Erie Indemnity Co (ERIE) 2002 Q4 法說會逐字稿

Hello, and welcome to the Erie Indemnity Company Fourth Quarter and Year-End Earnings Conference. At the request of Erie Indemnity, this conference is being recorded for instant replay purposes. At this time, all participants are in a listen-only mode. Following prepared remarks by management, we will open the call for Q&A. Now, I would like to introduce your host for today's conference call, Karen Kraus Phillips, Assistant Vice President and Manager of Corporate Communications and Investor Relations. Please go ahead ma'am.

Thank you Michelle and good morning. This is Erie Indemnity Company's first investor conference call, and we appreciate you joining us today. As many of you know, we just completed a secondary offering on Tuesday February 4th, on behalf of one our major shareholders, the Black Interests Limited Partnership. For Erie, this was akin to an IPO, since it was really the first opportunity we have had to tell our story to our broad audience of investors. On behalf of Jeff Ludrof, Phil Garcia, and myself, I would like extent our gratitude to many of you who took time to meet with us, and learn know more about Erie Indemnity Company, and to those just joining us we look forward to the opportunity to do so through today's call. Today, management will discuss our fourth quarter and year-end 2002 results. Joining me are, Jeff Ludrof, President and CEO; Chief Financial Officer, Phil Garcia; and Brian Burlash, Associate General Counsel.

To accommodate everyone's hectic schedules, we'll keep the call to no more than an hour. In our prepared remarks, we would discuss fourth quarter and year-end results for 2002. Following those remarks, we will open the call for questions. In respect of time, we'd ask that you please keep to one question and a follow-up. We issued our earnings release and additional supplements last night after the market closed. If you need a copy of the press release or any of the exhibits, you can find these in the investor section of our website, at erieinsurance.com. We also filed an 8-K with SEC containing the press release and supplemental data. The Company's 10-K will be filed on or about March 15th.

Before I turn the call over to our CEO, Jeff Ludrof, I would like to note that on today's call management of Erie Indemnity Company will share important information about current and feature initiatives being undertaken at the Company. As a result, certain forward-looking statements within the meaning of Private Securities Litigation Reform Act of 1995 may be incorporated in to their comments. These forward-looking statements reflect the company's current views about future events and are based on assumptions subject to known, and unknown risks and uncertainties. These risks and uncertainties may cause actual results to differ materially from those anticipated as described in those statements. Many of the factors that would determine future events or achievements are beyond our ability to control or predict. For information on important factors that may cause such differences, please see the Safe Harbor Statements in our latest 8-K, which we filed with the SEC dated February 25, 2003, and in the related press release. This call is being recorded, and the recording is the property of Erie Indemnity Company. It is not intended for reproduction or rebroadcast by any other party without the prior consent of Erie Indemnity Company. A replay will be available on our website today, after 1:30 p.m. ET. Your participation on this call will constitute consent to the recording, publication, webcast, broadcast, and use of your name, voice, and comments by Erie Indemnity. If you do not agree with these terms, please disconnect. Thank you, I'd now like to turn the call over to Erie's President and CEO Jeff Ludrof. Jeff?

Thank you Karen, and good morning to everyone. Before, Phil and I get into a discussion of the Company's fourth quarter and year-end results, I would like to share my overall perspectives with you about Erie Insurance Group in 2002. To put the year in context, 2002 was a transition year for the Company. Steve Milne, our previous CEO, a strong leader and friend, retired in January of 2002, to focus on his battle with ALS, a progressive illness, more commonly known as Lou Gehrig's disease. Sadly Steve ended his battle in September. In May, I was named President and CEO of the Company. While I may be relatively new to my position, I have spent 22 years with the company. My career with the Erie spans a variety of positions. In claims, sales, field operations, and various management positions. Just prior to becoming CEO, I served as Executive Vice President of insurance operations. Collectively, our six executive officers represent more than 120 years of experience, and share a strong commitment, invested interest in our company's success. Our focus throughout this transitional year has remained fixed on the values, objectives, and the purpose that had driven the Erie's solid performance for nearly eight decades. Since our founding in 1925, Erie's business model has been to sell insurance only through independent agents, supported by dedicated Erie employees. That model combined with our long-term disciplined approach to doing business, has produced strong results when compared to our peers. I believe this is the most effective way to provide outstanding service at the lowest possible cost to our policyholders. In overtime, it has consistently benefited the shareholders of Erie Indemnity Company.

