Erie Indemnity Co (ERIE) 2006 Q1 法說會逐字稿

Hello and welcome to the Erie Indemnity Company first-quarter 2006 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 from management, we will open the call for questions and answers.

Now, I would like to introduce your host for today's conference call, Mr. Mark Dombrowski, from the Erie Indemnity Company Corporate Communications department. Please go ahead, sir.

Thank you, Tracy, and good morning. We appreciate all of you joining us today.

On today's call, management will discuss our first-quarter 2006 results. Joining me are Jeff Ludrof, President and CEO; Executive Vice President and Chief Financial Officer, Phil Garcia; Tom Morgan, Executive Vice President; and Brian Bolash, Associate General Counsel.

Today's prepared remarks will be approximately 30 minutes. Following those remarks, we will open the call for our questions. We would ask that you please keep to one question and a follow-up.

We issued our earnings release and additional supplements yesterday afternoon. We also filed Form 10-Q with the SEC. On today's call, the management of Erie Indemnity Company will share important information about current and future initiatives being undertaken at the Company. As a result, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 may be incorporated into 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 results to differ materially from those anticipated, as described in those statements. Many of the factors that will 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 10-Q filing with the SEC dated May 3, 2006, and then the related press release and 8-K.

In this call, we will discuss some non-GAAP measures. You can find a reconciliation of those measures to GAAP measures in the press release and in the supplement posted on our investor Web site at ErieInsurance.com.

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 Web site today after 12:30 PM Eastern time. 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 to these terms, please disconnect at this time.

Now, Erie's President and Chief Executive Officer, Jeff Ludrof.

Thank you, Mark, and good morning, everyone.

In today's earnings call, we will be taking a slightly different approach. Based on previous comments, we will avoid repeating much of the information contained in our 10-Q and press release. Rather, we intend to emphasize the financial highlights of our quarterly results and share information about our strategies to enhance our performance going forward. By taking this approach, we expect to get to your questions sooner.

A few months ago, at the conclusion of our fourth-quarter call, I briefly mentioned our company's strategy initiative. Our intent is to grow Erie into a top-performing competitor, differentiated by our strong underwriting, claims and service disciplines, and our product, price, and service value proposition. We are committed to building strong relationships with policyholders, agents and employees.

There were several favorable indications during the first quarter that suggest our strategy is beginning to take hold. Our total number of policies in force and retention ratio have increased slightly. New written premium has increased by 3.3% compared to the first quarter last year. And we continue to achieve strong underwriting profitability for Erie Indemnity Company and the Property and Casualty group as a whole, which enables us to grow or policyholder surplus. These are all positive steps, but there is still much work to be done.

We've repeatedly stated that sustaining the improvement in our underwriting profitability is critical as we work to grow our company. That certainly was the case in the first quarter, as the Property and Casualty group's adjusted statutory combined ratio for the first quarter of 2006 was 82.3%, compared to 81.4% a year earlier. The company's reported GAAP combined ratio was 86.5 for the first quarter of '06, versus 88.4 for the same quarter in 2005. That yielded an underwriting gain of $7.3 million for the first quarter, 2006.

As we look to the balance of this year and beyond, we will continue to align our efforts with our strategic plan to make Erie a regional gem, simply the best insurer wherever we do business, both now and in the future. That will happen by growing our company profitably and making certain that our personnel and financial resources are properly aligned with our strategic initiatives. Part of being simply the best insurer is adhering to our founding principle of providing the best possible protection and service at the lowest possible cost. So, continued focus on cost management, boosting employee productivity and managing expenses remain critical to our plan. We also must continue to focus on the ease of doing business with our company from both an agent and policyholder perspective, particularly in light of our decision to change our technology strategy.

As I noted earlier, we have begun to recognize a modest yet favorable growth trend from some of the actions we have taken to enhance our competitive position. We have a number of strategies in place or planned that we believe will further enhance our ability to attract and retain customers.

We continue to make refinements to our segmented pricing model for homeowners and private passenger auto business, allowing us to better match price with risk. As a result, we've been able to revise our underwriting guidelines to help provide agents more latitude for placing business with Erie. Because we will have more pricing options, we will be better positioned to attract and retain the very best customers.

We've also taken targeted rate reductions in the form of discounts for a variety of factors. These include a safe driver discount, a new auto and home discount for policyholders who also have life insurance with Erie Family Life, and our new payment plan discounts. Our new rate interactions are being positively received by new and existing policyholders in our agency force, and we will be introducing additional new pricing interactions in the fall.

Additions to our product portfolio we will also bolster our competitive position. For example, this month, we are introducing a very competitive identity recovery endorsement to our homeowners policy. In 2006, we expect to deepen our marketing reach by nearly doubling the appointment of new agencies. By year-end, we expect to appoint 125 new agencies in our existing territories, adding to the 65 we signed on last year.

