UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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 incorporation or organization)		(I.R.S. Employer Identification No.)
100 Erie Insurance Place, Erie, Pennsylvania		16530
(Address of principal executive offices)		(Zip Code)

(814) 870-2000

Not applicable

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes þ No o

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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer þ		Accelerated Filer o		Non-Accelerated Filer o		Smaller Reporting Company o
				(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No þ

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 $.0292 per share, was 51,123,747 at April 15, 2010.

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 2,546 at April 15, 2010.

The common stock is the only class of stock the registrant is presently authorized to issue.

 

 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

Consolidated Statements of Operations—Three months ended March 31, 2010 and 2009

Consolidated Statements of Financial Position—March 31, 2010 and December 31, 2009

Consolidated Statements of Shareholders’ Equity —Three months ended March 31, 2010 and 2009

Consolidated Statements of Cash Flows—Three months ended March 31, 2010 and 2009

Notes to Consolidated Financial Statements—March 31, 2010

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Item 4. Controls and Procedures

PART II. OTHER INFORMATION

Item 1A. Risk Factors

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Item 6. Exhibits

SIGNATURES

EX-10.1

EX-31.1

EX-31.2

EX-32

PART I. FINANCIAL INFORMATION

ITEM 1.		FINANCIAL STATEMENTS

ERIE INDEMNITY COMPANY

		Three months ended March 31,
		2010				2009
						(As adjusted Note 2)
Revenues
Premiums earned		$	978			$	957
Net investment income			104				117
Net realized investment gains (losses)			125				(155	)
Net impairment losses recognized in earnings			(2	)			(71	)
Equity in earnings (losses) of limited partnerships			3				(161	)
Other income			8				8
Total revenues			1,216				695
Benefits and expenses
Insurance losses and loss expenses			761				803
Policy acquisition and underwriting expenses			227				232
Total benefits and expenses			988				1,035
Income (loss) from operations before income taxes and noncontrolling interests			228				(340	)
Provision (benefit) for income taxes			66				(89	)
Net income (loss)		$	162			$	(251	)
Less: Net income (loss) attributable to noncontrolling interest in consolidated entity — Exchange			115				(262	)
Net income attributable to Indemnity		$	47			$	11
Earnings Per Share
Net income attributable to Indemnity per share
Class A common stock – basic		$	0.92			$	0.22
Class A common stock – diluted		$	0.82			$	0.19
Class B common stock – basic and diluted		$	132.83			$	34.78
Weighted average shares outstanding attributable to Indemnity – Basic
Class A common stock			51,185,736				51,270,240
Class B common stock			2,546				2,551
Weighted average shares outstanding attributable to Indemnity– Diluted
Class A common stock			57,310,247				57,409,460
Class B common stock			2,546				2,551
Dividends declared per share
Class A common stock		$	0.48			$	0.45
Class B common stock		$	72.00			$	67.50

See accompanying notes to Consolidated Financial Statements.

ERIE INDEMNITY COMPANY

		March 31,				December 31,
		2010				2009
		(Unaudited)				(As adjusted Note 2)
Assets
Investments-Indemnity
Available-for-sale securities, at fair value:
Fixed maturities (amortized cost of $648 and $642, respectively)		$	674			$	664
Equity securities (cost of $42 and $35, respectively)			48				38
Trading securities, at fair value (cost of $37 and $36, respectively)			45				42
Limited partnerships (cost of $279 and $281, respectively)			235				235
Other invested assets			1				1
Investments-Exchange
Available-for-sale securities, at fair value:
Fixed maturities (amortized cost of $6,249 and $6,277, respectively)			6,569				6,517
Equity securities (cost of $469 and $425, respectively)			536				472
Trading securities, at fair value (cost of $1,583 and $1,556, respectively)			1,933				1,835
Limited partnerships (cost of $1,336 and $1,392, respectively)			1,119				1,116
Other invested assets			20				20
Total investments			11,180				10,940
Cash and cash equivalents (Exchange portion of $172 and $158, respectively)			202				234
Premiums receivable from policyholders (Exchange portion of $728 and $715, respectively)			920				906
Reinsurance recoverable (Exchange portion of $214 and $212, respectively)			217				215
Deferred income taxes (Exchange portion of $22 and $75, respectively)			55				116
Deferred acquisition costs (Exchange portion of $405 and $416, respectively)			456				467
Other assets (Exchange portion of $319 and $306, respectively)			420				409
Total assets		$	13,450			$	13,287
Liabilities and shareholders’ equity
Liabilities
Indemnity liabilities
Losses and loss expense reserves		$	744			$	752
Unearned premiums			325				325
Other liabilities			334				387
Exchange liabilities
Losses and loss expense reserves			2,867				2,846
Life policy and deposit contract reserves			1,559				1,540
Unearned premiums			1,660				1,656
Other liabilities			50				56
Total liabilities			7,539				7,562
Indemnity’s shareholders’ equity
Class A common stock, stated value $0.0292 per share; authorized 74,996,930 shares; 68,289,600 issued; 51,128,506 and 51,203,473 shares outstanding, respectively			2				2
Class B common stock, convertible at a rate of 2,400 Class A shares for one Class B share, stated value $70 per share; 2,546 authorized, issued and outstanding, respectively			0				0
Additional paid-in-capital			8				8
Accumulated other comprehensive loss			(37	)			(43	)
Retained earnings, before cumulative effect adjustment			1,772				1,743
Cumulative effect of accounting changes, net of tax			0				6
Retained earnings, after cumulative effect adjustment			1,772				1,749
Total contributed capital and retained earnings			1,745				1,716
Treasury stock, at cost, 17,161,094 and 17,086,127 shares, respectively			(817	)			(814	)
Total Indemnity shareholders’ equity			928				902
Noncontrolling interest in consolidated entity — Exchange			4,983				4,823
Total equity			5,911				5,725
Total liabilities, shareholders’ equity and noncontrolling interest		$	13,450			$	13,287

See accompanying notes to Consolidated Financial Statements. See Note 21 for supplemental consolidating statements of financial position information.

