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ERIE INDEMNITY CO - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of financial condition and results of operations highlights significant factors influencing the Erie Insurance Group. This discussion should be read in conjunction with the historical financial information and the related notes thereto included in Item 1. "Financial Statements" of this Quarterly Report on Form 10- Q and with...

Edgar Online, Inc.
The following discussion of financial condition and results of operations
highlights significant factors influencing the Erie Insurance Group ("we," "us,"
"our").  This discussion should be read in conjunction with the historical
financial information and the related notes thereto included in Item 1.
"Financial Statements" of this Quarterly Report on Form 10-Q and with Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for the year ended December 31, 2011 contained in our Annual Report
on Form 10-K as filed with the Securities and Exchange Commission on
February 27, 2012.





INDEX

                                                               Page Number
  Cautionary Statement Regarding Forward-Looking Information       39
  Recent Accounting Pronouncements                                 40
  Operating Overview                                               41
  Results of Operations                                            47
  Management Operations                                            47
  Property and Casualty Insurance Operations                       49
  Life Insurance Operations                                        53
  Investment Operations                                            54
  Financial Condition                                              56
  Investments                                                      56
  Liabilities                                                      60
  Impact of Inflation                                              61
  Liquidity and Capital Resources                                  61
  Critical Accounting Estimates                                    64





CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

"Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995:


Statements contained herein that are not historical fact are forward-looking
statements and, as such, are subject to risks and uncertainties that could cause
actual events and results to differ, perhaps materially, from those discussed
herein.  Forward-looking statements relate to future trends, events or results
and include, without limitation, statements and assumptions on which such
statements are based that are related to our plans, strategies, objectives,
expectations, intentions and adequacy of resources.  Examples of forward-looking
statements are discussions relating to premium and investment income, expenses,
operating results, agency relationships, and compliance with contractual and
regulatory requirements.  Forward-looking statements are not guarantees of
future performance and involve risks and uncertainties that are difficult to
predict.  Therefore, actual outcomes and results may differ materially from what
is expressed or forecasted in such forward-looking statements.  Among the risks
and uncertainties, in addition to those set forth in our filings with the
Securities and Exchange Commission, that could cause actual results and future
events to differ from those set forth or contemplated in the forward-looking
statements include the following:



Risk factors related to the Erie Indemnity Company ("Indemnity") shareholder interest:

† dependence upon Indemnity's relationship with the Exchange and the management fee under the agreement with the subscribers at the Exchange;

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† costs of providing services to the Exchange under the subscriber's agreement;

† ability to attract and retain talented management and employees;

† ability to maintain uninterrupted business operations, including information technology systems;

† factors affecting the quality and liquidity of Indemnity's investment portfolio;

† credit risk from the Exchange;

† Indemnity's ability to meet liquidity needs and access capital; and

†          outcome of pending and potential litigation against Indemnity.



                                       39
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Risk factors related to the non-controlling interest owned by the Erie Insurance
Exchange ("Exchange"), which includes the Property and Casualty Group and Erie
Family Life Insurance Company:

†

†          general business and economic conditions;

†          dependence upon the independent agency system;

†          ability to maintain our reputation for customer service;

†          factors affecting insurance industry competition;

†          changes in government regulation of the insurance industry;

† premium rates and reserves must be established from forecasts of ultimate costs;

† emerging claims, coverage issues in the industry, and changes in reserve estimates related to the property and casualty business;

†          changes in reserve estimates related to the life business;

†          severe weather conditions or other catastrophic losses, including
terrorism;

† the Exchange's ability to acquire reinsurance coverage and collectability from reinsurers;

† factors affecting the quality and liquidity of the Exchange's investment portfolio;

†          the Exchange's ability to meet liquidity needs and access capital;

†          the Exchange's ability to maintain an acceptable financial strength
rating;

† outcome of pending and potential litigation against the Exchange; and

† dependency upon the service provided by Indemnity.




A forward-looking statement speaks only as of the date on which it is made and
reflects our analysis only as of that date.  We undertake no obligation to
publicly update or revise any forward-looking statement, whether as a result of
new information, future events, changes in assumptions, or otherwise.





RECENT ACCOUNTING PRONOUNCEMENTS




See Item 1. "Financial Statements - Note 2. Significant Accounting Policies,"
contained within this report for a discussion of adopted and/or pending
accounting pronouncements, none of which are expected to have a material impact
on our future financial condition, results of operations or cash flows.



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OPERATING OVERVIEW



Overview

The Erie Insurance Group represents the consolidated results of Indemnity and
the results of its variable interest entity, the Exchange.  The Erie Insurance
Group operates predominantly as a property and casualty insurer through its
regional insurance carriers that write a broad range of personal and commercial
coverages.  Our property and casualty insurance companies include the Exchange
and its wholly owned subsidiaries, Erie Insurance Company ("EIC"), Erie
Insurance Company of New York ("ENY"), Erie Insurance Property and Casualty
Company ("EPC"), and Flagship City Insurance Company ("Flagship").  These
entities operate collectively as the "Property and Casualty Group."  The Erie
Insurance Group also operates as a life insurer through the Exchange's wholly
owned subsidiary, Erie Family Life Insurance Company ("EFL"), which underwrites
and sells individual and group life insurance policies and fixed annuities (1).



The Exchange is a reciprocal insurance exchange, which is an unincorporated
association of individuals, partnerships and corporations that agree to insure
one another.  Each applicant for insurance to the Exchange signs a subscriber's
agreement, which contains an appointment of Indemnity as their attorney-in-fact
to transact the business of the Exchange on their behalf.



Pursuant to the subscriber's agreement and for its services as attorney-in-fact, Indemnity earns a management fee calculated as a percentage of the direct premiums written by the Exchange and the other members of the Property and Casualty Group, which are assumed by the Exchange under an intercompany pooling arrangement.