With the slow premium growth of 2005 expected to continue in our industry through at lease the first half of this year, the temptation in such a market is to introduce excessive rate cuts to gain market share. However, doing so leads to inadequate pricing and underwriting losses that are not sustainable. While some competitors might engage in these approaches to the softening market, we intend to pursue a pricing strategy that balances underwriting profitability with quality growth. We will be disciplined and rational in our pricing strategies. Our low operating expenses and our ability to deliver a high level of service at a low cost have always been significant contributors to Erie's competitive advantage. Our low prices, control of expenses -- our low prices have been the result of careful underwriting and the careful control of expenses.

To achieve our desired price-competitive position, we need to continue our focus on increased productivity and expense management. Erie's expense ratio is consistently around 7 points lower than the average for the Property/Casualty industry. Based on our Property/Casualty and premium volume in 2005, that equates to about a $280 million annual expense advantage for Erie. However, some Property/Casualty industry marketshare leaders have made great strides in reducing their cost structures. We can only sustain our relative competitive position with competitors by also aggressively seeking productivity gains and expense efficiency. Managing expenses while balancing premium growth with disciplined underwriting are important for both the short-term strengthening of our competitive position and the long-term profitability of the organization.

For 2006, we will commit to a plan to keep our noncommissioned expense levels to 6% over our 2005 operating expense for the ERIE group of companies, which translates to about a 9% increase for Erie Indemnity. Our plan calls for continuous review of our cost structure and for balancing work force requirements with business needs.

In the area of personnel expense, our plan calls for holding 2006 hiring to only critical positions and replacements and managing excess capacity through attrition and by utilizing Erie's work force redeployment practices. By moderating hiring and allowing for normal attrition, we anticipate a reduction in our staffing level this year. Driven by an effective work force management plan, we expect to not just sustain but enhance the service we provide to our policyholders and the support we offer our agents.

We have a cost structure that is among the best in the industry. In fact, of the 25 largest property and casualty insurers in the country, we rank third based on the five-year average expense ratio, right behind two of the largest direct writers who don't pay agent commission.

At the same time, we have the added advantage of partnering with professional and locally accessible agents who provide personal service to our policyholders. When we talk about service and support, we recognize technology and ease of doing business are critical to our organization. A few weeks ago, we announced that, after careful review, we determined that ERIEConnection is not the right system for our company. The estimated cost of retrofitting an acceptable front end for our agents was prohibitively high. In addition, after running the system on our mainframe, we determined that it would also be too expensive to scale the system up from the 50,000 policies that were part of the test mode to our multi-million policy book of business. Of course, this was a difficult decision and a disappointing result.

Moving forward, our technology approach will be marked by incremental milestones so our agents and employees benefit from technological advancements in a more timely manner. I have full confidence in our IT professionals, as we pursue a plan to build out our current agent interface system, as well as developing Commercial Connection, a Web-based system that allows agents to quote, write and endorse commercial policies online. Commercial Connection was a separate project under development in our IT area. Agent feedback indicates further development of our interface system, along with Commercial Connection, will meet their needs.

In 2005, Erie Insurance was able to achieve an adjusted combined ratio of 85.7. This allowed us to grow our policyholders surplus in the P&C group by nearly $600 million, a 20% increase. The policyholders surplus for Erie Insurance Exchange grew an additional $229 million during the first quarter of 2006 and now stands at over $3.6 billion. In fact, the policyholders surplus of Erie Insurance Exchange is stronger today on a risk-adjusted basis than at any time in the history of the organization. The availability of a strong surplus division provides support to grow our premium base. Our strong underwriting and surplus results are due in large part to the efforts of our agents and employees, and these results position us to execute our strategic plan to become the best insurer in all of the markets we serve.

Now, I will turn the call over to Phil to share some or financial highlights.

Thanks, Jeff, and good morning, everybody.

Both the Erie Indemnity Company and the Erie Insurance Exchange we manage are well-positioned to compete in today's soft markets and highly competitive environment. As Jeff just stated, our focus is on growth while maintaining underwriting discipline and sustaining our competitive cost advantage through cost-containment initiatives. As Jeff also noted, in my prepared remarks, I'm not going to go into many of the financial details contained in our information release.

For the first quarter of 2006, our net income decreased 14.4% to $49.5 million from $57.8 million. Our operating income, which is our net income, excluding the effects of net realized capital gains and income taxes on those gains, declined to $49 million or $0.72 a share from $54.2 million or $0.78 per share for the same quarter in '05. Included in that amount was a charge of $0.02 per share to recognize the write-off of the ERIEConnection system, and also, there was $0.02 per share adjustment to increase our service-charge income in the quarter.

