ERIE INDEMNITY COMPANY The following discussion of financial condition and results of operations highlights significant factors influencingErie Indemnity Company ("Indemnity", "we", "us", "our"). This discussion should be read in conjunction with the historical financial statements and the related notes thereto included in Part I, Item 1. "Financial Statements" of this Quarterly Report on Form 10-Q, and with Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" for the year endedDecember 31, 2021 , as contained in our Annual Report on Form 10-K filed with theSecurities and Exchange Commission onFebruary 24, 2022 . INDEX Page Number
Cautionary Statement Regarding Forward-Looking Information 22 Operating Overview 23 Results of Operations 26 Financial Condition 32 Liquidity and Capital Resources 33 Critical Accounting Estimates 35
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995: Statements contained herein that are not historical fact are forward-looking statements and, as such, are subject to risks and uncertainties that could cause actual events and results to differ, perhaps materially, from those discussed herein. Forward-looking statements relate to future trends, events or results and include, without limitation, statements and assumptions on which such statements are based that are related to our plans, strategies, objectives, expectations, intentions, and adequacy of resources. Examples of forward-looking statements are discussions relating to premium and investment income, expenses, operating results, and compliance with contractual and regulatory requirements. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Among the risks and uncertainties, in addition to those set forth in our filings with theSecurities and Exchange Commission , that could cause actual results and future events to differ from those set forth or contemplated in the forward-looking statements include the following: •dependence upon our relationship with the Erie Insurance Exchange ("Exchange") and the management fee under the agreement with the subscribers at the Exchange; •dependence upon our relationship with the Exchange and the growth of the Exchange, including: •general business and economic conditions; •factors affecting insurance industry competition; •dependence upon the independent agency system; and •ability to maintain our reputation for customer service; •dependence upon our relationship with the Exchange and the financial condition of the Exchange, including: •the Exchange's ability to maintain acceptable financial strength ratings; •factors affecting the quality and liquidity of the Exchange's investment portfolio; •changes in government regulation of the insurance industry; •litigation and regulatory actions; •emergence of significant unexpected events, including pandemics; •emerging claims and coverage issues in the industry; and •severe weather conditions or other catastrophic losses, including terrorism; •costs of providing policy issuance and renewal services to the Exchange under the subscriber's agreement; •ability to attract and retain talented management and employees; •ability to ensure system availability and effectively manage technology initiatives; •difficulties with technology or data security breaches, including cyber attacks; •ability to maintain uninterrupted business operations; •outcome of pending and potential litigation; •factors affecting the quality and liquidity of our investment portfolio; and •our ability to meet liquidity needs and access capital. 22
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A forward-looking statement speaks only as of the date on which it is made and reflects our analysis only as of that date. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changes in assumptions, or otherwise.
OPERATING OVERVIEW
Overview
We serve as the attorney-in-fact for the subscribers (policyholders) at the
Exchange, a reciprocal insurer that writes property and casualty insurance. Our
primary function as attorney-in-fact is to perform policy issuance and renewal
services on behalf of the subscribers at the Exchange. We also act as
attorney-in-fact on behalf of the Exchange, as well as the service provider for
its insurance subsidiaries, with respect to all administrative services.
The Exchange is a reciprocal insurance exchange, which is an unincorporated
association of individuals, partnerships and corporations that agree to insure
one another. Each applicant for insurance to the Exchange signs a subscriber's
agreement, which contains an appointment of Indemnity as their attorney-in-fact
to transact the business of the Exchange on their behalf. Pursuant to the
subscriber's agreement for acting as attorney-in-fact in these two
capacities, we earn a management fee calculated as a percentage of the direct
and affiliated assumed premiums written by the Exchange.
Our earnings are primarily driven by the management fee revenue generated for
the services we provide to the Exchange. The policy issuance and renewal
services we provide to the Exchange are related to the sales, underwriting and
issuance of policies. The sales related services we provide include agent
compensation and certain sales and advertising support services. Agent
compensation includes scheduled commissions to agents based upon premiums
written as well as additional commissions and bonuses to agents, which are
earned by achieving targeted measures. Agent compensation generally comprises
approximately two-thirds of our policy issuance and renewal expenses. The
underwriting services we provide include underwriting and policy processing. The
remaining services we provide include customer service and administrative
support. We also provide information technology services that support all the
functions listed above. Included in these expenses are allocations of costs for
departments that support these policy issuance and renewal functions.