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The Indemnity shareholder interest includes Indemnity's equity and income, but
not the equity or income of the Exchange.  The Exchange's equity, which is
comprised of its retained earnings and accumulated other comprehensive income,
is held for the interest of its subscribers (policyholders) and meets the
definition of a noncontrolling interest, which is reflected as such in our
consolidated financial statements.



"Indemnity shareholder interest" refers to the interest in Erie Indemnity Company owned by the Class A and Class B shareholders. "Noncontrolling interest" refers to the interest in the Erie Insurance Exchange held for the interest of the subscribers (policyholders).

The Indemnity shareholder interest in income generally comprises:




†          a management fee of up to 25% of all property and casualty insurance
premiums written or assumed by the Exchange, less the costs associated with the
sales, underwriting and issuance of these policies;

† a 0% equity interest in the net earnings of EFL after March 31, 2011 (the interest was 21.6% prior to March 31, 2011) (1);

† net investment income and results on investments that belong to Indemnity; and

† other income and expenses, including income taxes, that are the responsibility of Indemnity.

The Exchange's or the noncontrolling interest in income generally comprises:

† a 100% interest in the net underwriting results of the property and casualty insurance operations;

† a 100% equity interest in the net earnings of EFL after March 31, 2011 (the interest was 78.4% prior to March 31, 2011) (1);


†          net investment income and results on investments that belong to the
Exchange and its subsidiaries, which include EIC, ENY, EPC, Flagship and EFL;
and

† other income and expenses, including income taxes, that are the responsibility of the Exchange and its subsidiaries.





(1)      Prior to and through March 31, 2011, Indemnity retained a 21.6%
ownership interest in EFL, which accrued to the Indemnity shareholder interest,
and the Exchange retained a 78.4% ownership interest in EFL, which accrued to
the interest of the subscribers (policyholders) of the Exchange, or
noncontrolling interest.  Due to the sale of Indemnity's 21.6% ownership
interest in EFL to the Exchange on March 31, 2011, 100% of EFL's life insurance
results accrue to the interest of the subscribers (policyholders) of the
Exchange, or noncontrolling interest, after March 31, 2011.



                                       41

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Results of the Erie Insurance Group's Operations by Interest (Unaudited)

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The following tables represent a breakdown of the composition of the income
attributable to the Indemnity shareholder interest and the income attributable
to the noncontrolling interest (Exchange).  For purposes of this discussion,
EFL's investments are included in the life insurance operations.



                                                                                             Eliminations of
                                  Indemnity                  Noncontrolling interest          related party
 (in millions)              shareholder interest                    (Exchange)                 transactions        Erie Insurance Group
                                   Three months ended                Three months ended     Three months ended      Three months ended
                                      September 30,                    September 30,          September 30,            September 30,
                            Percent     2012      2011    Percent     2012        2011       2012         2011      2012          2011
Management
operations:
Management fee
revenue, net                 100.0%       $305     $280               $    -      $    -      $(305)     $(280)      $    -        $    -
Service agreement
revenue                      100.0%          8        8                    -           -           -          -           8             8
Total revenue from
management operations                      313      288                    -           -       (305)      (280)           8             8
Cost of management
operations                   100.0%        247      226                    -           -       (247)      (226)           -             -
Income from
management operations
before taxes                                66       62                    -           -        (58)       (54)           8             8

Property and casualty
insurance operations:
Net premiums earned                          -        -    100.0%      1,118       1,045           -          -       1,118         1,045
Losses and loss
expenses                                     -        -    100.0%        890         823         (2)        (1)         888           822
Policy acquisition
and underwriting
expenses                                     -        -    100.0%        329         302        (59)       (56)         270           246
Loss from property
and casualty
insurance operations
before taxes                                 -        -                (101)        (80)          61         57        (40)          (23)

Life insurance
operations: (1)
Total revenue                                -        -    100.0%         44          46           0          0          44            46
Total benefits and
expenses                                     -        -    100.0%         32          33           0          0          32            33
Income from life
insurance operations
before taxes                                 -        -                   12          13           0          0          12            13

Investment
operations:
Net investment income                        4        4                   81          83         (3)        (3)          82            84
Net realized gains
(losses) on
investments                                  2      (6)                  165       (421)           -          -         167         (427)
Net impairment losses
recognized in
earnings                                     0        0                    0           0           -          -           0             0
Equity in earnings of
limited partnerships                         6        7                   35          33           -          -          41            40
Income (loss) from
investment operations
before taxes                                12        5                  281       (305)         (3)        (3)         290         (303)

Income (loss) from
operations before
income taxes and
noncontrolling
interest                                    78       67                  192       (372)           -          -         270         (305)
Provision for income
taxes                                       27       20                   59       (145)           -          -          86         (125)
Net income (loss)                          $51     $ 47               $  133    $  (227)        $  -       $  -      $  184       $ (180)




(1)       Earnings on life insurance related invested assets are integral to the
evaluation of the life insurance operations because of the long duration of life
products.  On that basis, for presentation purposes, the life insurance
operations in the table above include life insurance related investment
results.  However, the life insurance investment results are included in the
investment operations segment discussion as part of the Exchange's investment
results.



Operating results in the third quarter of 2012 were impacted primarily by
improved earnings from our investment operations, offset slightly by increased
losses in our property and casualty insurance operations, compared to the third
quarter of 2011.  Our investment operations improved as a result of net realized
gains on investments compared to losses in the third quarter of 2011.  The
Exchange's property and casualty insurance operations experienced a 7.0%
increase in earned premium, driven by increases in policies in force and the
average premium per policy.  The Exchange's losses from its property and
casualty insurance operations increased primarily due to less favorable
development on prior accident year loss reserves, offset somewhat by lower
catastrophe losses compared to the third quarter of 2011.