ERIE INDEMNITY COMPANY

						Total												Accumulated																				Noncontrolling
						Indemnity												other				Class A				Class B				Additional								interest
		Total				shareholders’				Comprehensive				Retained				comprehensive				common				common				paid-in				Treasury				in consolidated
		equity				equity				income (loss)				earnings				(loss) income				stock				stock				capital				stock				entity—Exchange
Balance December 31, 2008 (As adjusted - Note 2)		$	4,759			$	792							$	1,729			$	(136	)		$	2			$	0			$	8			$	(811	)		$	3,967
Comprehensive income (loss):
Net income			446				108				108				108																								338
Other comprehensive income (loss):
Unrealized loss on securities, net of tax			498				75				75								75																				423
Cumulative effect of accounting changes, net of tax			95				0								6				(6	)																			95
Postretirement plans:
Prior service cost, net of tax			0				0				0								0
Net actuarial gain, net of tax			27				27				27								27
Loss due to amendments, net of tax			(2	)			(2	)			(2	)							(2	)
Curtailment/settlement loss, net of tax			(1	)			(1	)			(1	)							(1	)
Postretirement plans net of tax:			24				24				24								24
Comprehensive income		$	1,063							$	207																											$	856
Purchase of treasury stock			(3	)			(3	)																											(3	)
Conversion of Class B shares to Class A shares			0				0																0				0
Dividends declared:
Class A $1.83 per share			(94	)			(94	)							(94	)
Class B $274.50 per share			0				0								0
Balance December 31, 2009 (As adjusted - Note 2)		$	5,725			$	902							$	1,749			$	(43	)		$	2			$	0			$	8			$	(814	)		$	4,823
Comprehensive income:
Net income			162				47				47				47																								115
Other comprehensive income (loss):
Unrealized loss on securities, net of tax (Note 17)			51				6				6								6																				45
Comprehensive income		$	213							$	53																											$	160
Purchase of treasury stock			(3	)			(3	)																											(3	)
Dividends declared:
Class A $0.48 per share			(24	)			(24	)							(24	)
Class B $72.00 per share			0				0								0
Balance March 31, 2010		$	5,911			$	928							$	1,772			$	(37	)		$	2			$	0			$	8			$	(817	)		$	4,983

See accompanying notes to Consolidated Financial Statements.

ERIE INDEMNITY COMPANY

		Three months ended March 31,
		2010				2009
						(As adjusted Note 2)
Cash flows from operating activities
Premiums collected		$	965			$	935
Net investment income received			99				102
Limited partnership distributions			18				15
Service agreement fee received			8				8
Commissions and bonuses paid to agents			(169	)			(183	)
Losses paid			(622	)			(602	)
Loss expenses paid			(106	)			(96	)
Other underwriting and acquisition costs paid			(159	)			(147	)
Income taxes (paid) recovered			(7	)			206
Net cash provided by operating activities			27				238
Cash flows from investing activities
Purchase of investments:
Fixed maturities			(525	)			(285	)
Preferred stock			(67	)			(41	)
Common stock			(249	)			(492	)
Limited partnerships			(30	)			(47	)
Sales/maturities of investments:
Fixed maturity sales			233				109
Fixed maturity calls/maturities			315				170
Preferred stock			29				42
Common stock			251				495
Sale of and returns on limited partnerships			3				4
Purchase of property and equipment			(9	)			(3	)
Net distributions on agent loans			0				(1	)
Net cash used in investing activities			(49	)			(49	)
Cash flows from financing activities
Annuity and supplementary contract deposits and interest			33				44
Annuity and supplementary contract surrenders and withdrawals			(18	)			(28	)
Universal life deposits and interest			11				5
Universal life surrenders			(8	)			(5	)
Purchase of treasury stock			(3	)			(1	)
Dividends paid to shareholders			(25	)			(23	)
Decrease in collateral from securities lending			0				(19	)
Redemption of securities lending collateral			0				19
Net cash used in financing activities			(10	)			(8	)
Net (decrease) increase in cash and cash equivalents			(32	)			181
Cash and cash equivalents at beginning of year			234				277
Cash and cash equivalents at end of period		$	202			$	458

See accompanying notes to Consolidated Financial Statements. See Note 21 for supplemental cash flow information.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1. Nature of Operations

Erie Indemnity Company (“Indemnity”) is a publicly held Pennsylvania business corporation that since 1925 has been the managing Attorney-in-Fact for the subscribers (policyholders) of Erie Insurance Exchange (“Exchange”). The Exchange is a subscriber (policyholder) owned Pennsylvania-domiciled reciprocal insurer that writes property and casualty insurance.

Indemnity’s primary function is to perform certain services for the Exchange relating to sales, underwriting and issuance of policies on behalf of the Exchange. This is done in accordance with a subscribers agreement (a limited power of attorney) executed by each subscriber (policyholder), appointing Indemnity as their common attorney-in-fact to transact business on their behalf and to manage the affairs of the Exchange. Indemnity earns a management fee from the Exchange for these services, which is paid from the premiums collected from subscribers (policyholders).

Indemnity also operates as a property and casualty insurer through its wholly-owned subsidiaries, Erie Insurance Company (“EIC”), Erie Insurance Company of New York (“ENY”) and the Erie Insurance Property and Casualty Company (“EPC”).