Now, I will talk a little bit about our financial results from the management operations segment. Income from our management operations for the first quarter of 2006 decreased to $46.7 million from $57.5 million as a result of an increase in the cost of management operations that was greater than the increase in revenue. Our management fee revenue increased by 1.1%, and as you know, we had a higher management fee rate in 2006 of 24.75%, resulting in $9.4 million more in management-fee revenue for the quarter ended March 31. As you know, the management-fee rate was 23.75% in the first quarter of '05.

Our management-fee revenue was only up by about 1.1%, primarily as the result of slower growth in premiums, as the management-fee rate was 100 basis points higher in the quarter. The property and casualty direct written premiums of the Group decreased 3% for the quarter. The decline in written premium was caused by declines in the average written premium per policy. We saw a small increase in unit growth for the quarter, as new written premium increased slightly, as did the policy retention rate. The decline in the average premium per policy is really a result of rate reductions, our segmented pricing refinements, the introduction of our new premium discounts, as well as the change in the mix of business for both lower-tiered auto and home tiers.

Our service-agreement revenue increased 2.8 million in the first quarter of 2006. That's really a result of two factors. The first is related to changes in the service fees charged to our policyholders. We increased that service fee on installments from $3 to $5 beginning in 2006. And while this increase is impacting the total rise in service agreement revenues, the mix of billing plans selected by policyholders is also changing, primarily due to the introduction of payment-plan discounts for our auto policyholders, who decide to pay their premium upfront. These policyholders pay no service fees. We've had a shift of over about 30,000 policyholders in the last year to these new payment options.

The second factor was a $2 million adjustment related to prior years for the unearned portion of service-agreement revenue made during the first quarter of 2006 that increased service agreement revenue. As I said before, the impact of that adjustment increased net income about $0.02 per share, diluted.

The cost of management operations increased 9.1% for the first quarter of 2006. Our commission costs increased 6.3% partially due to an increase in our accrual for the Founders Award bonus, while operating costs, other than commissions, rose 5.9%.

Our personnel costs increased 15.3% as a result of higher average pay rates, increased staffing levels, increased allocation of IT personnel costs to the Company, and higher estimates of future payouts for our management incentive plan.

As Jeff pointed out, we understand that our cost structure provides us with a unique competitive advantage, one that provides our policyholders with the personal service, professional and locally acceptable agents with a cost structure that is competitive with direct writers. The cost-management plan developed by our senior management team refocuses our management team on ensuring that Erie is positioned to compete long-term. We are taking a strategic look at processes and expense structure to ensure we can provide the competitively priced products our policyholders have come to expect from the Erie.

Our insurance underwriting operations continued to perform profitably in the first quarter of '06. We reported a GAAP combined ratio of 86.4%. In 2006, the Company's not participating in the excessive loss reinsurance arrangement with the Exchange and therefore did not pay a premium for the treaty in the first quarter. In the first quarter of 2005, the premium on that treaty recorded by the Company was $844,000.

As I also mentioned earlier, we ceased development of ERIEConnection, which resulted in a charge to the Company's net income of about $1.3 million or $0.02 per share in the quarter ended March 31, '06, and that change is -- that charge is reflected in the Company's insurance underwriting expenses.

The adjusted statutory combined ratio for our Property and Casualty group for the first quarter of 2006 was 82.3 compared to 81.4 for the first quarter of 2005. The first quarter of 2006 Property and Casualty group results were helped by lower capacity losses, positive development of prior-year reserves, salvage and subrogation receipts from prior accident years, and reserve decreases to reflect the seasonal nature of our first-quarter loss experience. We disclosed the detail of those items in our information release.

Also included in the Property and Casualty adjusted combined ratio in the first quarter of '06 is a charge to the underwriting expense ratio of the Property/Casualty group of about 4 combined ratio points to reflect the write-off of the ERIEConnection asset on the books of the Property and Casualty Group company.

The Company's investment operations recorded income of about $20.6 million during the first quarter of '06, compared to 22.8 million in the same period of '05, a decrease of about 9.9%. Investment income net of expenses increased 3.7% to $15 million from the 14.5 million a year earlier. Funds used to repurchase company stock will impact our future investment income.

Jeff noted the capital and the surplus of the Erie Insurance Exchange has grown strongly in the last 18 months. During the first quarter, the Erie announced plans to utilize about 75 million of that capital from the Exchange to purchase the 25% of Erie Family Life Common Stock not owned by Erie Indemnity and the Exchange. The Exchange has offered to acquire the balance of the Erie Family Life Common Stock at $32 per share in cash during the second quarter of 2006.

As part of the Company's capital management plan during the first quarter of '06, the Company repurchased almost 800,000 shares of Class A Common Stock under our repurchase plan, spending about $41 million. We were pleased with that level of repurchases during the quarter, especially considering we refrained from purchases in March due to the Erie Family Life tender announcement.