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                                                                                                  Eliminations of
                                    Indemnity                   Noncontrolling interest            related party
 (in millions)                 shareholder interest                    (Exchange)                   transactions        Erie Insurance Group
                                     Nine months ended                   Nine months ended        Nine months ended       Nine months ended
                                       September 30,                       September 30,            September 30,           September 30,
                           Percent       2012     2011        Percent   2012          2011         2012        2011      2012         2011
Management operations:
Management fee revenue,
net                         100.0%        $882     $816                  $   -           $   -      $(882)    $(816)      $   -          $   -
Service agreement
revenue                     100.0%          23       25                      -               -           -         -         23             25
Total revenue from
management operations                      905      841                      -               -       (882)     (816)         23             25
Cost of management
operations                  100.0%         734      667                      -               -       (734)     (667)          -              -
Income from management
operations before taxes                    171      174                      -               -       (148)     (149)         23             25

Property and casualty
insurance operations:
Net premiums earned                          -        -        100.0%    3,279           3,089           -         -      3,279          3,089
Losses and loss expenses                     -        -        100.0%    2,501           2,653         (4)       (4)      2,497          2,649
Policy acquisition and
underwriting expenses                        -        -        100.0%      963             882       (153)     (154)        810            728
Loss from property and
casualty insurance
operations before taxes                      -        -                  (185)           (446)         157       158       (28)          (288)

Life insurance
operations: (1) (2)
Total revenue                21.6%  (2)      -       10     78.4% (2)      133             124         (1)       (1)        132            133
Total benefits and                  (2)
expenses                     21.6%           -        7     78.4% (2)       99              89           0         0         99             96
Income from life
insurance operations
before taxes                                 -        3                     34              35         (1)       (1)         33             37

Investment operations:
Net investment income                       12       12                    251             252         (8)       (8)        255            256
Net realized gains
(losses) on investments                      4        1                    348           (247)           -         -        352          (246)
Net impairment losses
recognized in earnings                       0        0                      0               0           -         -          0              0
Equity in earnings of
limited partnerships                        10       25                     89             124           -         -         99            149
Income from investment
operations before taxes                     26       38                    688             129         (8)       (8)        706            159

Income (loss) from
operations before income
taxes and noncontrolling
interest                                   197      215                    537           (282)           -         -        734           (67)
Provision for income
taxes                                       67       72                    167           (126)           -         -        234           (54)
Net income (loss)                         $130     $143                  $ 370         $ (156)        $  -      $  -      $ 500        $  (13)




(1)       Earnings on life insurance related invested assets are integral to the
evaluation of the life insurance operations because of the long duration of life
products.  On that basis, for presentation purposes, the life insurance
operations in the table above include life insurance related investment
results.  However, the life insurance investment results are included in the
investment operations segment discussion as part of the Exchange's investment
results.



(2)       Prior to and through March 31, 2011, Indemnity retained a 21.6%
ownership interest in EFL, which accrued to the Indemnity shareholder interest,
and the Exchange retained a 78.4% ownership interest in EFL, which accrued to
the interest of the subscribers (policyholders) of the Exchange, or
noncontrolling interest.  Due to the sale of Indemnity's 21.6% ownership
interest in EFL to the Exchange on March 31, 2011, 100% of EFL's life insurance
results accrue to the interest of the subscribers (policyholders) of the
Exchange, or noncontrolling interest, after March 31, 2011.





Operating results in the first nine months of 2012 were impacted primarily by
increased earnings from our investment operations and lower losses from our
property and casualty insurance operations, compared to the first nine months of
2011.  Our investment operations improved primarily as a result of net realized
gains on investments, compared to losses in the first nine months of 2011,
offset somewhat by lower equity in earnings of limited partnerships.  The
Exchange's property and casualty insurance operations experienced a 6.1%
increase in earned premium, driven by increases in policies in force and the
average premium per policy.  The Exchange's losses from its property and
casualty insurance operations decreased primarily due to lower catastrophe
losses, offset by less favorable development on prior accident year loss
reserves compared to the first nine months of 2011.



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Reconciliation of Operating Income to Net Income (Unaudited)


We disclose operating income, a non-GAAP financial measure, to enhance our
investors' understanding of our performance related to the Indemnity shareholder
interest.  Our method of calculating this measure may differ from those used by
other companies, and therefore comparability may be limited.



Indemnity defines operating income as net income excluding realized capital gains and losses, impairment losses and related federal income taxes.




Indemnity uses operating income to evaluate the results of its operations.  It
reveals trends that may be obscured by the net effects of realized capital gains
and losses including impairment losses.  Realized capital gains and losses,
including impairment losses, may vary significantly between periods and are
generally driven by business decisions and economic developments such as capital
market conditions which are not related to our ongoing operations.  We are aware
that the price to earnings multiple commonly used by investors as a
forward-looking valuation technique uses operating income as the denominator.
Operating income should not be considered as a substitute for net income
prepared in accordance with U.S. generally accepted accounting principles
("GAAP") and does not reflect Indemnity's overall profitability.



The following table reconciles operating income and net income for the Indemnity
shareholder interest:



                                                         Indemnity Shareholder Interest
                                                   Three months ended      Nine months ended
(in millions, except per share data)                 September 30,           September 30,
                                                    2012        2011        2012        2011
                                                      (Unaudited)             (Unaudited)
Operating income attributable to Indemnity           $  50        $ 51       $ 128       $ 142
Net realized gains (losses) and impairments
on investments                                           2         (6)           4           1
Income tax (expense) benefit                           (1)           2         (2)           0
Realized gains (losses) and impairments, net
of income taxes                                          1         (4)           2           1
Net income attributable to Indemnity                 $  51        $ 47      

$ 130$ 143


Per Indemnity Class A common share-diluted:
Operating income attributable to Indemnity           $0.93       $0.93       $2.38       $2.57
Net realized gains (losses) and impairments
on investments                                        0.05      (0.09)        0.08        0.03
Income tax (expense) benefit                        (0.02)        0.03      (0.03)      (0.01)
Realized gains (losses) and impairments, net
of income taxes                                       0.03      (0.06)        0.05        0.02
Net income attributable to Indemnity                 $0.96       $0.87       $2.43       $2.59



Summary of Results - Indemnity Shareholder Interest

Three months ended September 30, 2012


Net income attributable to Indemnity per share-diluted was $0.96 per share in
the third quarter of 2012, compared to $0.87 per share in the third quarter of
2011.