By virtue of its legal structure as a reciprocal insurer, the Exchange does not
have any employees or officers. Therefore, it enters into contractual
relationships by and through an attorney-in-fact. Indemnity serves as the
attorney-in-fact on behalf of the Exchange with respect to its administrative
services. The Exchange's insurance subsidiaries also utilize Indemnity for these
services in accordance with the service agreements between each of the
subsidiaries and Indemnity. Claims handling services include costs incurred in
the claims process, including the adjustment, investigation, defense, recording
and payment functions. Life insurance management services include costs incurred
in the management and processing of life insurance business. Investment
management services are related to investment trading activity, accounting and
all other functions attributable to the investment of funds. Included in these
expenses are allocations of costs for departments that support these
administrative functions. The amounts incurred for these services are reimbursed
to Indemnity at cost in accordance with the subscriber's agreement and the
service agreements. State insurance regulations require that intercompany
service agreements and any material amendments be approved in advance by the
state insurance department.
Our results of operations are tied to the growth and financial condition of the
Exchange as the Exchange is our sole customer, and our earnings are largely
generated from management fees based on the direct and affiliated assumed
premiums written by the Exchange. The Exchange generates revenue by insuring
preferred and standard risks, with personal lines comprising 70% of the 2021
direct and affiliated assumed written premiums and commercial lines comprising
the remaining 30%. The principal personal lines products are private passenger
automobile and homeowners. The principal commercial lines products are
commercial multi-peril, commercial automobile and workers compensation.
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Coronavirus ("COVID-19") pandemic
In March 2020 , the outbreak of the coronavirus ("COVID-19") was declared a
global pandemic and pandemic conditions have influenced various economic
factors, including a more inflationary environment in recent months. As the
uncertainty resulting from the COVID-19 pandemic and subsequent resulting
conditions continues to evolve, the ultimate impact and duration remain
uncertain at this time.
While we were not required to close our physical locations under the state
mandated closure of nonessential services, out of concern for the health and
safety of our employees, over 90% of our workforce has been working remote since
March 2020 . We have had no significant interruption to our core business
processes or systems to date. We have had no significant changes to our
financial close or reporting processes or related internal controls, nor do we
anticipate any significant future challenges at this time. We have a dedicated
team responsible for the development and implementation of a return to office
plan. We began a phased return of our workforce in April 2022 and expect to
continue reopening our offices over the next several months. Consistent with our
process from the beginning of the pandemic, we will prioritize the health and
safety of our employees and adjust when and where appropriate.
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Financial Overview
Three months ended March 31,
(dollars in thousands, except per share data) 2022 2021 % Change
(Unaudited)
Operating income $ 84,312 $ 76,095 10.8 %
Total investment income 3,009 17,988 (83.3)
Interest expense 999 1,009 (1.0)
Other income (expense) 473 (519) NM
Income before income taxes 86,795 92,555 (6.2)
Income tax expense 18,176 18,989 (4.3)
Net income $ 68,619 $ 73,566 (6.7) %
Net income per share - diluted $ 1.31 $ 1.41 (6.7) %
NM = not meaningful
Operating income increased in the first quarter of 2022, compared to the first
quarter of 2021, as growth in operating revenue outpaced the growth in operating
expenses. Management fee revenue for policy issuance and renewal services
increased 7.1% to $488.0 million in the first quarter of 2022. Management fee
revenue is based upon the management fee rate we charge and the direct and
affiliated assumed premiums written by the Exchange. The management fee rate was
25% for both 2022 and 2021. The direct and affiliated assumed premiums written
by the Exchange increased 7.0% to $2.0 billion in the first quarter of 2022,
compared to the same period in 2021.
Cost of operations for policy issuance and renewal services increased 6.0% to
Management fee revenue for administrative services decreased 3.6% to$14.3 million in the first quarter of 2022, compared to the same period in 2021. The administrative services reimbursement revenue and corresponding cost of operations increased both total operating revenue and total operating expenses by$163.3 million and$153.5 million in the first quarter of 2022 and 2021, respectively, but had no net impact on operating income.