Now, let's take a look at those results. The growth strategies, we put in place in 2000 and 2001, continue through this year. We appointed 225 new agencies in 2002, while down slightly from the previous year, it is an aggressive number of appointments considering our rigorous agent selection process. In fact, within the last 5 years, we've expanded our agency force by over 50%, spreading our risk over a wider geographic area. We've entered new states, and expanded within existing states. At the end of 2002, our agency force numbered 1,750 independent agencies, and we're beginning to see solid unit growth from that expansion. We also conducted a year long sales and [center] contest for our personal property casualty, and life products. This contest had a positive effect on our 2002 policies and force growth. As you will see from our fourth quarter and year-end numbers, these strategies are proving successful. The company reported a 48-cent per share increase in net income to 33.9m in the fourth quarter compared to 5.9m or 8 cents per share in 2001. The 2001 fourth quarter net income was affected by net realized losses in investments, and a charge relating to Steve Milne's retirement. For the year 2002, net income increased by 40.8% with net income per share increasing 41.3% over 2001. Management fee revenue, which is based on direct return premiums of the property and casually group continues to rise at a steady pace. For the fourth quarter 2002, management fee revenue was up by 17.9% over the same quarter in 2001. For the year, management fee revenue had risen by 22.2% compared to 2001. When you look at our management fee revenue, it's apparent that we're seeing very strong growth in direct return premiums for the property and causality group. I attribute this to our strong competitive position in the marketplace. It's not just price, it's the combination of quality products, and incomparable service provided by agents and employees at a very competitive price, that's what keeps us successful. We don't advertise and that's by choice. What we offer to our customers is a strong value proposition. Our agents are loyal, and they know that Erie won't abandon the market, like so many of our other competitors have done. And our policyholders know that Erie's commitment to service to their piece of mind is real, not just some slogan. When we talk about customer loyalty, the evidence is in the retention ratio that remains at an enviable level in the industry, a strong 91.2% at year-end. Take a look at the exhibit regarding unit growth rates for the property and casualty group, which was issued with the press release. Total policies enforced grew by 12.8% in 2002 over the prior year, a very strong growth rate. This put our year-end unit count of 3.5m policies with the under-writing profitability initiatives, we're employing in 2003. I anticipate our growth rate will level off and perhaps the decelerate. A review of our unit growth results shows that in just the last three years we have grown policy accounts by 30.5%. As I said earlier, we are expanding our geographic reach, entering new states, Illinois in 1999, Wisconsin in 2001, and soon Minnesota in 2004. And we are expanding our presence within existing states. But we are also seeing significant growth in same store sales with Erie agent stepping up their marketing efforts throughout their territories. We are not with our growing pains. When you are growing at such a rate you are bound to see some adverse loss experience, and we do see that happening. Our underwriting loses for 2002 were greater than they anticipated. Fortunately, given our growth position and our solid policyholder base, we can focus more fully on reselection through fundamentals like underwriting and re-underwriting while still maintaining steady growth. I will talk about our plans regarding underwriting profitability in some detail later in this call.

Before I turn the call over to Phil, I would like to touch on the management fee reduction we announced in December. First of all, the Erie Indemnity Company Board of Directors sees the management fee as a tool to balance the interest of the shareholders, of the Erie Indemnity Company with the policyholders of the exchange. Keep in mind the exchange assumes 94.5% of the total underwriting risk and is the only corporate customer of the Erie Indemnity Company. Given the strong revenues and earnings growth of the Erie Indemnity company and the underwriting loses we are experiencing at the exchange, the Board opted this past December to reduce the management fee from 25 to 24%. To put that in to perspective, the fee cannot be more than 25% and over the past 12 years it has not been less than 23%. At the same time, the Board increased the Class A common stock dividend to 19 cents from 17 cents per quarter in 2001, an increase of 11.8%. The board took this action in recognition of the strong financial position of the Company. Now, I will turn it over to Phil to provide details on our fourth quarter and yearend results.