Operating income attributable to Indemnity per share-diluted (excluding net realized gains or losses, impairments on investments and related taxes) was $0.93 per share in both the third quarters of 2012 and 2011.

Nine months ended September 30, 2012


Net income attributable to Indemnity per share-diluted was $2.43 per share for
the nine months ended September 30, 2012, compared to $2.59 per share for the
nine months ended September 30, 2011.  The nine months ended September 30, 2011
net income per share-diluted amount includes $0.02 per share related to the life
insurance operations sold to the Exchange.



Operating income attributable to Indemnity per share-diluted (excluding net
realized gains or losses, impairments on investments and related taxes) was
$2.38 per share for the nine months ended September 30, 2012, compared to $2.57
per share for the nine months ended September 30, 2011.  The nine months ended
September 30, 2011 operating income per share-diluted amount includes $0.02 per
share related to the life insurance operations sold to the Exchange.



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Operating Segments

Our reportable segments include management operations, property and casualty insurance operations, life insurance operations and investment operations.

Management operations


Management operations generate internal management fee revenue, which accrues to
the Indemnity shareholder interest, as Indemnity provides services relating to
the sales, underwriting and issuance of policies on behalf of the Exchange.
Management fee revenue is based upon all premiums written or assumed by the
Exchange and the management fee rate, which is not to exceed 25%.  Our Board of
Directors establishes the management fee rate at least annually, generally in
December for the following year, and considers factors such as the relative
financial strength of Indemnity and the Exchange and projected revenue streams.
The management fee rate was set at 25% for both 2012 and 2011.  Management fee
revenue is eliminated upon consolidation.



Property and casualty insurance operations


The property and casualty insurance business is driven by premium growth, the
combined ratio and investment returns.  The property and casualty insurance
industry is cyclical, with periods of rising premium rates and shortages of
underwriting capacity followed by periods of substantial price competition and
excess capacity.  The cyclical nature of the insurance industry has a direct
impact on the direct written premium of the Property and Casualty Group.



The property and casualty insurance operation's premium growth strategy focuses
on growth by expansion of existing operations including a careful agency
selection process and increased market penetration in existing operating
territories.  Expanding the size of our existing agency force of nearly 2,200
independent agencies, with almost 10,000 licensed property and casualty
representatives, will contribute to future growth as new agents build their
books of business with the Property and Casualty Group.



The property and casualty insurance operations insure preferred and standard
risks while maintaining a disciplined underwriting approach.  Based upon direct
written premium in 2011, approximately 50% of our premiums were derived from
personal auto, 20% from homeowners and 30% from commercial lines.  Pennsylvania,
Maryland and Virginia made up 63% of the property and casualty lines insurance
business 2011 direct written premium.



Members of the Property and Casualty Group pool their underwriting results under
an intercompany pooling agreement.  Under the pooling agreement, the Exchange
retains a 94.5% interest in the net underwriting results of the Property and
Casualty Group, while EIC retains a 5.0% interest and ENY retains a 0.5%
interest.



The key measure of underwriting profitability traditionally used in the property
and casualty insurance industry is the combined ratio, which is expressed as a
percentage.  It is the sum of the ratio of losses and loss expenses to premiums
earned (loss ratio) plus the ratio of policy acquisition and other underwriting
expenses to premiums earned (expense ratio).  When the combined ratio is less
than 100%, underwriting results are generally considered profitable; when the
combined ratio is greater than 100%, underwriting results are generally
considered unprofitable.



Factors affecting losses and loss expenses include the frequency and severity of
losses, the nature and severity of catastrophic losses, the quality of risks
underwritten and underlying claims and settlement expenses.



Investments held by the Property and Casualty Group are reported in the investment operations segment, separate from the underwriting business.

Life insurance operations


EFL generates revenues through the sale of its individual and group life
insurance policies and fixed annuities.  These products provide our property and
casualty agency force an opportunity to cross-sell both personal and commercial
accounts.  EFL's profitability depends principally on the ability to develop,
price and distribute insurance products, attract and retain deposit funds,
generate investment returns and manage expenses.  Other drivers include
mortality and morbidity experience, persistency experience to enable the
recovery of acquisition costs, maintenance of interest spreads over the amounts
credited to deposit funds and the maintenance of strong ratings from rating
agencies.



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Earnings on life insurance related invested assets are integral to the
evaluation of the life insurance operations because of the long duration of life
products.  On that basis, for presentation purposes, the life insurance
operations segment discussion includes the life insurance related investment
results.  However, also for presentation purposes, the segment footnote and the
investment operations segment discussion also include the life insurance
investment results as part of the Exchange's investment results.



Prior to and through March 31, 2011, Indemnity retained a 21.6% ownership
interest in EFL, which accrued to the Indemnity shareholder interest, and the
Exchange retained a 78.4% ownership interest in EFL, which accrued to the
interest of the subscribers (policyholders) of the Exchange, or noncontrolling
interest.  Due to the sale of Indemnity's 21.6% ownership interest in EFL to the
Exchange on March 31, 2011, 100% of EFL's life insurance results accrue to the
interest of the subscribers (policyholders) of the Exchange, or noncontrolling
interest, after March 31, 2011.



Investment operations


We generate revenues from our fixed maturity, equity security and limited
partnership investment portfolios to support our underwriting business.  The
portfolios are managed with the objective of maximizing after-tax returns on a
risk-adjusted basis.  Management actively evaluates the portfolios for
impairments.  We record impairment writedowns on investments in instances where
the fair value of the investment is substantially below cost, and we conclude
that the decline in fair value is other-than-temporary.