The “Property and Casualty Group” refers to the Exchange and its wholly-owned subsidiary, Flagship City Insurance Company (“Flagship”) and Indemnity’s wholly-owned subsidiaries. The Property and Casualty Group operates in 11 Midwestern, Mid-Atlantic and Southeastern states and the District of Columbia and primarily writes personal auto insurance, which comprises 48% of its 2009 direct premiums.

Erie Family Life Insurance Company (“EFL”) is an affiliated life insurance company that underwrites and sells nonparticipating individual and group life insurance policies and fixed annuities. Indemnity and the Exchange own 21.6% and 78.4% of EFL, respectively.

“Indemnity shareholder interest” refers to the interest in Erie Indemnity Company owned by the Class A and Class B shareholders. In addition to referring to Erie Insurance Exchange, the term “Exchange” sometimes refers to the noncontrolling interest held for the benefit of the subscribers (policyholders) and includes its interests in Flagship and EFL.

The accompanying consolidated financial statements of Erie Indemnity Company reflect the consolidated results of Indemnity and its variable interest entity, the Exchange, which we refer to collectively as “Erie Insurance Group”.

Note 2. Significant Accounting Policies

Retrospective adoption of new accounting principle

On June 12, 2009, the Financial Accounting Standards Board (FASB) updated ASC 810, Consolidation, which amended the existing guidance for determining whether an enterprise is the primary beneficiary of a variable interest entity (“VIE”). As of January 1, 2010 Erie Indemnity Company adopted the new accounting principle on a retrospective basis since inception.

This guidance changed the methodology for assessing whether an enterprise is the primary beneficiary of a VIE by requiring a qualitative analysis to determine if an enterprise’s variable interest gives it a controlling financial interest. The qualitative analysis looks at the power to direct activities of the VIE that most significantly impact economic performance and the right to receive benefits (or obligation to absorb losses) from the VIE that could potentially be significant.

In accordance with the new accounting guidance, Indemnity is deemed to be the primary beneficiary of the Exchange given the significance of the management fee to the Exchange and Indemnity’s power to direct the Exchange’s significant activities. Under the previously issued accounting guidance, Indemnity was not deemed the primary beneficiary of the Exchange and its financial position and operating results were not consolidated with Indemnity’s. Following adoption of the new accounting guidance, as primary beneficiary of the Exchange, Erie Indemnity Company has consolidated Indemnity and the Exchange’s financial position and operating results. Furthermore, upon consolidation of the Exchange, 100% of the ownership of EFL resides within the consolidated entity and consequently EFL’s financial results are also consolidated. The financial statements and notes to the financial statements presented herein have all been adjusted to reflect the retrospective adoption of the new accounting principle.

There was no cumulative effect to Indemnity’s shareholders’ equity from consolidation of the Exchange and EFL. The noncontrolling interest in total equity represents the amount of the Exchange’s subscribers’ (policyholders’) equity.

In January 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair Value Measurements. This guidance updated the disclosures for FASB ASC 820, Fair Value Measurements and Disclosures. The additional disclosures include the amounts and reasons for significant transfers between the levels in the fair value hierarchy, the expansion of fair market disclosures by each class of assets, disclosure of the policy for recognition of level transfers, and disclosure of the valuation techniques used for all Level 2 and Level 3 assets. These disclosures are effective for periods beginning after December 15, 2009 and have been included in Note 6. An additional disclosure requirement to present purchases, sales, issuances, and settlements of Level 3 activity on a gross basis becomes effective with periods beginning after December 15, 2010.

Basis of presentation and principles of consolidation

The accompanying consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) and include the accounts of Indemnity together with its affiliate companies in which Indemnity holds a majority voting or economic interest. In addition, we consolidate the Exchange as a variable interest entity for which Indemnity is the primary beneficiary. All intercompany accounts and transactions have been eliminated in consolidation. The required presentation of noncontrolling interests is reflected in the consolidated financial statements. Noncontrolling interests represent the ownership interests of the Exchange, all of which is held by parties other than Indemnity (i.e. the Exchange’s subscribers (policyholders)). Noncontrolling interests also include the Exchange subscribers’ 78.4% ownership interest in EFL.

Presentation of assets and liabilities – While the assets of the Exchange are presented separately in the Consolidated Statements of Financial Position, the Exchange’s assets can only be used to satisfy the Exchange’s liabilities or for other unrestricted activities. ASC 810, Consolidation, does not require separate presentation of the Exchange’s assets. However, because the shareholders of Indemnity have no rights to the assets of the Exchange and, conversely, the Exchange has no rights to the assets of Indemnity, we have presented the invested assets of the Exchange separately on the Consolidated Statements of Financial Position along with the remaining consolidated assets reflecting the Exchange’s portion parenthetically. Liabilities are required under ASC 810, Consolidation, to be presented separately for the Exchange on the Consolidated Statements of Financial Position as the Exchange’s creditors do not have recourse to the general credit of Indemnity.

Rights of shareholders of Indemnity and subscribers (policyholders) of the Exchange – The shareholders of Indemnity, through the management fee, have a controlling financial interest in the Exchange, however, they have no other rights to or obligations arising from assets and liabilities of the Exchange. The shareholders of Indemnity own its equity but have no rights or interest in the Exchange’s (noncontrolling interest) income or equity. The noncontrolling interest equity represents the Exchange’s equity held for the benefit of its subscribers (policyholders), who have no rights or interest in the Indemnity shareholder interest income or equity.

All intercompany assets and liabilities between Indemnity and the Exchange have been eliminated in the Consolidated Statements of Financial Position.