Subsequent to the quarter end, we also entered into an agreement with the Black family to repurchase a large block of Class A shares, including 260 Class B voting shares after a conversion to Class A, for a total of $106 million. The Company believes it's in the best interests of the Company and all of our shareholders to have acquired the Class B voting shares that represent about 9.2% of the Class B voting stock of the Company. Considering the first-quarter repurchase activity and that 106 million Black block repurchase, the Company has about $200 million remaining in repurchase authority under its repurchase plan.

Our focus, moving forward, is on maintaining our underwriting discipline and sustaining our competitive cost advantage through cost-containment initiatives. By doing so, we can provide the competitive price, products and services that our agents and policy owners expect.

Thank you for your attention, and now I will turn the call back over to Mark.

Thanks, Phil. That concludes our prepared remarks. Tracy, if you could now open the call for questions from our phone audience.

Thank you, sir. the question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS).

Tracy, are there any questions?

We will take our first question from Ron Bobman, Capital Returns.

Good morning. Congrats on some real attractive underwriting results.

I had a few questions, a couple of clarifications, and also I appreciate you shrinking the prepared remarks. I had a question. Phil, as part of your comments, as part of your statements you made a mentioned and I didn't quite understand it, about lower tier auto and homeowners, and I missed the point you were trying to make. Could you go over what you meant by that?

Sure. We're seeing declines on our average premium per policy, and those declines vary by line of business. In, for instance, our commercial lines of business, we are writing an average-sized policy in terms of premium that is smaller this year in 2006 than in '05. We're doing that on purpose.

In personal lines, auto and home, we are seeing a shift to the lower tiers that we offer in our new price tiered, segmented pricing model for auto and home for our new business, so we are collecting less premium on a particular auto and home policy because we have better pricing at the lower tiers. That's to our advantage, because we believe that those tiers have better underwriting and loss characteristics and warrant a lower premium.

So, we are seeing an overall decline in our average premium per policy. As you saw, units were up slightly and our retention was up slightly. New business units were up slightly, yet our premium was down 3%. That really goes to the average premium shrinking, average premium per policy shrinking.

Okay. Now, just so I understand, in the auto and the homeowner portion, so should I consider the auto book as marginally shifting to more of a nonstandard, or is that sort of overstating the degree at which the book is shifting? In the homeowners language, should I assume you are increasingly inner city or lower income mix of homes, or is that the wrong take-away?

No, when I say lower tiers, those are better tiers, better tiers. So, I think you took it exactly the opposite -- (multiple speakers) -- a lower tier was substandard business; it's actually the more preferred business. Our lower tiers result in a lower premium per policy because they have better loss characteristics. Okay?

Okay, thanks for that clarification. I saw the Workers' Comp numbers were in the 60s on the combined, so was there some favorable development there? Because short of writing in California, I don't think we are seeing numbers like that.

No, our Workers' Comp continues to perform well. I don't actually have how much the development here in front of me was in the Workers' Comp line itself for the quarter. But we continue to make progress on Workers' Comp.

Okay. Then, my lat question and I will go back in the queue -- the buyback that was in the Q and that you mentioned on the call from the Black family, you know the price obviously comes out to like nearly 57.50. So, how did you arrive at that? Were there any third parties involved on the Company side? Obviously how do you justify a number so far north of $51, where we are now?

Well, as you know, there's no real established market for the B stock. There was a precedent transaction about a year ago in which a shareholder bought a fairly large block of B stock for about a 15% premium. But that's the only precedent transaction.

This, however, was a 9.2% -- represented 9.2% of the B stock. This was a much bigger block of B stock. We consulted with our Board of Directors, our investment committee and some outside advisors regarding what the B stock might be worth, and we deliberated and arrived at the price you see that we paid for it. (multiple speakers).

Presumably the whole Board signed off on that, I would imagine.

We consulted with our Board of Directors, yes we did, and outside advisors, and we did the due diligence we felt was necessary and deliberations we thought were necessary to make that offer.

Why -- you know, why would you opt to spend 57.50 for a combination of the A and B from the Black family, and not take the $100 million and say we're going to do a tender and offer 54 to all shareholders?

Because there was B stock involved.

Right but -- that's floating stock, right? (indiscernible)

Correct, which is a fairly unique commodity. I mean -- (multiple speakers).

Right, but are the balance of the shareholders any better off because the B bought in? You know I don't -- the only people better off I would imagine are the remaining B shareholders who are now at more leverage.

Well, we deliberated on it. We thought the purchase was good for the Company and all of our shareholders, including our controlling shareholder.

If I split it out between what those Bs converted into the A shares, you get like a $70 value for the Bs and the $51 the other As obviously -- (multiple speakers) -- saying were bought at $51. Is that the wrong way to look at it?