Earnings from our investment operations increased in the third quarter of 2012,
compared to the third quarter of 2011, due to net realized gains in the third
quarter of 2012.  Net realized gains totaled $169 million, compared to losses of
$422 million in the prior year quarter, primarily reflecting valuation gains on
our common stock portfolio in the third quarter of 2012 compared to valuation
losses in the third quarter of 2011.  Net investment income totaled $105 million
in the third quarter of 2012, compared to $108 million in the third quarter of
2011.  Equity in earnings of limited partnerships was $41 million in the third
quarter of 2012, compared to $40 million in the third quarter of 2011.  The
results from our limited partnerships are based upon financial statements
received from our general partners, which are generally received on a quarter
lag.  As a result, our third quarter 2012 partnership earnings reflect the
market conditions experienced in the second quarter of 2012 and not in the third
quarter of 2012.


General Conditions and Trends Affecting Our Business

Economic conditions


Unfavorable changes in economic conditions, including declining consumer
confidence, inflation, high unemployment and the threat of recession, among
others, may lead the Property and Casualty Group's customers to modify coverage,
not renew policies, or even cancel policies, which could adversely affect the
premium revenue of the Property and Casualty Group, and consequently Indemnity's
management fee.  These conditions could also impair the ability of customers to
pay premiums when due, and as a result, the Property and Casualty Group's bad
debt write-offs could increase.  Our key challenge is to generate profitable
revenue growth in a highly competitive market that continues to experience the
effects of uncertain economic conditions.



Financial market volatility


Our portfolio of fixed income, preferred and common stocks, and limited
partnerships are subject to market volatility especially in periods of
instability in the worldwide financial markets.  Over time, net investment
income could also be impacted by volatility and by the general level of interest
rates, which impact reinvested cash flow from the portfolio and business
operations.  Depending upon market conditions, which are unpredictable and
remain uncertain, considerable fluctuation could exist in our reported total
investment income, which could have an adverse impact on our financial
condition, results of operations and cash flows.



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RESULTS OF OPERATIONS


The information that follows is presented on a segment basis prior to eliminations.




Management Operations

Management fee revenue is earned by Indemnity from services relating to the
sales, underwriting and issuance of policies on behalf of the Exchange as a
result of its attorney-in-fact relationship, and is eliminated upon
consolidation. A summary of the results of our management operations is as
follows:



                                                Indemnity Shareholder Interest
                                      Three months ended               Nine months ended
                                         September 30,                   September 30,
(dollars in millions)              2012     2011    % Change       2012     2011    % Change
                                    (Unaudited)                     (Unaudited)
Management fee revenue, net         $305     $280       8.8 %       $882     $816       8.1 %
Service agreement revenue              8        8       (7.4)         23       25       (8.1)
Total revenue from management
operations                           313      288         8.3        905      841         7.6
Cost of management operations        247      226         9.5        734      667        10.1
Income from management
operations -Indemnity (1)           $ 66     $ 62       4.0 %       $171     $174      (2.2)%
Gross margin                       20.9%    21.7%   (0.8)pts.      18.8%    20.7%   (1.9)pts.




(1)      Indemnity retains 100% of the income from management operations.





Management fee revenue

Management fee revenue is based upon all premiums written or assumed by the
Exchange and the management fee rate, which is determined by our Board of
Directors at least annually. Management fee revenue is calculated by multiplying
the management fee rate by the direct premiums written by the Exchange and the
other members of the Property and Casualty Group, which are assumed by the
Exchange under an intercompany pooling agreement. The following table presents
the calculation of management fee revenue:



                                               Indemnity Shareholder Interest
                                      Three months ended             Nine months ended
                                        September 30,                  September 30,
(dollars in millions)              2012     2011    % Change      2012     2011    % Change
                                    (Unaudited)                    (Unaudited)
Property and Casualty Group
direct written premium            $1,215   $1,119      8.6 %     $3,532   $3,271      8.0 %
Management fee rate               25.00%   25.00%                25.00%   25.00%

Management fee revenue, gross 304 280 8.6 883

  818      8.0
Change in allowance for
management fee returned on
cancelled policies (1)                 1        -         NM        (1)      (2)         NM
Management fee revenue, net of
allowance                         $  305   $  280      8.8 %     $  882   $  816      8.1 %




NM = not meaningful


(1) Management fees are returned to the Exchange when policies are cancelled mid-term and unearned premiums are refunded. We record an estimated allowance for management fees returned on mid-term policy cancellations.






Direct written premium of the Property and Casualty Group increased 8.6% in the
third quarter of 2012, compared to the third quarter of 2011, due to a 3.4%
increase in policies in force and a 4.1% increase in the year-over-year average
premium per policy for all lines of business.  The year-over-year policy
retention ratio was 90.8% at September 30, 2012, compared to 90.7% at
December 31, 2011, and 90.8% at September 30, 2011.  See the "Property and
Casualty Insurance Operations" segment that follows for a complete discussion of
property and casualty direct written premium, which has a direct bearing on
Indemnity's management fee.



The management fee rate was set at 25%, the maximum rate, for both 2012 and 2011. Changes in the management fee rate can affect the segment's revenue and net income significantly.




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Service agreement revenue

Service agreement revenue includes service charges Indemnity collects from policyholders for providing extended payment terms on policies written by the Property and Casualty Group and late payment and policy reinstatement fees.

The

service charges are fixed dollar amounts per billed installment.  Service
agreement revenue totaled $8 million in both the third quarters of 2012 and
2011, and $23 million and $25 million for the nine months ended September 30,
2012 and 2011, respectively.  The decrease in service agreement revenue resulted
from a slight decline in late payment and policy reinstatement fees and a
continued shift in policies to the monthly direct debit payment plan, which does
not incur service charges, and the no-fee single payment plan, which offers a
premium discount.  The shift to these plans is driven by the consumers' desire
to avoid paying service charges and to take advantage of the discount in pricing
offered for paid-in-full policies.