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. 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 month period ended March 31, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. For further information, refer to the consolidated financial statements and footnotes included in our Form 10-K for the year ended December 31, 2009 as filed with the Securities and Exchange Commission on Febuary 25, 2010.

Investments

Available-for-sale securities – Fixed maturity and preferred stock securities are classified as available-for-sale and are reported at fair value. Unrealized holding gains and losses, net of related tax effects, on fixed maturities and preferred stock are charged or credited directly to shareholders’ equity as accumulated other comprehensive income (loss).

Realized gains and losses on sales of fixed maturity and preferred stock securities are recognized in income based upon the specific identification method. Interest and dividend income are recognized as earned.

Fixed income and redeemable preferred stock (debt securities) are evaluated monthly for other-than-temporary impairment loss. For debt securities that have experienced a decline in fair value and we intend to sell or for which it is more likely than not we will be required to sell the security before recovery of its amortized cost, an other-than-temporary impairment is deemed to have occurred and is recognized in earnings.

Debt securities that have experienced a decline in fair value and that we do not intend to sell, and that will not be required to sell before recovery, are evaluated to determine if the decline in fair value is other-than-temporary.

Some factors considered in this evaluation include:

•

the extent and duration to which fair value is less than cost;

•

historical operating performance and financial condition of the issuer;

•

short and long-term prospects of the issuer and its industry based on analysts’ recommendations;

•

specific events that occurred affecting the issuer, including a ratings downgrade;

•

near term liquidity position of the issuer; and

•

compliance with financial covenants.

If a decline is deemed to be other-than-temporary, an assessment is made to determine the amount of the total impairment related to a credit loss and that related to all other factors. Consideration is given to all available information relevant to the collectability of the security in this determination. If the entire amortized cost basis of the security will not be recovered, a credit loss exists. Currently, we have the intent to sell all of our securities that have been determined to have a credit-related impairment. As a result, the entire amount of the impairment has been recognized in earnings. If we had securities with credit impairments that we did not intend to sell, the non-credit portion of the impairment would have been recorded in other comprehensive income.

Impairment charges on non-redeemable preferred securities and hybrid securities with equity characteristics are included in earnings consistent with the treatment for equity securities. This is a more conservative approach since the lack of a final maturity and unlikelihood of a call means recovery is uncertain and would occur over a multi-year period.

Trading securities – Our common stock securities are trading securities which are reported at fair value. Unrealized holding gains and losses on these securities are included in net realized gains (losses) in the Consolidated Statement of Operations. Realized gains and losses on sales of common stock are recognized in income based on the specific identification method. Dividend income is recognized as earned.

Limited partnerships – Limited partnerships include U.S. and foreign private equity, real estate and mezzanine debt investments. The private equity limited partnerships invest primarily in small- to medium-sized companies. The general partners for our limited partnerships determine the market value of investments in the partnerships, including any other-than-temporary impairments of these individual investments. The primary basis for the valuation of limited partnership interests are financial statements prepared by the general partner. Because of the timing of the preparation and delivery of these financial statements, the use of the most recently available financial statements provided by the general partners result in a quarter delay in the inclusion of the limited partnership results in our Consolidated Statements of Operations. Due to this delay, these financial statements do not yet reflect the market conditions experienced in the first quarter of 2010.

Nearly all of the underlying investments in our limited partnerships are valued using a source other than quoted prices in active markets. The fair value amounts for our private equity and mezzanine debt partnerships are based on the financial statements of the general partners, who use multiple methods to estimate fair value including the market approach, income approach and/or the cost approach. The market approach uses prices and other pertinent information from market-generated transactions involving identical or comparable assets or liabilities. Such valuation techniques often use market multiples derived from a set of comparables. The income approach uses valuation techniques to convert future cash flows or earnings to a single discounted present value amount. The measurement is based on the value indicated by current market expectations on those future amounts. The cost approach is derived from the amount that is currently required to replace the service capacity of an asset. If information becomes available that would impair the cost of these partnerships, then the general partner would generally adjust to the net realizable value.

For real estate limited partnerships, the general partners record these at fair value based on an independent appraisal or internal estimates of fair value.

We perform various procedures in review of the general partners’ valuations. While we generally rely on the general partners’ financial statements as the best available information to record our share of the partnership unrealized gains and losses resulting from valuation changes, we adjust our financial statements for impairments at the fund level as necessary. There were no valuation changes in 2010 or 2009. As there is a limited market for these investments, they have the greatest potential for market price variability.

Unrealized gains and losses for these investments are reflected in equity in losses of limited partnerships in our Consolidated Statements of Operations in accordance with the equity method of accounting. Cash contributions made to and distributions received from the partnerships are recorded in the period in which the transaction occurs.

Cash and cash equivalents – Cash and cash equivalents are principally comprised of investments in money market funds and approximate fair value.

Deferred acquisition costs

Acquisition costs that vary with and relate to the production of insurance and investment-type contracts are deferred. Such costs consist principally of commissions, premium taxes and policy issuance expenses.

Property and casualty insurance – Deferred acquisition costs (“DAC”) for property and casualty insurance contracts, which is primarily composed of commissions and certain underwriting expenses, is amortized on a pro rata basis over the applicable policy term. The amount of costs to be deferred would be reduced to the extent future policy premiums and anticipated investment income would not exceed related losses, expenses and policyholder dividends. There was no reduction in costs deferred in any periods presented. The DAC profitability is analyzed annually to ensure recoverability.