No, I think that's the reasonable way to look at it. Because during the quarter, Ron, we bought stock for about $53 a share, right? 300,000 shares. So, at 57, we paid -- all-in we paid a slight premium for the repurchases during the quarter. Right? Less than 10%. We were buying B stock, a large block of B stock of the Company. So, under that view, I don't think it's an unreasonable transaction -- paying less than a 10% premium, getting a large block, 9.2% block of our B stock when we were paying 53 under a repurchase for them during the quarter.

I'm sorry I'm taking a fair bit of time up. So, should I consider, as of May 1 or whenever (indiscernible) date cited in the Q -- so should I at least have comfort now the Company is a buyer of its stock at 57.50 or better?

If you bring us 260 shares of B, that might be a fair analysis.

Well, I think you might pay $70 a share if I brought you that much B.

Well, in combination with A.

Thanks for your time. I will circle back.

Michael [Philips], Stifel, Nicolaus.

It's actually [Mayor]. How are you? If I understood your comments before, you are anticipating an increase in management operations expenses in the 9% range.

Yes.

Okay (indiscernible) I just wanted to make sure I got that right.

Entity-wide. That's all of our companies together, about six. Indemnity is responsible for certain things, obviously underwriting and issuing policies, and it's got some costs, particularly on the underwriting side, that are going to run at higher levels. What I'm talking about is credit scores and MBRs and those sorts of things we have to get to underwrite our auto and home policies.

Okay. I'm assuming that discontinuing ERIEConnection doesn't have any measurable impact on your ability to implement more segmented pricing.

No.

Okay. I really only have one strategic question. One of the contributors to the higher expense in management operations was compensation for the strong underwriting results.

Yes.

Wouldn't it make more sense for compensation to be tied more tightly to margins in that unit, since that has a greater impact on Erie's earnings?

You know, there's two plans that we have, and they are described in our proxy. I'm talking about the plans for executive management. There's an annual plan, and it's paid in cash, and that plan, the Board has -- there's a couple of elements in that. One is our profitability and the other is our growth. Here in 2006, they've moved that plan to be balanced between growth and profitability. Last year, it was weighted towards profitability. So, there is a growth component and it's weighted 50% on the cash plan for executive management in 2006. It's weighted 50% towards premium growth, which is obviously an important driver of Erie Indemnity's earnings and its margins.

Then we have a long-term plan, which is kind of -- it's measured over a three-year period of time, and that plan for 2006, 7 and 8 is also moving in the same direction. It's got an underwriting component and a premium component, and the Board has moved the benchmarks to be more premium-focused in that plan. But what's happening with the '04 and the '05 plan, they were more profitability-based, and we continue to have great profitability numbers, so the accruals for those plans continue to go up and they continue to be reflected in expense in '06.

So the Board has recognized that profitability is -- the focus on profitability is now going to shift towards premiums, a little bit more towards premium, which does go to the point that you made at Erie Indemnity Company.

Did that help or did I totally confuse you?

No, no, it helped but I'm inferring -- well, I understand your use of the word 'profitability' as underwriting profitability as opposed to management operations profitability.

Right. But if we are incented to grow premium and we grow premium, Erie Indemnity's margins will be affected positively. The management -- obviously the management fee will be affected positively. So they have made that shift in the 2006 plans.

Okay, fair enough.

Yes, I think that's important for shareholders to know.

James Pan, CP&E Partners.

Great results on the SAP combined adjusted ratio.

A question -- you mentioned that our costs are competitive with the direct insurers like GEICO and Progressive. I imagine that's who you are thinking about. Their growth rates are significantly higher with their model than ours, even though our combined ratios are slightly better now, but their combined ratios are still very respectable.

Do you think we can -- where do you think we're going to be growing premiums with our cost advantages?

I guess a second part of the question -- a couple of years ago, two or three years ago, I guess our combined ratio was much higher, north of 100. What do you think is the major difference in the last two or three years that (indiscernible) combined ratio lower?

Well, James, let me start with the underwriting ratio and the activities that we have taken place, the efforts that we've made over the past several years. You know, we introduced a plan several years ago to reduce our exposure to increase our underwriting discipline in a number of different ways, and our agents and employees totally embrace that. It involved making sure we had the proper valuation on risk, the proper classification of risk such as various auto classifications. It involved the reinspection of properties; it involved taking look at the type of commercial business that we were writing.

So collectively, all of those actions have obviously had a very positive impact on restoring the underwriting discipline necessary at our company, and it's reflected in those loss ratio results. So the movement has clearly been to one of discipline and involvement at every level, from our agents all the way through our underwriting process, all the way through our loss-adjustment process, so we are seeing improvements, fortunately, in all areas.

Now, our intent, of course, is to maintain that discipline and at the same time grow our company.

Well, are you saying that we didn't have that discipline two or three years ago? Is that --?

Well, what I'm saying is that there's always room for improvement, and based on, as you described, underwriting results that were north of 100, those are unacceptable results to us and we retrenched and evaluated every single aspect of our disciplines and made enhancements in every single area of those disciplines to improve the results.