Cost of management operations



                                                       Indemnity Shareholder Interest
                                  Three months ended September 30,         Nine months ended September 30,
(in millions)                    2012        2011         % Change        2012       2011         % Change
                                   (Unaudited)                              (Unaudited)
Commissions                        $163        $151              8.2 %      $477       $446             7.0 %
Non-commission expense               84          75               12.2       257        221              16.3
Total cost of management
operations                         $247        $226              9.5 %      $734       $667            10.1 %




Commissions - Commissions increased $12 million in the third quarter of 2012 and
$31 million for the nine months ended September 30, 2012, compared to the same
respective periods in 2011, primarily as a result of the 8.6% and 8.0%,
respectively, increase in direct written premium of the Property and Casualty
Group.  Impacting this increase for the nine months ended September 30, 2012,
was an adjustment that reduced commission expense by $6 million that occurred in
the second quarter of 2012.  This amount represents the reimbursement by the
North Carolina Reinsurance Facility (NCRF) for commissions Indemnity paid to
agents on the surcharges collected on behalf of the NCRF in prior periods.  This
amount was incorrectly recorded as a benefit to the Exchange in prior periods.
If these amounts had been correctly recorded, Indemnity's commission expense
would have been lower by $0.5 million and $0.7 million, for the years ended
December 31, 2011 and 2010, respectively.



Non-commission expense - Non-commission expense increased $9 million in the
third quarter of 2012, compared to the third quarter of 2011.  Sales, policy
issuance, advertising, and underwriting costs increased $2 million primarily due
to increased levels of applications and policies and increased agent related
advertising and support.  Information technology costs increased $3 million,
which included $1 million of personnel costs, $1 million of software costs and
$1 million of professional fees.  Personnel and all other operating costs,
excluding information technology related costs, increased $4 million as a result
of a $2 million increase related to higher staffing levels primarily associated
with policy acquisition and customer service functions, a $1 million increase in
pension costs, and a $1 million increase in the estimate for annual incentive
plan compensation related to growth and underwriting performance.



For the nine months ended September 30, 2012, non-commission expense increased
$36 million, compared to the nine months ended September 30, 2011.  Sales,
policy issuance, advertising, and underwriting costs increased $8 million
primarily due to increased levels of applications and policies and increased
agent related advertising and support.  Information technology costs increased
$13 million, which included $4 million of personnel costs, $5 million of
software costs and $4 million of professional fees.  Personnel and all other
operating costs, excluding information technology related costs, increased $15
million as a result of a $7 million increase related to higher staffing levels
primarily associated with policy acquisition and customer service functions, a
$4 million increase in pension and health care costs, and a $4 million increase
in the estimate for annual incentive plan compensation related to growth and
underwriting performance.



Gross margin

The gross margin in the third quarter of 2012 was 20.9%, compared to 21.7% in
the third quarter of 2011, and was 18.8% for the nine months ended September 30,
2012, compared to 20.7% for the nine months ended September 30, 2011, as a
result of expense increases outpacing revenue growth.  Excluding the adjustment
that reduced commission expense by $6 million that occurred in the second
quarter of 2012, the gross margin would have been 18.2% for the nine months
ended September 30, 2012.



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Property and Casualty Insurance Operations

The Property and Casualty Group operates in 11 Midwestern, Mid-Atlantic and
Southeastern states and the District of Columbia and primarily writes private
passenger automobile, homeowners, commercial multi-peril, commercial automobile,
and workers compensation lines of insurance.  A summary of the results of our
property and casualty insurance operations is as follows:

                                                            Property and 

Casualty Group

                                      Three months ended September 30,        Nine months ended September 30,
(dollars in millions)                   2012         2011      % Change         2012        2011      % Change
                                           (Unaudited)                            (Unaudited)
Premiums:
Direct written premium                $1,215       $1,119       8.6  %        $3,532       $3,271      8.0  %
Reinsurance - assumed and ceded           (8 )         (4 )   (81.1 )            (22 )        (12 )  (82.3 )
Net written premium                    1,207        1,115       8.4            3,510        3,259      7.7
Change in unearned premium                89           70      28.7              231          170     36.2
Net premiums earned                    1,118        1,045       7.0            3,279        3,089      6.1
Losses and loss expenses:
Current accident year, excluding
catastrophe losses                       794          746       6.2            2,200        2,092      5.1
Current accident year catastrophe
losses                                   114          174     (34.4 )            343          777    (55.8 )
Prior accident years, including
prior year catastrophe losses            (18 )        (97 )    73.1              (42 )       (216 )   80.6
Losses and loss expenses                 890          823       7.9            2,501        2,653     (5.8 )
Policy acquisition and other
underwriting expenses                    329          302       8.7              963          882      9.0
Total losses and expenses              1,219        1,125       8.1            3,464        3,535     (2.1 )
Underwriting loss - Exchange (1)      $ (101 )     $  (80 )   (22.6 )%      

$ (185 ) $ (446 ) 58.9 %


Loss and loss expense ratios:
Current accident year loss ratio,
excluding catastrophe losses            70.9  %      71.4  %   (0.5 )pts.       67.0  %      67.7  %  (0.7 )pts.
Current accident year catastrophe
loss ratio                              10.2         16.7      (6.5 )           10.5         25.1    (14.6 )
Prior accident year loss ratio,
including prior year catastrophe
losses                                  (1.6 )       (9.3 )     7.7             (1.3 )       (6.9 )    5.6
Total loss and loss expense ratio       79.5         78.8       0.7             76.2         85.9     (9.7 )
Policy acquisition and other
underwriting expense ratio              29.4         28.9       0.5             29.4         28.6      0.8
Combined ratio                         108.9  %     107.7  %    1.2  pts.      105.6  %     114.5  %  (8.9 )pts.



(1) The Exchange retains 100% of the income from the property and casualty insurance operations.