Thanks Jeff and welcome everyone. As Jeff indicated, we cap the year with a solid fourth quarter. Net income increased to $33.9m or 48 cents per share in the fourth quarter of 2002. For the year, net income was $2.42 per share versus a $1.71 per share in 2001. Net income excluding the effects of realized capital losses and income taxes on those losses, rose 54.8% for the quarter to 50 cents per share and for the year rose 26.5% to $2.52 per share. Our management fee revenue grew by 17.9% to $181.8m for the fourth quarter putting management fee revenue at $775.7m for the year, compared to $635m for 2001. We finished the year with a gross margin from our management operations of 30.3% compared to 27.9% a year earlier. As I commented on our operations, my remarks are going to be made in the context of our statement of operations on an operating segment basis, which is the way we manage the Company. The exhibit reflecting this breakdown is labeled Consolidated Statement of Operations Segment Basis and is included in the supplemental data issued with the press release. First, I would like to discuss our performance in our management operation segment.

Direct written premium of the property in cash of the group grew by 25.7% in the fourth quarter, rising to $775m compared to $617m a year earlier. This growth is based primarily on unit growth in policies of 12.8% and increases in average premium as a result of rating actions. For the fourth quarter commercial lines written premium grew by 34.4% with a 22.3% rise in personal lines written premium, and for the year direct written premium rose to $3.2b compared to $2.5b for 2001. For the fourth quarter new written premium growth in personal lines increased by more than 42% and commercial lines rose 33 and 1/3%. Average written premium per policy grew by 9.9% for the year to $898 from $817 in 2001. As Jeff said, our retention ratios for the year were also a very strong 91.2%. In the fourth quarter 2002, we recorded a one-time charge for establishing allowance for returned management fess. Management fees are returned when policyholders cancel their coverage mid term and unearned premiums are refunded by the Company. The charge reduced fourth quarter management fee revenue by $11.9m and reduced our net income by $4m or 6 cents per share after taxes. The cost of management operations increased by 6.6% in the fourth quarter to $136.3m. Commission costs for our 8400 independent agents represent over half the Company's cost of management operations. This expense increased by 21.3% to $95.7m in the fourth quarter 2002. This is slower than the growth in direct written premium for the quarter of 25.7% due to an adjustment to record returned commissions of $5.8m related to the returned management fee allowance I mentioned earlier. For the year, commission cost rose 23.3% to $398.3m from $323.1 for 2001. You will also note a decrease in management operating expenses other than commissions in the fourth quarter 2002 compared to 2001. This is primarily due to the charge we took in the fourth quarter of 2001 relating to Steve Milne's retirement, which Jeff mentioned earlier. If you exclude that charge, operating expenses would have increased by 6.2% in the fourth quarter and 10.6% for the year.

Next I would like to discuss our insurance underwriting segment. We took a fourth quarter charge for adverse development of loss reserves principally in personal and commercial automobile coverage. While we see the frequency of losses declining slightly, claims severity continues to increase, particularly in automobile bodily injury and uninsured and underinsured motors coverage as well as Workers Compensation and home owner lines of business. As previously announced, due to these loss trends we recorded reserve strengthening in December of 2002 of an $184m. The Erie Indemnity share of that reserve strengthening was about $6.6m or 9 cents per share after taxes excluding the effect of the excess of the loss agreement between the Company and the Exchange for the fourth quarter 2002. Approximately 50% of the reserve strengthening was for prior accident years. It is just that our 2002 underwriting losses for the Property and Casualty Group were higher than anticipated for the year. The Erie Indemnity Company retains a 5.5% share of the underwriting results of the Property Casualty Group. In the fourth quarter, Erie Indemnity recorded underwriting losses of $11.2m, and as Jeff indicated, our underwriting losses for the year were $27.1m. The underwriting losses resulted from the continued adverse loss development of prior accident years that I just mentioned as well as above average catastrophe losses brought on by a succession of spring and fall storms this year.

Next I would like to discuss the Investment Operations segment. Our Investment Operations during the fourth quarter recorded an income of $8m compared to a loss of $19.2m for the same period in 2001. For the year, net revenue from investment operations was $42.3m compared to $18.8m in 2001. Net investment income increased by 13.1% to $14.7m for the fourth quarter and by 11.1% to $55.4m for the year. The Company realized losses on investments of $2.6m due to the impairment of securities in the fourth quarter of 2002. Impairment charges of $7.7m related to fixed income and equity security investments were recorded in the fourth quarter of 2002. These impairment losses were partially offset by net realized gains from the sale of investments of $5.1m. The Company also recorded equity and losses from limited partnerships in the fourth quarter 2002 as a result of the impairment charges of $5.5m compared to $2.7m in the fourth quarter 2001. The company also saw an increase in earnings from its 21.6% equity ownership of Erie Family Life Insurance Company as a result of a fourth quarter profit for Erie Family life of $3m compared to a net loss for the fourth quarter of 2001 of $8.9m. We issued a separate press release yesterday summarizing the results for Erie Family Life's fourth quarter. Now I would like to turn the call back over to Jeff, for some observations on the year ahead.