Life insurance – DAC related to traditional life insurance products is amortized in proportion to premium revenues over the premium-paying period of related policies using assumptions about mortality, morbidity, lapse rates, expenses and future yield on related investments established when the policy was issued. Amortization is adjusted each period to reflect policy lapse or termination rates as compared to anticipated experience. DAC related to universal life products and deferred annuities is amortized over the estimated lives of the contracts in proportion to actual and expected future gross profits, investment, mortality and expense margins and surrender charges. Both historical and anticipated investment returns, including realized gains and losses, are considered in determining the amortization of DAC.

Estimated gross profits are adjusted monthly to reflect actual experience to date and/or for the unlocking of underlying key assumptions based on experience studies. DAC is periodically reviewed for recoverability. For traditional life products, if the benefit reserves plus anticipated future premiums and interest earnings for a line of business are less than the current estimate of future benefits and expenses (including any unamortized DAC), a charge to income is recorded for additional DAC amortization or for increased benefit reserves. For universal life and deferred annuities, if the current present value of future expected gross profits is less than the unamortized DAC, a charge to income is recorded for additional DAC amortization.

Deferred taxes

Deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements, using the statutory tax rates in effect for the year in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date under the law. Valuation allowances on deferred tax assets are estimated based on our assessment of the realizability of such amounts.

Property and casualty unpaid losses and loss expenses

Unpaid losses and loss expenses include estimates for claims that have been reported and those that have been incurred but not reported, as well as estimates of all expenses associated with processing and settling these claims, less estimates of anticipated salvage and subrogation recoveries. Unpaid loss and loss expense reserves are set at full expected cost, except for workers compensation loss reserves, which have been discounted using an interest rate of 2.5%. Estimating the ultimate cost of future losses and loss expenses is an uncertain and complex process. This estimation process is based on the assumption that past developments are an appropriate indicator of future events, and involves a variety of actuarial techniques that analyze experience, trends and other relevant factors. The uncertainties involved with the reserving process include internal factors, such as changes in claims handling procedures, as well as external factors, such as economic trends and changes in the concepts of legal liability and damage awards. Accordingly, final loss settlements may vary from the present estimates, particularly when those payments may not occur until well into the future.

We regularly review the adequacy of our estimated loss and loss expense reserves by line of business. Adjustments to previously established reserves are reflected in the operating results of the period in which the adjustment is determined to be necessary. Such adjustments could possibly be significant, reflecting any variety of new and adverse or favorable trends.

Life insurance reserves

The liability for future benefits of life insurance contracts is the present value of such benefits less the present value of future net premiums. Life insurance and income-paying annuity future policy benefit reserves are computed primarily by the net level premium method with assumptions as to mortality, withdrawal, lapses and investment yields. Traditional life insurance products are subject to loss recognition testing. The adequacy of the related reserves is verified as part of loss recognition testing. Loss recognition is necessary when the sum of the reserve and the present value of projected policy cash flows is less than unamortized DAC.

Deferred annuity future benefit reserves are established at accumulated account values without reduction for surrender charges. These account values are credited with varying interest rates determined at the discretion of EFL subject to certain minimums.

Agent bonus estimates

Agent bonuses are based on an individual agency’s property and casualty underwriting profitability and also include a component for growth in agency property and casualty premiums if the agency’s underwriting profitability targets for our book of business are met. The estimate for agent bonuses, which are based on the performance over 36 months, is modeled on a monthly basis using actual underwriting data by agency for the two prior years combined with the current year-to-date actual data. At December 31 of each year, we use actual data available and record an accrual based on the expected payment amount. These costs are included in the policy acquisition and underwriting expenses in the Consolidated Statements of Operations.

Recognition of premium revenues and losses

Property and casualty insurance – Insurance premiums written are earned over the terms of the policies on a pro-rata basis. Unearned premiums represent that portion of premiums written which is applicable to the unexpired terms of policies in force. Losses and loss expenses are recorded as incurred.

Life insurance – Premiums on traditional life insurance products are recognized as earned when due. Reserves for future policy benefits are established as premiums are earned. Premiums received for annuity and universal life products are not reported as revenue, but as deposits, and included in liabilities. For universal life products, revenue is recognized as amounts are assessed against the policyholder’s account for mortality coverage and contract expenses. The primary source of revenue on annuity deposits is derived from the interest earned by EFL, which is reflected in net investment income.

Reinsurance

Property and casualty insurance – Property and casualty assumed involuntary and ceded reinsurance premiums are earned over the terms of the reinsurance contracts. Premiums ceded to other companies are reported as a reduction of premium income. Reinsurance contracts do not relieve the Property and Casualty Group from its obligations to policyholders.

Life insurance – Reinsurance premiums, commissions and expense reimbursements on reinsurance ceded on life insurance policies are accounted for on a basis consistent with those used in accounting for the underlying reinsured policies. Expense reimbursements received in connection with new reinsurance ceded have been accounted for as a reduction of the related policy acquisition costs. Amounts recoverable from reinsurers for future policy benefits are estimated in a manner consistent with the assumptions used for the underlying policy benefits. Amounts recoverable for incurred claims, future policy benefits and expense reimbursements are recorded as assets. Reinsurance contracts do not relieve EFL from its obligations to policyholders.

Recognition of management fee revenue

Indemnity earns management fees from the Exchange for providing sales, underwriting and policy issuance services. The management fee revenue is calculated as a percentage of the direct written premium of the Property and Casualty Group. The Exchange issues policies with annual terms only. Management fees are recorded as revenue upon policy issuance or renewal, as substantially all of the services required to be performed by us have been satisfied at that time. Certain activities are performed and related costs are incurred by us subsequent to policy issuance in connection with the services provided to the Exchange; however, these activities are inconsequential and perfunctory. Management fee revenue is eliminated in consolidation.