Okay, and then given your pricing actions and everything like that to increase your combined ratio, where do you think -- how is your compensation tied to -- I mean I guess the question is at what level is your compensation level tied to having a combined ratio on an adjusted basis below 100? How much of your compensation is going to come from that if you achieve that in the next few years?

Well, as Phil mentioned, the incentive plans, both the annual and the long-term plan, have been balanced between underwriting profitability and growth. We want to fire on all cylinders, so we've moved more away from underwriting profitability. If you go back several years, as an example, our long-term plan was based on 85%, 85% weighting with underwriting profitability and 15% based on direct written premium growth. The '06 to '08 plan takes a balanced approach. It's a comparison of our results to a peer group in the industry. There's a 40% weighting on the underwriting profitability component, a 40% weighting on the growth component, and a 20% weighting on the total return on invested assets. So, it's certainly much more balanced. It's appropriately aligned with our intent to grow profitably.

Okay, great. Thanks.

[Blake Philips], Fox-Pitt Kelton.

My questions have been answered. Thanks.

[Jeff Hallus], [Tyndall] Management.

Good morning. As the prior questioner mentioned, you are implicitly paying $70 a share for the B shares, which represents roughly a 40% premium to the underlying A shares. I have yet to hear a justification for that premium. I'm hoping you can go into that.

Jeff, as Phil mentioned, we believe this is in the best interest of all shareholders. We had an opportunity here to, of course, buy back both Bs converted to As, as well as an opportunity to make a significant dent in our repurchase program. This is accretive to earnings; this helps our company by not having additional B shares that are out there, that could end up in anybody's hands. So, collectively we believe that it's in the best interest of the entire company -- all shareholders, all stakeholders -- to make this buyback.

you paid $12 million more to this former director of the Company. That $12 million could have been spent repurchasing an additional 250,000 Erie shares, which were been more accretive than the transaction that you effected. Please once again tell me why you think it's in the best interest of the shareholders to do the transaction.

I believe that you can look at it the way you just described, but I also believe it's very important to consider where those outstanding B shares could end up. They could end up in the hands of a competitor. So, what we did is we used this as an opportunity to protect the future of our company and thus all shareholders. We believe that deserved a premium.

Isn't control of the Company held by two trusts which currently hold 83% of the voting stock?

That is correct.

So what difference would it make if a competitor purchased the B shares?

Jeff, there are scenarios in which it would be possible for those shares to be a tiebreaker.

Could you describe those scenarios, because I can't think of them?

Jeff, I really can't. Those are unique aspects to the trust and I won't even speculate on the likelihood of them. What I don't want to -- (multiple speakers).

(multiple speakers) -- you will spend $12 million.

But I don't want to jeopardize all shareholders of the Company by not protecting the Company from those possibilities.

Jeff, as we talked yesterday a little about this, you are assuming that no premium at all affixes to these B shares, when in fact an independent third party a year ago paid a premium, a significant premium -- about 15% -- for the same sort of stock we bought, and it wasn't a block as large as this which has the potential, as Jeff said, to, under certain scenarios, to be a significant decider of things. So, you are assuming that no premium was justified, when we do have actually a precedent transaction from the totally disinterested party where a premium was paid. So you know --

Phil (indiscernible) I think you said that that was 15%, rather than the 40% you paid. That's number one. Number two --

(multiple speakers).

Number two, I don't think there was any intention when the voting stock was created for the voting stock to having economic advantage over the nonvoting stock. In fact, the advantage was given to the nonvoting stock by virtue of the higher dividend rate.

That's true; that is a true statement.

First of all, I dispute your 40%. I think the premium is more like 30%, so I want to correct you on that point. Or at least, that's my perception; I don't know if I am correct.

My math is different than yours, then.

Yes, my math is different from yours. So, it's a very unique transaction; it's a one-off transaction -- has a precedent a year ago --

A precedent of half the premium that you just mentioned.

That's correct. This is a larger block, so I think it's even more unique. You know, I think, Jeff, we talked about this yesterday. I think we're going to have to agree to disagree on this. But, we did deliberate on it with our investment committee; we deliberated on it with our full Board; and we did deliberate with outside advisors. We did not to this capriciously. We considered it carefully, considered all of the facts and decided to make this purchase. We think and we will say it again, that it benefits all of our shareholders and the Company to have done this.

Well, you say that so as you did last night, but I guess I haven't heard how it benefits the shareholders more than spending the extra $12 million to purchase 250,000 more shares.

Well I guess, like I said, we're just going to have to agree to disagree on it.

I guess I will have one last question on this. The press release said that you signed an agreement to purchase the shares. Are there any conditions to that agreement closing?

None, other than delivery of the stock.

Has that occurred already?

I believe it has.

Well, we disagree on the prior topic, strongly.