Thanks Phil. I am going to address a number of points briefly. First a few talk on the competition. Second, our underwriting profitability initiatives and third, some thoughts on Erie's corporate culture. Like everyone else we see the hard market continuing through 2003. We foresee more rate increases from the competition. We too plan to file for additional rate relief particularly in states like New York where we are seeing increasing loss experience due to the involuntary auto market. We anticipate company-wide premium rates increases of almost 200m for the year 2003. The competition continues to wrestle with underwriting losses, as do we. There will be more focus on underwriting profitability across the board. At this time in a hard market cycle tighter underwriting guidelines are warranted given our strong premium growth in competitive position we are focusing our attention on underwriting profitability. We have adopted a four-point strategy to address this issue. We will manage our exposure growth, we are honing our risk selection approach, we are controlling loss severity, and taking rate increases where warranted. We will continue to grow our agency force approximately 130 new agencies for the year. But our approach will be more targeted primarily in newer states such as Illinois and Wisconsin with some expansion in our existing states. Instead of concentrating on recruiting new agents our sales managers will focus greater attention on agent performance and profitability. It's our intention to always write the most desirable risk. With this in mind we are revising our underwriting guidelines and earlier this month launched a multifaceted education program we call Aware. Aware stands for agents writing and re-underwriting excellence. As we speak our new executive Vice President of insurance operations Tom Morgan is on tour meeting with every licensed agent in our company and also the underwriting employees. There is no better person to deliver the message of Aware than Tom who is a former successful and profitable Erie agent and knows first hand the important of Erie's judgment based underwriting fundamentals. We are also taking actions in 2003 to address the severity trend. We are bolstering in-house medical expertise providing intensive fraud training to our claims adjustors and putting more advanced technology in the hands of field adjustors. We have also provided new property valuation tools to our agents and by year-end 2003 agents will begin to have access to Erie connection our e-commerce interface bringing greater efficiencies in customer relationship management and policy production. And of course we are maintaining our competitive pricing strategy and taking rate increases where appropriate. As I have already said we see this trend continuing through 2003 with the rate increases already approved for 2003, we anticipate additional premium of 121m and then for those pending another 79m. With the focus on underwriting profitability I anticipate that our unit growth will begin to stabilize.

Our goal continues to be of reporting combined ratio of 100% for the property in casualty group. While I don't expect us to achieve this result in 2003 I do expect to see improvement towards that goal. Another area of emphasis in 2003 is sustaining Erie's corporate culture. I truly believe that our greatest competitive advantage is the unique culture that exist at our company defined by the values of family spirit, believing in the gold rule, responsible use of resources, and behaving in the highest ethical manner Erie's culture is what distinguishes us from the rest of the industry. In the past 5 years we have not only doubled our agency force, but nearly half of our employees are recent higher. It's absolutely essential that these individuals understand [inaudible] to the Erie philosophy and we're seeing that. Our strategies are simply and straightforward on comprise service, strict adherence underwriting discipline, consistent steady growth, and a low expense ratio. Erie agents placed the majority of their business with us. In fact I know many Erie agents who have 80% or more of their business with Erie. They appreciate our consistency, our commitment to them as our sole distribution force, and our attention to personal service for examining the clients. They know they can count on you as nationally recognized superior service. It's this reputation that generates strong customer loyalty year-after-year and produces retention ratios like last years of 91.2%. As a result our agents have rewarded us with an average 1.7m in premiums per agency. This allows us to leverage our cost of operations over a larger revenue base. It is vital that we maintain this approach, which is truly embedded, in our corporate culture. Our employees and agents are loyal to the company and committed to its success in our mission. We have a number of initiatives in place that will continue to foster an environment that makes that possible. To support these initiatives I have appointed Mike Krahe, our former Senior Vice President and Divisional Officer of Human Resources to a new position. Mike is now the Executive Vice President of Human Development and Leadership. Mike will focus his attention on the development of every Erie employee cultivating leadership skills and competencies to keep our company and our culture strong.