Total investment income decreased
General Conditions and Trends Affecting Our Business Economic conditions Unfavorable changes in economic conditions, including declining consumer confidence, inflation, high unemployment, and the threat of recession, among others, may lead the Exchange's customers to modify coverage, not renew policies, or even cancel policies, which could adversely affect the premium revenue of the Exchange, and consequently our management fee. The extent to which economic conditions could impact the Exchange's operations and our management fee was exacerbated with the COVID-19 pandemic. Further, pandemic conditions have created an inflationary environment in recent months. In particular, unanticipated increased inflation costs including medical cost inflation, building material cost inflation, auto repair cost inflation, and tort issues may impact estimated loss reserves and future premium rates of the Exchange. The extent and duration of the impact to economic conditions remain uncertain as the pandemic and subsequent resulting conditions continue to evolve. If any of these items impacted the financial condition or operations of the Exchange, it could have an impact on our financial results. See Financial Condition and Liquidity and Capital Resources contained within this report, as well as Part I. Item 1A. "Risk Factors" included in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 as filed with theSecurities and Exchange Commission onFebruary 24, 2022 for a discussion of the potential impacts to our operations or those of the Exchange, including pandemics. Financial market volatility Our portfolio of fixed maturity and equity security investments is subject to market volatility especially in periods of instability in the worldwide financial markets. Over time, net investment income could also be impacted by volatility and by the general level of interest rates, which impact reinvested cash flow from the portfolio and business operations. Depending upon market conditions, which are unpredictable and remain uncertain, considerable fluctuation could exist in the fair value of our investment portfolio and reported total investment income, which could have an adverse impact on our financial condition, results of operations, and cash flows. Although the conditions of the COVID-19 pandemic appear to be improving, the recent conflict betweenRussia andUkraine has had a significant impact on the global financial markets. The value of our invested assets could be adversely impacted and there is potential for future losses and/or impairments on our investment portfolio due to the ongoing pandemic, the Russian/Ukraine war, and the resulting conditions including inflationary pressures and rising interest rates. 25 -------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS Management fee revenue We have two performance obligations in the subscriber's agreement, providing policy issuance and renewal services and acting as attorney-in-fact for the Exchange, as well as the service provider for its insurance subsidiaries, with respect to all administrative services. We earn management fees for acting as the attorney-in-fact for the subscribers at the Exchange in these two capacities, and allocate our revenues between our performance obligations. The management fee is calculated by multiplying all direct and affiliated assumed premiums written by the Exchange by the management fee rate, which is determined by our Board of Directors at least annually. The management fee rate was set at 25%, the maximum rate, for both 2022 and 2021. Changes in the management fee rate can affect our revenue and net income significantly. The transaction price, including management fee revenue and administrative service reimbursement revenue, includes variable consideration and is allocated based on the estimated standalone selling prices developed using industry information and other available information for similar services. We update the transaction price and the related allocation at least annually based upon the most recent information available or more frequently if there have been significant changes in any components considered in the transaction price. Our current transaction price allocation review resulted in a minor change in the allocation percentages between the two performance obligations. The change in allocation will not have a material impact on our financial statements.
The following table presents the allocation and disaggregation of revenue for our two performance obligations:
Three months ended March 31,
(dollars in thousands) 2022 2021 % Change
(Unaudited)
Policy issuance and renewal services Direct and affiliated assumed premiums written by the Exchange$ 2,010,197 $ 1,878,182 7.0 % Management fee rate 24.3 % 24.3 % Management fee revenue
488,478 456,398 7.0 Change in estimate for management fee returned on cancelled policies (1)
(486) (680) 28.6
Management fee revenue - policy issuance and renewal services
Administrative services Direct and affiliated assumed premiums written by the Exchange$ 2,010,197 $ 1,878,182 7.0 % Management fee rate 0.7 % 0.7 % Management fee revenue 14,071 13,147 7.0 Change in contract liability (2) 238 1,707 (86.1)
Change in estimate for management fee returned on cancelled policies (1)
4 (7) NM
Management fee revenue - administrative services 14,313 14,847 (3.6)
Administrative services reimbursement revenue 163,327 153,533 6.4
Total revenue from administrative services $ 177,640 $ 168,380 5.5 %
NM = not meaningful
(1)A constraining estimate of variable consideration exists related to the potential for management fees to be returned if a policy were to be cancelled mid-term. Management fees are returned to the Exchange when policies are cancelled mid-term and unearned premiums are refunded.