Well, we appreciate your comments, Jeff.

Adam Klauber, Cochran Caronia & Waller.

Good morning, thanks. Could you comment on the competitive environment, particularly in Pennsylvania? Given the competitive environment, are your rate actions having the impact you would like to see?

Yes. Good morning, Adam. The competitive environment in Pennsylvania is continuing to be intense. Players like Allstate we are aware have made recent rate changes, effective May 7 I believe is the date. Of course, Travelers has entered the Pennsylvania market with some changes that they are making. At the same time, we have made changes in Pennsylvania, changes that involve further interactions, involve discounts, and we are seeing positive results as a result of those changes. We have additional changes that we intend to make later this year, in the fall, to further refine our market. We believe that our competitive position is improving.

We also observe that this is not the first time we've seen others come into this market with what may be unsustainable changes. We, of course, have a long history in Pennsylvania, have a very credible set of statistics regarding trends in Pennsylvania, and we believe that our interactions are appropriately priced so that we can maintain a profit level and compete successfully in the market.

So yes, there's more competition out there but we feel that we have an opportunity to win in this market.

The follow-up on that, within the commercial business, have you've seen increased competition over the last six months? What's your view of that market, which can get more competitive than the, say, auto market? If that market really deteriorates, will you be able to grow in the commercial lines markets?

We've seen very small changes in the commercial marketplace. You know, there's been a lot of softening in the commercial market. You know, the larger risk, which we tend to write the small to medium, there's more fluctuations in the larger risk than there are in the markets that we are in to the largest extent. So we see a flat growth in that area as it relates to premium.

Okay. Also, could you talk about how is progress as far as appointing new agent from I guess a numbers standpoint and also from a territory standpoint?

I'm pleased to tell you that we are on pace for our goal of 125 newly appointed agencies in 2006, and we have a good distribution where those agents are coming from.

Would you say they are more newer states or more your mature states?

It's a nice balance of both, actually.

(OPERATOR INSTRUCTIONS). Mike [Vengas], private investor.

Hello, my questions have been answered already. Thank you.

Michael [Lowenstein], [Canseco].

This is actually [Tom Coleman]. I want to also agree with the other callers. It's outrageous; the premium is outrageous and you guys are -- it feels like you guys are ducking the question, and I think you should -- if you're not going to answer it, you should get some of the directors on the call and let them speak to the shareholders directly and justify the premium and answer the questions.

I think we have answered the question.

You really haven't. You haven't explained why we are better off having paid that premium for the Bs.

Why we are better off? Well, you know, it's a qualitative decision because it's a one-off, unique transaction. So, in those sorts of valuation scenarios, it's common for people to disagree about the emphasis that is placed on one element or another of the deal. Obviously, we disagree. So, I think we have explained it. It's a unique transaction that we considered and involved outside advisors in consideration of and came up with the price. It was actually a negotiated transaction between buyer and seller.

You mentioned -- did you talk to any shareholders or non-B shareholders before you decided on the premium?

Did we talk to shareholders? Other than shareholders that --

Other than Board members who are shareholders? I'm getting the impression you didn't talk to any non-B shareholders.

Well, other than people that are in the management team and on our Board, no, we did not talk to a third-party shareholder about the fact that we were in a negotiated transaction for B shares and what price we might pay; no, we did not do that. I don't think that would have been appropriate, either.

Ron Bobman, Capital Returns.

As I sort of started -- at least the first one -- to ask the question about the stock purchase, I'm sympathetic with these two other gentlemen, but you know, I can appreciate paying some premium but I really think they're right, this last gentlemen's comment, that it's still not clear to me why the B is so important. Maybe you look at the transcript after this call, it's just -- I am sort of at a loss as to why the B shares are so important. You know, Jeff, you alluded to a control feature, but I am still feeling sort of whatever. I think you've at least not exhausted what you could as far as explaining this, so I would just repeat that.

I was wondering, on a going-go-forward basis, if the termination or the ending of the ERIEConnection spend, which obviously was a huge amount of money squandered over several years, is that on a going-forward basis going to improve the expense burden of either the Exchange and/or Indemnity? I mean, are we going to sort of see a benefit to margins as a result of that?

Well, you know, the big spend on ERIEConnection was in really '03 and '04. The levels came down in '05. We've announced that we're going to employ us around -- what we call it's around strategy with our existing personal lines -- (multiple speakers) -- system. We're going to spend some money doing that. I don't think it's going to be to the magnitude of what we spent on ERIEConnection, and I think it will take place over time. So there will be some expense levels related to that initiative. Will they reach the peak expense levels of ERIEConnection spend? I don't think so.

Was there some degree of sort of responsibility taken for -- you know, the little that I know -- the failure of ERIEConnection? Was the head of IT or the project manager -- you know, is he still with the Company or -- as an outsider and just reading the public docs, it sort of ranks up there as far as a record level squandering of money. So I know it's not a pleasant topic but it's all of our money, obviously.