Last fall we conducted an employee culture survey and the results gave me every reason to be confident that employees at Erie understand the importance of Erie's culture and are working to ensure our Company's continued success. [Watson Whyte] the firm we worked with on the survey said that Erie's results were among the most favorable they have ever seen, here is just a few of them. 99% of Erie employees responded they are committed to helping Erie to be successful. 98% agree that Erie products are of high quality and 95% say they are proud to work at the Erie. The results tell the story of a great attitude among employees who share Erie's commitment to providing exceptional service and our rightfully proud of working here. As CEO I couldn't be more fortunate to have such a dedicated group of people to support our organization's goals and objectives. I had mentioned earlier our six executive officers have over a 120 years of experience here at the Erie. I can tell you this we're focused. We've made underwriting profitability at corporate culture, our highest priorities. Erie employees and agents know that and I believe by working together we can continue to realize meaningful results. Now I will turn the call back over to Karen.

Thanks Jeff. That concludes our prepared remarks. Michelle if you could please open the call for questions for our phone audience.

Thank you. The question and answer session will be conducted electronically. If you would like to ask a question please do so by pressing the star key followed by the digit "1" on your touchtone telephone. If you are using a speakerphone please make sure your mute function is turned off to allow your signal to reach our equipment. We will proceed in the order that you signal us and we will take as many questions as time permits. Once again please press star "1" to ask your question, and we'll pause for just a moment. We will take our first question from Charles Gates with CS First Boston.

Hey, good morning.

Good morning Charlie, how are you?

Good. Thank you. I have two questions, one question and a follow up. My question can you appoint as to any assessment of the impact of the president [inaudible] on the company's operations?

Well, we are still totaling up the losses from that storm, Charlie. What has happened this week is that the snow has started to melt; we are seeing increased losses from the increased weight of snow on route and some flooding losses, even though flooding is not covered but we are seeing a lot of wet basements. So we are still totaling that up and we will put out a release when we feel it is appropriate, when we feel our numbers have stabilized on that. So, little too early to give you a number on that right now, Charlie.

But once again 94.5% of that would be held by the exchange as opposed to you?

Correct.

Okay. Here is my follow-up question, my -- Given the erosion in the surplus of the exchange from the very high level of several years ago, seemingly there is some likelihood that at some point the best rating might be reduced from A++ to A+, but I think it would have material impact on company given the strength of its balance sheet. Is one of you apply in to that?

Charlie, I think that is a good reflection. I don't believe it would have a material effect on the company. We take our ratings very seriously and as you commented our surplus levels have decreased. We have an annual meeting with AM Best as a matter of normal practice; we met with them in December this year and again in February. We had the opportunity to share with them what our plans are for 2003 to address underwriting profitability. And I believe they are taking a very close look at those plans and what they predict the impact those plans will have going forward.

Thank you.

Thank you.

Next David Sushi with JP Morgan will have our next question.

Good morning everyone.

Good morning, David.

Congratulations, you got your first conference of the often going here so.

Thank you.

Good start here. Just a quick, I guess, math question. Just checking the calculus here on the adjustment on the allowance side. It looks like the operating margins for the management operations fall out at about 32.2% when you add back the 11.9 and that looks like it is up about more than 450 basis points when considering the retirement cost. Is that coming in line with what you are thinking about?

You have to adjust the prior year fourth quarter for that 10.6m.

Yes.

And that takes the margins up to 27% for the prior fourth quarter.

Okay.

27 in change.

Okay. And I guess, second, expense side question on capital allocation on the computers and E-Commerce initiatives. I mean, are the guidance that you are looking at, that you have already put out there anywhere from about 5.4m kind of heading the P&L in 2003. Is that in line?

Yes we are sticking...

What do you think about?

...with the same guidance that we put out at the third quarter.

Very good, I appreciate it.

Hey Phil it is Hugo as well.

Hi Hugo.

Just one follow-up question, when we look at the [PIF] counts, I mean the [PIF] counts were exceptionally strong and obviously the agency appointments. But can you give us a little color on that?

Sure.

