, we purchased 9,725 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $1.5 million. Of this amount, we purchased 3,246 shares for $0.4 million, or $132.35 per share, for stock-based awards in conjunction with our equity compensation plan, for which the shares were delivered to plan participants in January 2019. We purchased 2,304 shares for $0.4 million, or $183.62 per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The shares were transferred to the rabbi trust in February 2019. The remaining 4,175 shares were purchased at a total cost of $0.7 million, or $175.23 per share, to fund the rabbi trust for the incentive compensation deferral plan. The shares were transferred to the rabbi trust in February and March 2019.

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



21


Note 12.  Accumulated Other Comprehensive Income (Loss)
 
Changes in accumulated other comprehensive income ("AOCI") (loss) by component, including amounts reclassified to other comprehensive income ("OCI") (loss) and the related line item in the Statements of Operations where net income is presented, are as follows:
 
 
Three months ended
 
Three months ended
 
 
March 31, 2019
 
March 31, 2018
(in thousands)
 
Before Tax
Income Tax
Net
 
Before Tax
Income Tax
Net
Investment securities:
 
 
 
 
 
 
 
 
AOCI (loss), beginning of period
 
$
(9,169
)
$
(1,926
)
$
(7,243
)
 
$
3,410

$
716

$
2,694

OCI (loss) before reclassifications
 
8,774

1,843

6,931

 
(7,130
)
(1,497
)
(5,633
)
Realized investment (gains) losses
 
(1,918
)
(403
)
(1,515
)
 
345

72

273

Impairment losses
 
78

16

62

 
0

0

0

Cumulative effect of adopting ASU 2016-01 (1)
 



 
(85
)
(18
)
(67
)
OCI (loss)
 
6,934

1,456

5,478

 
(6,870
)
(1,443
)
(5,427
)
AOCI (loss), end of period
 
$
(2,235
)
$
(470
)
$
(1,765
)
 
$
(3,460
)
$
(727
)
$
(2,733
)
 
 
 
 
 
 
 
 
 
Pension and other postretirement plans:
 
 
 
 
 
 
 
 
AOCI (loss), beginning of period
 
$
(155,749
)
$
(32,708
)
$
(123,041
)
 
$
(200,954
)
$
(42,201
)
$
(158,753
)
Amortization of prior service costs (2)
 
349

73

276

 
0

0

0

Amortization of net actuarial loss (2)
 
1,210

254

956

 
0

0

0

OCI
 
1,559

327

1,232

 
0

0

0

AOCI (loss), end of period
 
$
(154,190
)
$
(32,381
)
$
(121,809
)
 
$
(200,954
)
$
(42,201
)
$
(158,753
)
 
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
 
 
 
AOCI (loss), beginning of period
 
$
(164,918
)
$
(34,634
)
$
(130,284
)
 
$
(197,544
)
$
(41,485
)
$
(156,059