(2)Management fee revenue - administrative services is recognized over time as
the services are provided. See Part I, Item 1. "Financial Statements - Note 3,
Revenue, of Notes to Financial Statements" contained within this report.
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Direct and affiliated assumed premiums written by the Exchange
Direct and affiliated assumed premiums include premiums written directly by the
Exchange and premiums assumed from its wholly owned property and casualty
subsidiaries. Direct and affiliated assumed premiums written by the Exchange
increased 7.0% to $2.0 billion in the first quarter of 2022 compared to the
first quarter of 2021, primarily driven by increased homeowners and commercial
multi-peril premiums written. Year-over-year policies in force for all lines of
business increased 3.1% in the first quarter of 2022 compared to 2.8% in the
first quarter of 2021. The year-over-year average premium per policy for all
lines of business increased 1.5% at March 31, 2022 compared to a decrease of
1.5% at March 31, 2021 . The year-over-year average premium per policy at March
31, 2021 was impacted by the rate reductions for personal and commercial auto
policies written between July 1, 2020 and March 31, 2021 , in response to lower
driving activity as a result of the COVID-19 pandemic.
New business premiums increased 4.0% to $249 million in the first quarter of
2022 compared to the same period in 2021, primarily driven by increased premiums
written in the commercial multi-peril lines. Contributing to this change was a
6.3% increase in year-over-year average premium per policy on new business,
somewhat offset by a 4.7% decrease in new business policies written in the first
quarter of 2022. New business premiums increased 19.7% to $239 million in the
first quarter of 2021 compared to the same period in 2020 due primarily to
increased personal lines premiums written. In the first quarter of 2021, new
business policies written increased 22.4%, partially offset by a 5.8% decrease
in year-over-year average premium per policy.
Premiums generated from renewal business increased 7.5% to $1.8 billion in the
first quarter of 2022 compared to the first quarter of 2021 and decreased 0.5%
to $1.6 billion in the first quarter of 2021 compared to the first quarter of
2020. Underlying the trend in renewal business premiums was a slight increase
in the policy retention ratio and a 0.9% increase in year-over-year average
premium per policy at March 31, 2022 , compared to a 0.8% decrease in
year-over-year average premium per policy at March 31, 2021 .
Personal lines - Total personal lines premiums written increased 5.6% to $1.3
billion in the first quarter of 2022, compared to 1.3% in the first quarter of
2021, driven by a 3.0% increase in total personal lines policies in force and a
0.5% increase in total personal lines year-over-year average premium per policy.
Commercial lines - Total commercial lines premiums written increased 10.0% to
$674 million in the first quarter of 2022, compared to 2.4% in the first quarter
of 2021, driven by a 3.8% increase in total commercial lines year-over-year
average premium per policy and a 3.4% increase in total commercial lines
policies in force.
Future trends-premium revenue - Through a careful agency selection process, the
Exchange plans to continue its effort to expand the size of its agency force to
increase market penetration in existing operating territories to contribute to
future growth.
Changes in premium levels attributable to the growth in policies in force and
rate changes directly affect the profitability of the Exchange and have a direct
bearing on our management fee. Future premiums could be impacted by changes
resulting from the COVID-19 pandemic, including potential regulatory changes and
inflationary trends, among others. Longer-term, increased driving activity may
result in future rate increases due to higher claims frequency and severity. See
also Part I. Item 1A. "Risk Factors" included in our Annual Report on Form 10-K
for the fiscal year ended December 31, 2021 as filed with the Securities and
Exchange Commission on February 24, 2022 .