We measure profit or loss from our property and casualty insurance segment based
upon its underwriting results, which are represented by net premiums earned less
losses and loss expenses and policy acquisition and other underwriting expenses
on a pre-tax basis.  The loss and loss expense ratio and combined ratio are key
performance indicators that we use to assess business trends and to make
comparisons to industry results.  The investment results related to our property
and casualty insurance operations are included in our investment operations
segment discussion.



Premiums

Direct written premium - Direct written premium of the Property and Casualty
Group increased 8.6% to $1.2 billion in the third quarter of 2012, from $1.1
billion in the third quarter of 2011, driven by an increase in policies in force
and increases in average premium per policy.  Year-over-year policies in force
for all lines of business increased by 3.4% in the third quarter of 2012 as the
result of continuing strong policyholder retention, compared to an increase of
2.6% in the third quarter of 2011.  The year-over-year average premium per
policy for all lines of business increased 4.1% at September 30, 2012, compared
to an increase of 2.9% at September 30, 2011.  The combined impact of these
increases was seen primarily in our personal lines renewal business premiums and
to lesser degrees in our commercial lines renewal business, personal lines new
business, and commercial lines new business premiums.



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Premiums generated from new business increased 17.8% to $142 million in the
third quarter of 2012, compared to an increase of 1.8% to $121 million in the
third quarter of 2011.  Underlying the trend in new business premiums was a
10.0% increase in new business policies written in the third quarter of 2012,
compared to the same period in 2011, while the year-over-year average premium
per policy on new business increased 7.5% at September 30, 2012, compared to an
increase of 5.8% at September 30, 2011.



Premiums generated from renewal business increased 7.5% to $1.1 billion in the
third quarter of 2012, compared to an increase of 5.8% to $998 million in the
third quarter of 2011.  Underlying the trend in renewal business premiums were
increases in average premium per policy and steady policy retention trends. 

The

renewal business year-over-year average premium per policy increased 3.7% at
September 30, 2012, compared to 2.5% at September 30, 2011.  The Property and
Casualty Group's year-over-year policy retention ratio was 90.8% at
September 30, 2012, 90.7% at December 31, 2011, and 90.8% at September 30, 2011.



Personal lines - Total personal lines premiums written increased 7.6% to $903
million in the third quarter of 2012, from $840 million in the third quarter of
2011, driven by an increase of 3.3% in the total personal lines policies in
force and an increase of 3.2% in the total personal lines year-over-year average
premium per policy.



New business premiums written on personal lines increased 17.4% in the third
quarter of 2012, compared to an increase of 1.4% in the third quarter of 2011.
Personal lines new business policies written increased 12.1% in the third
quarter of 2012, compared to the same period in 2011, while the year-over-year
average premium per policy on personal lines new business increased 4.8% at
September 30, 2012, compared to an increase of 3.8% at September 30, 2011.



† Private passenger auto new business premiums written increased 10.0% in the third quarter of 2012, compared to an increase of 0.6% in the third quarter of 2011. New business policies written for private passenger auto increased 5.3% in the third quarter of 2012, compared to the same period in 2011, while the new business year-over-year average premium per policy for private passenger auto increased 3.6% at September 30, 2012, compared to an increase of 2.1% at September 30, 2011.




†         Homeowners new business premiums written increased 30.4% in the third
quarter of 2012, compared to an increase of 3.9% in the third quarter of 2011.
New business policies written for homeowners increased 18.1% in the third
quarter of 2012, compared to the same period in 2011.  The new business
year-over-year average premium per policy for homeowners increased 9.2% at
September 30, 2012, compared to an increase of 5.6% at September 30, 2011.



Renewal premiums written on personal lines increased 6.5% in the third quarter
of 2012, compared to an increase of 4.9% in the third quarter of 2011, driven by
increases in average premium per policy and steady policy retention trends. 

The

year-over-year average premium per policy on personal lines renewal business
increased 3.1% at September 30, 2012, compared to 2.4% at September 30, 2011.
The personal lines year-over-year policy retention ratio was 91.5% at
September 30, 2012 and December 31, 2011, and 91.6% at September 30, 2011.



†         Private passenger auto renewal premiums written increased 3.6% in the
third quarter of 2012, compared to 2.0% in the third quarter of 2011.  The
year-over-year average premium per policy on private passenger auto renewal
business increased 0.8% at September 30, 2012, compared to 1.2% at September 30,
2011.  The private passenger auto year-over-year policy retention ratio was
92.0% at September 30, 2012, 91.6% at December 31, 2011 and 91.7% at
September 30, 2011.



†         Homeowners renewal premiums written increased 11.8% in the third
quarter of 2012, compared to 10.6% in the third quarter of 2011.  The
year-over-year average premium per policy on homeowners renewal business
increased 8.4% at September 30, 2012, compared to 7.1% at September 30, 2011.
The homeowners year-over-year policyholder retention ratio was 90.9% at
September 30, 2012, 91.0% at December 31, 2011 and 91.2% at September 30, 2011.



Commercial lines - Total commercial lines premiums written increased 11.8% to $312 million in the third quarter of 2012, from $279 million in the third quarter of 2011, driven by a 4.3% increase in the total commercial lines policies in force and a 6.0% increase in the total commercial lines year-over-year average premium per policy.

New business premiums written on commercial lines increased 18.4% in the third quarter of 2012, compared to 2.6% in the third quarter of 2011, driven by increases in new business policies written and average premium per policy. The




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combined impact of these increases was seen primarily in the commercial
multi-peril and workers compensation lines of business.  Commercial lines new
business policies written increased 0.2% in the third quarter of 2012, compared
to the same period in 2011, while the year-over-year average premium per policy
on commercial lines new business increased 15.4% at September 30, 2012, compared
to 6.1% at September 30, 2011.



Renewal premiums for commercial lines increased 10.6% in the third quarter of
2012, compared to an increase of 8.7% in the third quarter of 2011, driven by
increases in average premium per policy and steady policy retention trends. 