Is it something with the new programs that we were put in place? I mean, is it just the new state, the new agents? I mean, somewhat happier growth is coming from actual unit from most of your line to business.

And you conceive that it is accelerated.

Right that is what I am trying to understand.

From 9.6 for the first quarter to 10.8-11.9-12.8.

Right.

Well, we are in a hard market. As you know, we have appointed a lot of agencies, as Jeff mentioned. Our same store agency sales are strong but you know our -- we don't we can continue to grow units at these levels, as Jeff alluded to in his brief remarks. We think that this is very fast growth, unit wise, and that we are going to see it stabilize. Jeff is going to make a few comments around that too.

Okay.

Hugo, in regard to the same store sales, as Phil said, that has been a very strong area. What was occurring is back around 1997 and on into '98 to '99. We saw our sales growth rate in a very competitive market place, really swelling. During that time our former CEO Steve Noam and the rest of our management made a strong effort to support our agents in developing marketing programs within their agencies. Many of our agents, candidly, did not have a marketing program for lines like Automobile. They did for life insurance and commercial, but for Automobile, they didn't need to have a marketing program in many cases. So what happened is we helped them develop marketing programs. Many of them began to turn their sales growth around. And collectively with that being over 80% of our population, we started to see strong growth come from that segment. As Phil said, you know, can it continue a 12.9 at those types of levels? I don't think so. Strong growth for our industry is unit growth over 8%. And, I would guess, our growth would be somewhere between where we've been in that 8% number.

Is it in a one particular territory, Jeff that this has been growing? I guess, you know, we know competitively in Pennsylvania, you guys are top notch. Are you seeing a lot of market shift changes inside a Pennsylvania that's driving some of these numbers on the private passenger side?

No, we really -- I won't say that we have, you know, we are around 13% change in our market penetration in Pennsylvania private passenger automobile. If there is a lot of horse-trading, maybe that goes on in terms of policyholders, but it's been pretty steady at the 13% level.

Okay.

There are larger increases in some of the smaller states, of course.

Sure.

But, it's no one single territory.

Okay, great, thanks a lot.

Thank you.

Next you'll hear from Iris Nallis with Legg Mason.

Hi. Good morning.

Good morning.

Jeff, I guess, I am naming a [inaudible] on the board -- I would be -- given that we've now seen some stabilization of surplus at the exchange. It is third quarter to fourth quarter and that the surplus or the capital of the public company continues to rise now close to a billion and one could argue maybe just to support the business that you are underwriting. Some, you know, $850m of that could be excess given what kind of standby credit you are for the exchange, you know, added that. What is your view as to what the company should do with the Texas capital, with the most stable exchange surplus situation?

Iris, I think we have an opportunity to evaluate all alternatives for use of our capital. One of those alternatives, of course, would be a repurchase program. I think you're familiar with the past repurchase program that we had, it expired in 2002. We actually suspended it to go out to the offering. During the previous program, we've repurchased about a 101m in shares. I think with our strong capital position, we do have an opportunity to revisit this topic as a board number. I'd interest in having us discuss this topic. It is a board matter as you point out. And so, I expect us to be discussing these topics at future board meetings, as well as other alternatives.

Okay. Thank you. One follow-up. Back to the premise of my question was a flat surplus at exchange. And, I guess, the question is, you mentioned that you're heading towards, you know, a combined ratio where you've been in the past. Can your surplus remain flat? You know, given in a flat stock market right now. Or do you think the combined ratio of this year, even without assuming normal cuts and who knows what that is. You know, it's still going to be, you know, in the upper 105-110 ratio, or could it be below that, you know, on our -- as you will go forward? I guess - I'm trying to test how -- what a good assumption is that we could keep surplus flat in a flat equity market?

Iris, this is Phil. In a flat equity market, with underwriting losses, it depends the magnitude of what the combined ratio is. We obviously generate a lot of investment income, about 8 points of investment income in terms of combined ratio point a year. So, if the equity markets are flat, you know, we don't mark our -- in the exchange we don't mark our bonds to market, third amortized cost. So I'm talking about the equity market appreciation, if it's flat. And we have eight points investment income. That means that if we have a reported combined ratio over 108, that will be some surplus drain. So, our goal is to get our underwriting results down from where they were this year, which is way north of 108, down to a level where we don't have a surplus drain that is outsized. So, that's the calculus there, to get the underwriting profitability back to where it's traditionally been here at the Erie. And, we are hopeful that we can, you know, you mentioned catastrophes, we are not getting enough to very good catastrophe start. It's been very cold in our operating territories for 2 months, and as you know, we had a huge snowstorm on President's Day. So, hopefully we'll have a good catastrophe year the rest of the year, and we'll get close to not having too much surplus drain from our underwriting losses.