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Policy issuance and renewal services
Three months ended March 31,
(dollars in thousands) 2022 2021 % Change
(Unaudited)
Management fee revenue - policy issuance and renewal services$ 487,992 $ 455,718 7.1 % Service agreement revenue 6,478 6,079 6.6 494,470 461,797 7.1 Cost of policy issuance and renewal services 424,471 400,549 6.0 Operating income - policy issuance and renewal services$ 69,999 $ 61,248 14.3 % Policy issuance and renewal services The management fee revenue allocated for providing policy issuance and renewal services was 24.3% of the direct and affiliated assumed premiums written by the Exchange for both three month periods endedMarch 31, 2022 and 2021. This portion of the management fee is recognized as revenue when the policy is issued or renewed because it is at that time that the services we provide are substantially complete and the executed insurance policy is transferred to the customer. The increase in management fee revenue for policy issuance and renewal services was driven by the increase in the direct and affiliated assumed premiums written by the Exchange discussed previously. Service agreement revenue Service agreement revenue primarily consists of service charges we collect from subscribers/policyholders for providing multiple payment plans on policies written by the Exchange and its property and casualty subsidiaries and also includes late payment and policy reinstatement fees. The service charges are fixed dollar amounts per billed installment. InJuly 2021 , we began receiving service agreement revenue from the Exchange for the use of shared office space. The increase in service agreement revenue is due to the previously mentioned agreement with the Exchange, somewhat offset by a decrease in service charges from subscribers/policyholders due to the continued shift to payment plans that do not incur service charges or offer a premium discount for certain payment methods.
Cost of policy issuance and renewal services
Three months ended March 31,
(dollars in thousands) 2022 2021 % Change
(Unaudited)
Commissions:
Total commissions $ 281,135 $ 261,381 7.6 %
Non-commission expense:
Underwriting and policy processing $ 41,054 $ 40,588 1.1 %
Information technology 45,666 46,405 (1.6)
Sales and advertising 12,725 10,943 16.3
Customer service 8,347 8,798 (5.1)
Administrative and other 35,544 32,434 9.6
Total non-commission expense 143,336 139,168 3.0
Total cost of policy issuance and renewal services $ 424,471 $ 400,549 6.0 %
Commissions - Commissions increased $19.8 million in the first quarter of 2022
compared to the same period in 2021, primarily driven by the growth in direct
and affiliated assumed written premium, primarily in lines of business that pay
a higher commission rate. The estimated agent incentive payouts at March 31,
2022 are based on actual underwriting results for the two prior years and
current year-to-date actual results and forecasted results for the remainder of
2022.
Non-commission expense - Non-commission expense increased
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Administrative services
Three months ended March 31,
(dollars in thousands) 2022 2021 % Change
(Unaudited)
Management fee revenue - administrative services$ 14,313 $ 14,847 (3.6) % Administrative services reimbursement revenue 163,327 153,533 6.4 Total revenue allocated to administrative services 177,640 168,380 5.5 Administrative services expenses Claims handling services 142,496 132,470 7.6 Investment management services 9,891 9,714 1.8 Life management services 10,940 11,349 (3.6) Operating income - administrative services$ 14,313 $ 14,847 (3.6) % Administrative services The management fee revenue allocated to administrative services was 0.7% of the direct and affiliated assumed premiums written by the Exchange for both three month periods endedMarch 31, 2022 and 2021. This portion of the management fee is recognized as revenue over a four-year period representing the time over which the services are provided. We also report reimbursed costs as revenues, which are recognized monthly as services are provided. The administrative services expenses we incur and the related reimbursements we receive are recorded gross in the Statements of Operations. Cost of administrative services By virtue of its legal structure as a reciprocal insurer, the Exchange does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services in accordance with the subscriber's agreement. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and Indemnity. The amounts incurred for these services are reimbursed to Indemnity at cost in accordance with the subscriber's agreement and the service agreements. We record these reimbursements due from the Exchange and its insurance subsidiaries as a receivable. 29 -------------------------------------------------------------------------------- Table of Contents Total investment income A summary of the results of our investment operations is as follows for the three months endedMarch 31 : (dollars in thousands) 2022 2021 % Change
(Unaudited)
Net investment income$ 10,504 $ 17,097 (38.6) % Net realized and unrealized investment (losses) gains (7,279) 804 NM Net impairment (losses) recoveries recognized in earnings (216) 87 NM Total investment income$ 3,009 $ 17,988 (83.3) % NM = not meaningful Net investment income Net investment income includes interest and dividends on our fixed maturity and equity security portfolios and the results of our limited partnership investments, net of investment expenses. Net investment income decreased$6.6 million in the first quarter of 2022, primarily due to equity in earnings of limited partnerships of$2.8 million in 2022 compared to equity in earnings of limited partnerships of$9.0 million in 2021.