Recognition of service agreement revenue

Included in service agreement revenue are service charges Indemnity collects from policyholders for providing multiple payment plans on policies written by the Property and Casualty Group. Service charges, which are flat dollar charges for each installment billed beyond the first installment, are recognized as revenue when bills are rendered to the policyholder. Service agreement revenue also includes late payment and policy reinstatement fees. Service agreement revenue is included in other income in the Consolidated Statements of Operations.

Note 3. Earnings Per Share

Basic earnings per share are calculated under the two-class method, which allocates earnings to each class of stock based on its dividend rights. Class B shares are convertible into Class A shares at a conversion ratio of 2,400 to 1. Class A diluted earnings per share are calculated under the if-converted method which reflects the conversion of Class B shares and the effect of potentially dilutive outstanding employee stock-based awards and awards not yet vested related to the outside directors’ stock compensation plan.

A reconciliation of the numerators and denominators used in the basic and diluted per-share computations is presented as follows for each class of Indemnity common stock:

		Indemnity Earnings Per Share Calculation
(dollars in millions,										Three months ended March 31,
except per share data)		2010												2009
		Allocated				Weighted				Per-				Allocated				Weighted				Per-
		net income				shares				share				net income				shares				share
		(numerator)				(denominator)				amount				(numerator)				(denominator)				amount
Class A – Basic EPS:
Income available to Class A stockholders		$	47				51,185,736			$	0.92			$	11				51,270,240			$	0.22
Dilutive effect of stock awards			0				14,111				—				0				16,820				—
Assumed conversion of Class B shares			0				6,110,400				—				0				6,122,400				—
Class A – Diluted EPS:
Income available to Class A stockholders on Class A equivalent shares		$	47				57,310,247			$	0.82			$	11				57,409,460			$	0.19
Class B – Basic and diluted EPS:
Income available to Class B stockholders		$	0				2,546			$	132.83			$	0				2,551			$	34.78

There were 11,200 and 14,400 shares of other stock-based awards not yet vested that were included in the diluted earnings per share calculations for the first quarters of 2010 and 2009, respectively. Awards not yet vested related to the outside directors’ stock compensation plan were 2,911 and 2,420 shares for the first quarters of 2010 and 2009, respectively.

Note 4. Variable Interest Entity

Exchange

The Exchange is a reciprocal insurance exchange domiciled in Pennsylvania, for which Indemnity serves as attorney-in-fact. Indemnity holds a variable interest in the Exchange because of the absence of decision-making capabilities by the equity owners (i.e. subscribers (policyholders)) of the Exchange and because of the significance of the management fees the Exchange pays to Indemnity as the decision maker. The new accounting guidance, which we adopted on January 1, 2010, requires entities to perform a qualitative analysis to determine the primary beneficiary of variable interest entities. As a result of adopting the new guidance, Indemnity is deemed to have a

controlling financial interest in the Exchange and is considered the primary beneficiary. The Exchange’s results have been consolidated with those of Indemnity. We have retrospectively applied the new accounting guidance and have consolidated the Exchange for all periods presented in this report for comparability purposes. See Note 2.

Consolidation of the Exchange is required given the significance of the management fee to the Exchange and because Indemnity has the power to direct the activities of the Exchange that most significantly impact the Exchange’s economic performance. Indemnity earns management fee revenues from the Exchange for services provided as attorney-in-fact for the Exchange. Indemnity’s management fee revenues are based on the direct written premiums of the Exchange and the other members of the Property and Casualty Group. Indemnity’s Board of Directors determines the management fee rate paid by the Exchange to Indemnity. This rate cannot exceed 25% of the direct and affiliated assumed written premiums of the Exchange, as defined by the subscriber agreement signed by each policyholder. The management fee revenues and management fee expenses are eliminated in consolidation.

Indemnity participates in the underwriting results of the Exchange through the pooling arrangement in which its insurance subsidiaries have a 5.5% participation. If the Exchange were to default, Indemnity’s insurance subsidiaries would be liable for the policies that they wrote directly. Indemnity’s property and casualty insurance subsidiaries wrote approximately 16% of the 2009 direct written premiums of the Property and Casualty Group. Indemnity’s Board of Directors determines the continuation and participation percentage of Indemnity’s property and casualty subsidiaries in the reinsurance pooling arrangement.

Indemnity has no obligation related to any underwriting and/or investment losses experienced by the Exchange. Indemnity would however be adversely impacted if the Exchange incurred significant underwriting and/or investment losses. If the surplus of the Exchange were to decline significantly from its current level, its financial strength ratings could be reduced and as a consequence the Exchange could find it more difficult to retain its existing business and attract new business. A decline in the business of the Exchange would have an adverse effect on the amount of the management fees Indemnity receives and the underwriting results of the Property and Casualty Group in which Indemnity has a 5.5% participation. In addition, a decline in the surplus of the Exchange from its current level may impact the management fee rate received by Indemnity. Indemnity also has an exposure to a concentration of credit risk related to the unsecured receivables due from the Exchange for its management fee, reinsurance recoverables from unpaid losses and loss expenses and unearned premium balances ceded under the pooling arrangement and cost reimbursements.

Indemnity has not provided financial or other support to the Exchange for the reporting periods presented. At March 31, 2010, there are no explicit or implicit arrangements that would require Indemnity to provide future financial support to the Exchange. Indemnity is not liable if the Exchange was to be in violation of its debt covenants or was unable to meet its obligation for unfunded commitments to limited partnerships.

Note 5. Segment Information

As a result of the changes in our reporting entity at January 1, 2010 (see Note 2), our reportable segments have increased from three to four. Our reportable segments include management operations, property and casualty insurance operations, life insurance operations and investment operations. The segment information presented below includes reclassification of all comparative prior period segment information. Accounting policies for segments are the same as those described in the summary of significant accounting policies. See Note 2. Assets are not allocated to the segments but rather are reviewed in total for purposes of decision-making. No single customer or agent provides 10% or more of revenues.