But is, kind of, not big enough to hit your cap programs because of the [inaudible] or whatever?

Right. Well, this is an occurrence cap, so it covers any occurrence over the 72-hour period of time. And as you know, we retain the first 115m of that. So, we are hopeful that we don't have a 72-hour occurrence that hits that limit.

Thank you very much.

As a reminder, to ask your question please press star followed by the digit "1". And we'll take our next question from Bet Malone with Advest Investors.

Thank you. Good morning and congratulations on the quarter.

Good morning to you.

Hi, I have a couple of questions. One is on the -- could you talk a little bit more, I know you mentioned your competitors but there was an article in Wall Street Journal talking about [State Farm], and could you talk about how important that company is in the markets in which you operate? And what are you seeing in terms of competitor pricing particularly from that company?

Bet, thank you for your question. Yeah, State Farm as that article indicated represents about 20% of the private passenger auto marketplace in almost every state. We take a very long-term approach, and while we certainly run into State Farm quite often out there, some days they are more price competitive then us, and other days vice versa. On average our rates through time have been in the plus or minus 6% range. And so, even companies as significant as State Farm do not have as much impact on us because of our long-term approach. Some of the items mentioned in that article that affects State Farm don't affect us in the same way. When you are company the size of State Farm [all State], you are affected by national trends. I think the article talked about new car sales, and State Farm and [all state] are in 50 states. And so they are going to be more affected by that. Erie operates in 11 states in the District of Columbia, and of course, we have plans to expand on into Minnesota in 2004. And we mentioned our agency force, which continues to grow a 130 new agents in 2003 is another 7% added to our agent population. So, we are very watchful. I think State Farm does impact the industry and will impact what others decide to do in their pricing. And I would say that we differ from many of those others because we take a longer-term approach, not trying to stock our policyholders in anyone price change. So, I think we'll be able to continue our steady growth, while others might be more affected if you will by what State Farm does.

Okay. Kind of follow on to that, with your ability to get rate increases in the market share end, are you anticipating or seeing any kind of resistance from regulators with these rate increases or any consumer backlash at all?

We haven't seen it yet, but it's not out of the question. I think we are in tough economic times in our country. In the markets where we operate in, I think consumers are having to make choices. Fortunately, we operate through independent agents and that's what our agents do best, is they sit down with the customers and help them make choices about managing their insurance program, not you're selling them policies. And, so I think from our customer base, we have possibly less consternation about some of the price changes, but the pricing of insurance products result in a public issue, and no doubt as the pricing has been very strong, I would expect there to be some stronger public reaction to it, but so far, we have been able to make the changes that we believe are appropriate with the exception in New York where right now the voluntary auto market in New York is subsidizing the high risk drivers in New York, and that's been a real problem.

Okay. Just two more quick questions; one is on the guarantee fund assessment. Do you have an estimate of what they might be for 2003, or do we just have to wait and see what happens?

As we said in the release, we didn't take charge related to an insolvency in Pennsylvania. If I go insolvency in Pennsylvania of about $12m, we were concerned about that one because that was a fairly large insolvency here in Pennsylvania. We have a large presence here obviously. That's the one that was hanging in over us -- the big one that was hanging over us. We don't really have a beat on 2003, what it might be about.

Okay. And final question; when you talk about your technology, I am sorry, I missed when it was going to be implemented, and also is there way for you to quantify what the cost savings or the expense ratio reduction might be as you implement the new technology?