Net realized and unrealized investment (losses) gains
A breakdown of our net realized and unrealized investment (losses) gains is as
follows for the three months ended
(in thousands) 2022 2021 Securities sold: (Unaudited) Available-for-sale securities$ (2,080) $ 1,483 Equity securities (280) (289) Equity securities change in fair value (4,921) (390) Miscellaneous 2 0 Net realized and unrealized investment (losses) gains$ (7,279) $ 804
Net realized and unrealized losses during the first quarter of 2022 were primarily due to market value adjustments on equity securities and disposals of available-for-sale securities. Net realized and unrealized gains during the first quarter of 2021 were primarily due to disposals of available-for-sale securities.
Net impairment (losses) recoveries recognized in earnings Net impairment (losses) recoveries during the first quarter of 2022 and 2021 were primarily related to available-for-sale securities.
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Financial condition of Erie Insurance Exchange
Serving in the capacity of attorney-in-fact for the Exchange, we are dependent
on the growth and financial condition of the Exchange, who is our sole customer.
The strength of the Exchange and its wholly owned subsidiaries is rated annually
by A.M. Best Company through assessing its financial stability and ability to
pay claims. The ratings are generally based upon factors relevant to
policyholders and are not directed toward return to investors. The Exchange and
each of its property and casualty subsidiaries are rated A+ "Superior", the
second highest financial strength rating, which is assigned to companies that
have achieved superior overall performance when compared to the standards
established by A.M. Best and have a superior ability to meet obligations to
policyholders over the long term. On July 27, 2021 , the outlook for the
financial strength rating was affirmed as stable. As of December 31, 2021 , only
approximately 12% of insurance groups, in which the Exchange is included, are
rated A+ or higher.
The financial statements of the Exchange are prepared in accordance with
statutory accounting principles prescribed by the Commonwealth of Pennsylvania .
Financial statements prepared under statutory accounting principles focus on the
solvency of the insurer and generally provide a more conservative approach than
under U.S. generally accepted accounting principles. Statutory direct written
premiums of the Exchange and its wholly owned property and casualty subsidiaries
grew 7.0% to $2.0 billion in the first quarter of 2022 compared to the first
quarter of 2021. These premiums, along with investment income, are the major
sources of cash that support the operations of the Exchange. Policyholders'
surplus determined under statutory accounting principles was $11.5 billion at
March 31, 2022 , $11.7 billion at December 31, 2021 , and $11.3 billion at
March 31, 2021 . The Exchange and its wholly owned property and casualty
subsidiaries' year-over-year policy retention ratio continues to be high at
90.3% at March 31, 2022 , 90.1% at December 31, 2021 and 90.0% at March 31, 2021 .
We have prepared our financial statements considering the financial strength of
the Exchange based on its A.M. Best rating and strong level of surplus. We are
monitoring risks related to the COVID-19 pandemic on an ongoing basis and
believe that the Exchange falls within defined risk tolerances. However, see
Part I. Item 1A. "Risk Factors" included in our Annual Report on Form 10-K for
the fiscal year ended December 31, 2021 as filed with the Securities and
Exchange Commission on February 24, 2022 for possible outcomes that could impact
that determination.
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FINANCIAL CONDITION
Investments
Our investment portfolio is managed with the objective of maximizing after-tax returns on a risk-adjusted basis. The following table presents the carrying value of our investments as of:
(dollars in thousands) March 31, 2022 % to total December 31, 2021 % to total
(Unaudited)
Fixed maturities $ 923,320 83 % $ 946,085 83 %
Equity securities 78,069 7 87,743 8
Agent loans (1) 69,342 6 66,368 6
Other investments 38,602 4 36,846 3
Total investments $ 1,109,333 100 % $ 1,137,042 100 %
(1)The current portion of agent loans is included with prepaid expenses and other current assets in the Statements of Financial Position.