Our management operations segment consists of serving as attorney-in-fact for the Exchange. Indemnity operates in this capacity solely for the Exchange. We evaluate profitability of our management operations segment principally on the gross margin from management operations.

Indemnity earns management fees from the Exchange for providing sales, underwriting and policy issuance services. The management fee revenue, which is eliminated in consolidation, is calculated as a percentage of the direct written premium of the Property and Casualty Group. The Exchange issues policies with annual terms only. Management fees are recorded upon policy issuance or renewal, as substantially all of the services required to be performed by Indemnity have been satisfied at that time. Certain activities are performed and related costs are incurred by us subsequent to policy issuance in connection with the services provided to the Exchange; however, these activities are inconsequential and perfunctory. Although these management fee revenues and expenses are

eliminated in consolidation, the amount of the fee directly impacts allocations of our consolidated net income between noncontrolling interest, which bears the management fee expense and represents the interests of the Exchange subscribers, and Indemnity’s interests which earns the management fee revenue and represents Indemnity shareholder interest in net income.

Our property and casualty insurance segment includes personal and commercial lines. Personal lines consist primarily of personal auto and homeowners and are marketed to individuals. Commercial lines consist primarily of commercial multi-peril, commercial auto and workers compensation and are marketed to small- and medium-sized businesses. Our property and casualty policies are sold by independent agents. Our property and casualty insurance underwriting operations are conducted through Indemnity subsidiaries and the Exchange, which includes assumed voluntary reinsurance from nonaffiliated domestic and foreign sources, assumed involuntary and ceded reinsurance business. The Exchange exited the assumed voluntary reinsurance business effective December 31, 2003, and therefore unaffiliated reinsurance includes only run-off activity of the previously assumed voluntary reinsurance business. We evaluate profitability of the property and casualty operations principally based on net underwriting results represented by the combined ratio.

Our life insurance operations segment includes traditional and universal life insurance products and fixed annuities marketed to individuals using the same independent agency force utilized by our property and casualty operations. We evaluate profitability of the life insurance segment principally based on segment net income, including investments, which for segment purposes are reflected in the investment operations segment. At the same time, we recognize that investment-related income is integral to the evaluation of the life insurance segment because of the long duration of life products. Through March 31, 2010, investment activities on life insurance-related assets generated revenues of $27 million resulting in EFL reporting income before income taxes of $10 million, before intercompany eliminations. Through March 31, 2009, investment activities on life insurance-related assets generated revenue of $6 million resulting in EFL reporting losses before income taxes of $6 million, before intercompany eliminations. See Note 22 for EFL supplemental information.

The investment operations segment performance is evaluated based on appreciation of assets, rate of return and overall return. Investment-related income for the life operations is included in the investment segment results.

The following tables summarize the components of the Consolidated Statements of Operations by reportable business segments:

		Erie Insurance Group
		For the three months ended March 31, 2010
		Management				Property and				Life insurance
(in millions)		operations				casualty operations				operations				Investments				Eliminations				Consolidated
Premiums earned/life policy revenue						$	962			$	16											$	978
Net investment income														$	107			$	(3	)			104
Net realized investment gains (losses)															125								125
Net impairment losses recognized in earnings															(2	)							(2	)
Equity in earnings (losses) of limited partnerships															3								3
Management fee revenue		$	237																(237	)			—
Service agreement and other revenue			8																				8
Total revenues			245				962				16				233				(240	)			1,216
Cost of management operations			192																(192	)			—
Insurance losses and loss expenses							738												(1	)			737
Benefits and other changes in policy reserves											24												24
Policy acquisition and underwriting expense							265				9								(47	)			227
Total benefits and expenses			192				1,003				33				—				(240	)			988
Income (loss) before income taxes			53				(41	)			(17	)			233				—				228
Provision (benefit) for income taxes			18				(14	)			(6	)			68				—				66
Net income (loss)		$	35			$	(27	)		$	(11	)		$	165			$	—			$	162

		Erie Insurance Group
		For the three months ended March 31, 2009
		Management				Property and				Life insurance
(in millions)		operations				casualty operations				operations				Investments(1)				Eliminations				Consolidated
Premiums earned/life policy revenue						$	941			$	16							$	—			$	957
Net investment income														$	120				(3	)			117
Net realized investment losses															(155	)							(155	)
Net impairment losses recognized in earnings															(71	)							(71	)
Equity in losses of limited partnerships															(161	)							(161	)
Management fee revenue		$	230																(230	)			—
Service agreement and other revenue			8																				8
Total revenues (losses)			238				941				16				(267	)			(233	)			695
Cost of management operations			193																(193	)			—
Insurance losses and loss expenses							782												(1	)			781
Benefits and other changes in policy reserves											22												22
Policy acquisition and underwriting expense							265				6								(39	)			232
Total benefits and expenses			193				1,047				28				—				(233	)			1,035
Income (loss) before income taxes			45				(106	)			(12	)			(267	)			—				(340	)
Provision (benefit) for income taxes			14				(37	)			(4	)			(62	)			—				(89	)
Net income (loss)		$	31			$	(69	)		$	(8	)		$	(205	)		$	—			$	(251	)

See the “Results of the Erie Insurance Group’s operations by interest” table in the Management’s Discussion and Analysis for the composition of income attributable to Indemnity and income attributable to the noncontrolling interest (Exchange).

Note 6. Fair Value

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

Valuation techniques used to derive the fair value of our available-for–sale and trading securities are based on observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources.