Yes, it is, and it's very disappointing to all of us. Clearly, the project did not meet our expectations. Yet, I think it's very important that we not lose sight of taking calculated risk, some which are going to work out and some which are not. I don't make that statement lightly. We went into this with good intent, with good diligence. We thought we had a system that would meet our needs, that would meet the needs of our agents. As we further challenged it, we found out that in fact was not the case, and it was a smart thing to do, to get out.

We do currently have a vacancy in our Chief Information Officer position, and we are very aggressively looking to fill that position. We have a new opportunity to, as Phil mentioned, build on the program that we've been using. A lot has happened in the marketplace during this time. Other companies using a similar product, albeit customizable to various companies, have also added surround features to the product, enhancing its functionality. So, difficult situation -- we've learned a lot from it and we are employing what we've learned as we move forward.

Okay, thanks. Actually, it's a couple of more questions about the stock purchase. Phil, the transaction you cited about a year ago at the premium, how big was that transaction? How many shares were transacted amongst those parties where there was a 15% premium paid, approximately?

150.

150 B shares -- and when you mentioned that you had advisors, could you -- I mean, I'm not looking for names but could you describe the type of advisors that you employed?

Wall Street advisors?

Yes -- (multiple speakers) -- financial advisors --.

Investment banks, yes.

Okay. Were you of the impression that it was a so-called competitive position that you weren't the only one looking to buy the shares?

It's our understanding that there are other people interested in the B stock, yes.

Okay. All right, thanks again for your time.

Michael [Philips], Stifel, Nicolaus.

It's [Phil Mayer], I'm sorry. I want to know if I'm reading too much into something that Phil mentioned earlier about expanding the reach of the segmented product. Does that at all include moving into -- I don't want to say nonstandard but the less standard or maybe nonstandard markets in addition to clearly the deeper penetration in the preferred and super-preferred?

Well, the topic of nonstandard has become a bit blurry in the more recent past. It used to be more stark in the sense of a nonstandard market. With the advent of segmented pricing, there's a whole continuum, as you know, in terms of what one might consider to be better risk or the old nonstandard label.

We continue to endeavor to write average and above-average risk as part of our strategic planning effort. We are also evaluating whether or not to expand the continuum into what we may have labeled years ago a nonstandard risk. We have not made any determinations to do that at this time. That is not something we have on our immediate drawing board, so I don't expect us to be doing anything like that in 2006. But we will certainly evaluate that, in terms of this continuum, to see if there's an opportunity for us to grow profitably by expanding that continuum into what would have been the old, nonstandard label.

Okay. On the subject of growth, I guess we made reference earlier to GEICO and Progressive. I think the difference in their growth rates the last year seems to be pretty closely tied to differences in advertising. I was wondering what your thoughts are in terms of using that lever to stimulate growth.

Well, first of all, it's a very expensive lever. I'm sure you are aware of the level of spend that reached nearly $0.5 million for -- $0.5 billion, rather, for some competitors in terms of the advertising spend and range anywhere between, say, 200 to 300 million, up to that point. We believe that branding is very important; we introduced a branding campaign last year. We are working closely with our agency force, but we do not intend to pursue large advertising campaigns like you're seeing out there from these other competitors. We intend to work with our agents, offer a strong value proposition, distinguish ourselves on the personal service that our agents and our employees provide, and build our company that way.

James Pan.

Just a follow-up I guess to the issue of the stock buyback -- I'm just kind of curious. I just looked at your Board of Directors. You guys have a roster of very knowledgeable, intelligent, talented stockholders. Yet I don't see any of these people on the Board; I'm not sure if you've asked them to. I look at your Board here, and the proxy, I don't see anyone who really is -- I guess you know, have, how shall I say, a record of very good assessments, stuff like that. Yet on this call and in your proxy, and I know two or three very good investors. Why don't you invite some of these people on the Board? So when this happens again, you have an opportunity like this, you might get someone who has a different opinion than the people on the Board, or the investment bankers?

Well, first, I would say that we have a very talented Board with a wide diversity of skills and abilities that, collectively, have been of tremendous support and help in terms of the opportunities and challenges that this company faces. Certainly, as we move forward, we have opportunities to evaluate that. I appreciate and respect your comments, and we will certainly take them under consideration.

I do think we have some Board members that do have successful track records as investors.

Great, thanks.

It appears there are no further questions at this time. I would like to turn the conference back over to your host, Mr. Dombrowski, for closing remarks.

Thank you, all. That concludes today's call. Again, a recording of the call will be posted on our Web site, ErieInsurance.com, after 12:30 PM Eastern time today. If you have any questions, please call me directly at 814-870-2285. Thank you again and have a great day.

That does conclude today's conference. We thank you for your participation.