Fixed maturities Under our investment strategy, we maintain a fixed maturity portfolio that is of high quality and well diversified within each market sector. This investment strategy also achieves a balanced maturity schedule. Our fixed maturity portfolio is managed with the goal of achieving reasonable returns while limiting exposure to risk. Fixed maturities are carried at fair value with unrealized gains and losses, net of deferred taxes, included in shareholders' equity. Net unrealized losses on fixed maturities, net of deferred taxes, totaled$20.7 million atMarch 31, 2022 , compared to net unrealized gains of$6.2 million atDecember 31, 2021 .
The following table presents a breakdown of the fair value of our fixed maturity portfolio by industry sector and rating as of:
(in thousands) March 31, 2022 (1)
Non-
investment Fair
AAA AA A BBB grade value
(Unaudited)
Basic materials $ 0 $ 0 $ 3,063 $ 0 $ 7,828 $ 10,891
Communications 0 8,375 8,081 15,284 17,425 49,165
Consumer 0 3,034 15,720 68,428 41,642 128,824
Diversified 0 0 0 0 1,408 1,408
Energy 0 3,990 7,382 20,982 7,685 40,039
Financial 0 0 79,322 127,830 17,691 224,843
Industrial 0 0 9,466 15,426 25,324 50,216
Structured securities (2) 122,348 181,012 26,518 14,779 0 344,657
Technology 4,991 0 5,512 21,130 14,484 46,117
U.S. Treasury 0 939 0 0 0 939
Utilities 0 0 3,536 18,077 4,608 26,221
Total $ 127,339 $ 197,350 $ 158,600 $ 301,936 $ 138,095 $ 923,320 (1)Ratings are supplied by S&P, Moody's, and Fitch. The table is based upon the lowest rating for each security.
(2)Structured securities include residential and commercial mortgage-backed securities, collateralized debt obligations, and asset-backed securities.
Equity securities
Equity securities primarily include nonredeemable preferred stocks and are
carried at fair value in the Statements of Financial Position with all changes
in unrealized gains and losses reflected in the Statements of Operations.
The following table presents an analysis of the fair value of our equity
securities by sector as of:
(in thousands) March 31, 2022 December 31, 2021
(Unaudited)
Consumer $ 3,089 $ 3,314
Energy 6,177 6,448
Financial services 61,917 71,722
Utilities 6,886 6,259
Total $ 78,069 $ 87,743
32-------------------------------------------------------------------------------- Table of Contents LIQUIDITY AND CAPITAL RESOURCES We continue to monitor the sufficiency of our liquidity and capital resources given the potential impact of the ongoing COVID-19 pandemic and theRussia /Ukraine war and resulting conditions, including rising interest rates and inflationary costs. While we did not see a significant impact on our sources or uses of cash in the first quarter of 2022, future disruptions in the markets could occur which may affect our liquidity position. If our normal operating and investing cash activities were to become insufficient to meet future funding requirements, we believe we have sufficient access to liquidity through our cash position, liquid marketable securities and our$100 million line of credit that does not expire untilOctober 2026 . See broader discussions of potential risks to our operations in the Operating Overview contained within this report and Part I. Item 1A. "Risk Factors" included in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 as filed with theSecurities and Exchange Commission onFebruary 24, 2022 . Sources and Uses of Cash Liquidity is a measure of a company's ability to generate sufficient cash flows to meet the short- and long-term cash requirements of its business operations and growth needs. Our liquidity requirements have been met primarily by funds generated from management fee revenue and income from investments. Cash provided from these sources is used primarily to fund the costs of our management operations including commissions, salaries and wages, pension plans, share repurchases, dividends to shareholders, the purchase and development of information technology, and other capital expenditures. We expect that our operating cash needs will be met by funds generated from operations. Cash in excess of our operating needs is primarily invested in investment grade fixed maturities. As part of our liquidity review, we regularly evaluate our capital needs based on current and projected results and consider the potential impacts to our liquidity, borrowing capacity, financial covenants and capital availability. Volatility in the financial markets presents challenges to us as we do occasionally access our investment portfolio as a source of cash. Some of our fixed income investments, despite being publicly traded, may be illiquid. Volatility in these markets could impair our ability to sell certain fixed income securities or cause such securities to sell at deep discounts. We believe we have sufficient liquidity to meet our needs from sources other than the liquidation of securities. Cash flow activities The following table provides condensed cash flow information for the three months endedMarch 31 : (in thousands) 2022 2021 (Unaudited) (Unaudited)