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

		Level 1		Quoted prices for identical instruments in active markets not subject to adjustments or discounts.
		Level 2		Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
		Level 3		Instruments whose significant value drivers are unobservable and reflect management’s estimate of fair value based on assumptions used by market participants in an orderly transaction as of the valuation date.

The following table represents the fair value measurements on a recurring basis for our consolidated available-for-sale and trading securities by asset class and level of input at March 31, 2010:

		Erie Insurance Group
						March 31, 2010
						Fair value measurements using:
						Quoted prices in								Significant
						active markets for				Significant				unobservable
						identical assets				observable inputs				inputs
(in millions)		Total				Level 1				Level 2				Level 3
Indemnity
Available for sale securities:
Fixed maturities
U.S. treasuries and government agencies		$	3			$	3			$	0			$	0
U.S. government sponsored enterprises			22				0				22				0
Foreign government			2				0				2				0
Municipal securities			247				0				247				0
U.S. corporate debt — non-financial			179				0				179				0
U.S. corporate debt — financial			137				0				135				2
Foreign corporate debt — non-financial			31				0				31				0
Foreign corporate debt — financial			18				0				18				0
Structured securities:
Asset-backed securities — auto loans			4				0				4				0
Collateralized debt obligations			9				0				0				9
Commercial mortgage-backed			6				0				6				0
Residential mortgage-backed:
Government sponsored enterprises			13				0				13				0
Non-government sponsored enterprises			3				0				3				0
Total fixed maturities-Indemnity		$	674			$	3			$	660			$	11
Equity securities
U.S. nonredeemable preferred securities:
Financial		$	28			$	7			$	19			$	2
Non-financial			14				6				8				0
Foreign nonredeemable preferred securities:
Financial			5				0				5				0
Non-financial			1				0				1				0
Total equity securities — Indemnity		$	48			$	13			$	33			$	2
Total available-for-sale securities — Indemnity		$	722			$	16			$	693			$	13
Trading securities:
Common stock			45				45				0				0
Total trading securities			45				45				0				0
Total Indemnity		$	767			$	61			$	693			$	13

		Erie Insurance Group
						March 31, 2010
						Fair value measurements using:
						Quoted prices in								Significant
						active markets for				Significant				unobservable
						identical assets				observable inputs				inputs
(in millions)		Total				Level 1				Level 2				Level 3
Exchange
Available for sale securities:
Fixed maturities
U.S. treasuries and government agencies		$	5			$	5			$	0			$	0
U.S. government sponsored enterprises			87				0				87				0
Foreign government			11				0				11				0
Municipal securities			1,421				0				1,421				0
U.S. corporate debt — non-financial			2,217				6				2,202				9
U.S. corporate debt — financial			1,549				6				1,543				0
Foreign corporate debt — non-financial			400				0				400				0
Foreign corporate debt — financial			360				0				360				0
Structured securities:
Asset-backed securities — auto loans			51				0				51				0
Asset-backed securities — other			28				0				23				5
Collateralized debt obligations			83				0				13				70
Commercial mortgage-backed			152				0				152				0
Residential mortgage-backed:
Government sponsored enterprises			172				0				172				0
Non-government sponsored enterprises			33				0				33				0
Total fixed maturities — Exchange		$	6,569			$	17			$	6,468			$	84
Equity securities
U.S. nonredeemable preferred securities:
Financial		$	333			$	105			$	223			$	5
Non-financial			137				57				80				0
Government sponsored enterprises			3				3				0				0
Foreign nonredeemable preferred securities:
Financial			54				16				38				0
Non-financial			9				0				9				0
Total equity securities — Exchange		$	536			$	181			$	350			$	5
Total available for sale securities — Exchange		$	7,105			$	198			$	6,818			$	89
Trading securities:
Common stock		$	1,933			$	1,923			$	0			$	10
Total trading securities			1,933				1,923				0				10
		— —
Total — Exchange		$	9,038			$	2,121			$	6,818			$	99
Total — Erie Insurance Group		$	9,805			$	2,182			$	7,511			$	112

Level 3 Assets — Quarterly Change:

		Erie Insurance Group
		Beginning																				Ending
		balance at								Included in other				Purchases,				Transfers in				balance at
		December 31,				Included in				Comprehensive				sales and				and (out) of				March 31,
(in millions)		2009				earnings (1)				income				adjustments				Level 3 (2)				2010
Indemnity
Available-for-sale securities:
Fixed maturities:
U.S. corporate debt — financial		$	2			$	0			$	0			$	0			$	0			$	2
Collateralized debt obligations			8				0				1				0				0				9
Total fixed maturities			10				0				1				0				0				11
Preferred stock:
U.S. nonredeemable — financial			1				0				1				0				0				2
Total preferred stock			1				0				1				0				0				2
Total Level 3 assets — Indemnity		$	11			$	0			$	2			$	0			$	0			$	13
Exchange
Available-for-sale securities:
Fixed maturities:
U.S. corporate debt — non-financial		$	17			$	0			$	0			$	(7	)		$	(1	)		$	9
Asset backed securities — other			5				0				0				0				0				5
Collateralized debt obligations			49				1				7				0				13				70
Total fixed maturities			71				1				7				(7	)			12				84
Preferred stock:
U.S. nonredeemable — financial			4				0				1				0				0				5
Total preferred stock			4				0				1				0				0				5
Trading securities:
Common stock			9				1				0				0				0				10
Total Level 3 assets — Exchange		$	84			$	2			$	8			$	(7	)		$	12			$	99
Total Level 3 assets — Erie Insurance Group		$	95			$	2			$	10			$	(7	)		$	12			$	112