Yes. As Jeff mentioned here in the latter half of 2003, we are going to start to rollout the Erie connection for certain lines of business, to certain agents in certain parts of the company. As far as quantifying the benefits, we have done that internally. One of the big benefits is in our commercial underwriting department, which is commercial underwriting automation, is kind of the wholly grail for proprietary cash due companies. It's very manual processing. We are hoping that system will add to our productivity in commercial lines. The other thing that we hope it will add is in our support staff. Right now, we have systems here running in the home office, and separate distinct systems that are duplicate systems running in our agents offices, and to keep the rules and rates and discounts for all our products in sink here and in those two systems that are in the field, is a tremendous amount of effort. The new system will be one system that both our agents, and our employees, and our policyholders will use, which will have one sets of rules, and rates, and products. So, we think that there will be some efficiencies there with respect to that activity. We really haven't published a number as to quantifying it, but we are very hopeful that it will allow us to maintain the tremendous operating efficiency that we now enjoy into the future.

Okay. Thank you.

As a final reminder to ask your question, please press star followed by the digit "1", and we will pause for just a moment. And, we will take a follow-up question from Dave Sushi with JP Morgan.

Hi guys, [if you once again]. Just a quick philosophical question, I think you had on, but I am just trying to round it out. You are growing very aggressively on the unit side; obviously, rates are going up, that's going positive. Going new states you have new agents. You are talking about improving on the underwriting side, so you have the big initiative going on board now to drive down the combines. Let me -- from a rate perspective with the number of volume and units that are seeing, doesn't that mean that your rate instead of trying to match with the market would be -- would start to accelerate your rates to beyond where the market maybe? Is that the wrong way to think about this? I guess, I am trying to think, you know, I am concerned about being adversely selected against, and I am also thinking that instead of matching what's going on in the industry with the strength that you have right now. Can you do a little bit more to help you quicker?

Well, let me respond to it this way to you. In terms of adverse selection, you know, one of the benefits of our business model is operating through independent agents who are our trusted eyes and ears out there in the field. And our agents are subject to an opportunity to earn a contingency award for generating profitable business for their agencies. And so fortunately to the largest extent our agents are very focused and have their interest aligned with ours in making sure that we are not adversely selected against. Now they are human as well and we are conscious of the fact that we want to be positioned in the marketplace that we are not being selected against. The judgment underwriting that we used is also another opportunity for our agents who are very interested in the attitude of our potential policyholders about risk. Whether it's how they manage their personal affairs or how they manage their businesses. The rate changes that we are making are rate changes that are made on a long-term basis. Again we don't look to shock the policyholders. You will see other companies often times in and out of markets. Often times in the same two-year period of time. A 30% decrease one year, a 30% increase the next year. And what they are doing is churning policyholders. In fact they are creating a shopping mindset with the policyholders. Our historically averages are plus or minus 6%, our agents are in there with the customers. I don't think our customers are -- price is very important to them. But I think our customers consider the full value proposition of the protection and service that they are getting from their agent and the company. So I am not sure if I answered your questions.

You know it was more philosophical --.

It is a philosophical approach that we take to managing this long-term.

And if your rate increases, because of Jeff mentioned, we are basically a steady-as-you go company. On the upside we tend to trail the rest of the industry in rate. You know the industry has taken rates up pretty aggressively. So you could say that we will probably trail the industry with a little bit more rate on the upside but again we are real conservative we don't -- as Jeff said we won't take rates up 50% one year and down 30% the next.

Let jump in again Phil, and just say this to you, in terms of being adversely selected against, you know, one of the points stronger than the rate is our strict underwriting guidelines. And so it is not necessarily a matter of -- okay may be our rates aren't going up as much as everybody else's but rather our tight underwriting guidelines, our strict adherence to that is what honestly prevents us from getting that business. So the business that does make it through those underwriting guidelines is then able to get a more reasonable competitive rate.

I am just staggered by the volume on the unit side that's all and I think that's positive because of the franchise but it makes me wonder if there is something either, you know, perhaps the underwriting standards aren't as high or the rate is just a very competitive rate still compared to what your peers are doing. That's all I am concerned about over the longer haul and it's clear with the opportunity you have to improve the combine and the track record of the last couple of years you have focus on getting that part of the equations fixed. And I am just trying to understand philosophically how you thought of the rates in that context. That was very helpful.

Thank you.

Thank you guys

At this time there are no further questions, I will turn the call back over to Karen Kraus Phillips for any additional or closing remarks.

Well I just like to thank you all for joining the call. Again a recording of the call will be posted on our website erieinsurance.com after 1:30 pm ET today and if you have any question at all please feel free to call me at 814-870-4665 for cell and again thank you and have a great day.

That concludes today's conference call. Thank you for your participation.