Net cash provided by operating activities
(13,732) (10,828)
Net cash used in financing activities (52,218)
(48,702)
Net decrease in cash and cash equivalents
Net cash provided by operating activities was$23.6 million in the first three months of 2022, compared to$33.5 million in the first three months of 2021. Decreased cash provided by operating activities in the first three months of 2022 was primarily due to an increase in administrative services expenses paid of$20.7 million , commissions paid to agents of$11.5 million and agent bonuses paid of$11.0 million , partially offset by an increase in administrative service reimbursements received of$36.2 million in the first quarter of 2022 compared to the same period in 2021. Net cash used in investing activities was$13.7 million in the first three months of 2022, compared to$10.8 million in the same period in 2021. Net cash used in investing activities in both periods was primarily driven by fixed asset purchases, as proceeds from sales and maturities/calls of investments were mostly offset by purchases of investments. Net cash used in financing activities totaled$52.2 million in the first three months of 2022, compared to$48.7 million in the first three months of 2021. The increase in cash used in the first three months of 2022, compared to the same period in 2021, was due to dividends paid to shareholders. We increased both our Class A and Class B shareholder regular quarterly dividends by 7.2% for 2022, compared to 2021. There are no regulatory restrictions on the payment of dividends to our shareholders. 33 -------------------------------------------------------------------------------- Table of Contents Capital Outlook We regularly prepare forecasts evaluating the current and future cash requirements for both normal and extreme risk events, including the current COVID-19 pandemic. Should an extreme risk event result in a cash requirement exceeding normal cash flows, we have the ability to meet our future funding requirements through various alternatives available to us. Outside of our normal operating and investing cash activities, future funding requirements could be met through: 1) cash and cash equivalents, which total approximately$141.3 million atMarch 31, 2022 , 2) a$100 million bank revolving line of credit, and 3) liquidation of unpledged assets held in our investment portfolio, including preferred stock and investment grade bonds, which totaled approximately$642.9 million atMarch 31, 2022 . Volatility in the financial markets could impair our ability to sell certain fixed income securities or cause such securities to sell at deep discounts. Additionally, we have the ability to curtail or modify discretionary cash outlays such as those related to shareholder dividends and share repurchase activities. As ofMarch 31, 2022 , we have access to a$100 million bank revolving line of credit with a$25 million letter of credit sublimit that expires onOctober 29, 2026 . As ofMarch 31, 2022 , 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 ofMarch 31, 2022 . Investments with a fair value of$110.9 million were pledged as collateral on the line atMarch 31, 2022 . The investments pledged as collateral have no trading restrictions and are reported as available-for-sale securities and cash and cash equivalents in the Statement of Financial Position. The banks require compliance with certain covenants, which include leverage ratios and debt restrictions. We were in compliance with our bank covenants atMarch 31, 2022 . 34
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Table of Contents CRITICAL ACCOUNTING ESTIMATES We make estimates and assumptions that have a significant effect on the amounts and disclosures reported in the financial statements. The most significant estimates relate to investment valuation and retirement benefit plans for employees. While management believes its estimates are appropriate, the ultimate amounts may differ from estimates provided. Our most critical accounting estimates are described in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" for the year endedDecember 31, 2021 of our Annual Report on Form 10-K as filed with theSecurities and Exchange Commission onFebruary 24, 2022 . See Part I, Item 1. "Financial Statements - Note 5, Fair Value, of Notes to Financial Statements" contained within this report for additional information on our valuation of investments.
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