The

combined impact of these increases was seen primarily in the commercial multi-peril and workers compensation lines of business. The year-over-year average premium per policy on commercial lines renewal business increased 4.4% at September 30, 2012, compared to 2.5% at September 30, 2011. The year-over-year policy retention ratio for commercial lines was 86.0% at September 30, 2012, 85.5% at December 31, 2011 and 85.3% at September 30, 2011.




Future trends - premium revenue - We plan to continue our efforts to grow
Property and Casualty Group premiums and improve our competitive position in the
marketplace.  Expanding the size of our agency force through a careful agency
selection process and increased market penetration in our existing operating
territories will contribute to future growth as existing and new agents build
their books of business with the Property and Casualty Group.  At September 30,
2012, we had nearly 2,200 agencies with almost 10,000 licensed property and
casualty representatives.



Changes in premium levels attributable to the growth in policies in force and
rate changes directly affect the profitability of the Property and Casualty
Group and have a direct bearing on Indemnity's management fee.  Our continued
focus on underwriting discipline and the maturing of our pricing sophistication
models have contributed to the Property and Casualty Group's growth in new
policies in force and steady policy retention ratios.



Losses and loss expenses


Current accident year, excluding catastrophe losses - The current accident year
loss and loss expense ratio for all lines of business, excluding catastrophe
losses, was 70.9% in the third quarter of 2012, compared to 71.4% in the third
quarter of 2011, and 67.0% for the nine months ended September 30, 2012,
compared to 67.7% for the nine months ended September 30, 2011.  The decline
during the first nine months of 2012 was driven primarily by a lower volume of
claims resulting from mild winter weather in the first quarter of 2012, compared
to the first quarter of 2011.



Current accident year catastrophe losses - Catastrophic events, destructive
weather patterns, or changes in climate conditions are an inherent risk of the
property and casualty insurance business and can have a material impact on our
property and casualty insurance underwriting results.  In addressing this risk,
we employ what we believe are reasonable underwriting standards and monitor our
exposure by geographic region.  The Property and Casualty Group's definition of
catastrophes includes those weather related or other loss events that we
consider significant to our geographic footprint which, individually or in the
aggregate, may not reach the level of a national catastrophe as defined by the
Property Claim Service ("PCS").  The Property and Casualty Group maintains
property catastrophe reinsurance coverage from unaffiliated reinsurers to
mitigate future potential catastrophe loss exposures and no longer participates
in the voluntary assumed reinsurance business, which lowers the variability of
the Property and Casualty Group's underwriting results.



Catastrophe losses for the current accident year, as defined by the Property and
Casualty Group, totaled $114 million in the third quarter of 2012, compared to
$174 million in the third quarter of 2011, and contributed 10.2 points and 16.7
points, respectively, to the loss ratios.  For the nine months ended
September 30, 2012, catastrophe losses totaled $343 million, compared to $777
million for the nine months ended September 30, 2011, and contributed 10.5
points and 25.1 points to the respective loss ratios.



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Prior accident years, including prior accident year catastrophe losses - The
following table provides a breakout of our property and casualty insurance
operation's prior year loss reserve development, including prior accident year
catastrophe loss reserves, by type of business:


                                                      Property and Casualty Group
                                             Three months ended          Nine months ended
                                               September 30,               September 30,
(in millions)                                2012           2011        2012          2011
                                                (Unaudited)                 (Unaudited)
Direct business including salvage and
subrogation                                  $(15 )        $(92 )       $(33 )        $(203 )
Assumed reinsurance business                   (3 )          (5 )         (3 )           (9 )
Ceded reinsurance business                      0             0           (6 )           (4 )
Total prior year loss development            $(18 )        $(97 )       $(42 )        $(216 )



Negative amounts represent a redundancy (decrease in reserves), while positive amounts represent a deficiency (increase in reserves).




Direct business, including reserves for catastrophe losses and salvage and
subrogation - In the third quarter of 2012, the Property and Casualty Group
experienced favorable development on direct prior accident year loss reserves of
$15 million and improved the combined ratio by 1.3 points, compared to $92
million in the third quarter of 2011 that improved the combined ratio by 8.8
points.  For the nine months ended September 30, 2012, favorable development of
direct prior accident year loss reserves totaled $33 million and improved the
combined ratio by 1.0 points, compared to $203 million and 6.6 points for the
nine months ended September 30, 2011.



The favorable development in the third quarter and first nine months of 2012 was
impacted by better than expected severity trends in the commercial multi-peril
line of business and better than expected frequency trends in the homeowners
line of business.  Offsetting this favorable development in the first nine
months of 2012 was adverse development in the personal auto and workers
compensation lines of business driven by increased severity trends.  In the
third quarter and first nine months of 2011, the favorable development was
impacted by the closing of massive injury lifetime medical benefits claims in
the workers compensation and personal auto lines of business.  The first nine
months of 2011 was also impacted by better than expected severity trends in the
personal auto, commercial multi-peril and homeowners lines of business.



Assumed reinsurance - The Property and Casualty Group experienced favorable
development on prior accident year loss reserves for its assumed reinsurance
business totaling $3 million and $5 million in the third quarters of 2012 and
2011, respectively, and $3 million and $9 million for the nine months ended
September 30, 2012 and 2011, respectively.  The favorable development in 2012
and 2011 was due to less than anticipated growth in involuntary reinsurance.



Ceded reinsurance - The Property and Casualty Group's ceded reinsurance reserve
recoveries remained flat in both the third quarters of 2012 and 2011, and
increased by $6 million and $4 million for the nine months ended September 30,
2012, and 2011, respectively.  The increase in ceded recoveries is reflected as
favorable loss development as it represents an increase in recoveries resulting
from adverse development on our direct loss reserves.  In the first nine months
of 2012, the increase in ceded recoveries was primarily the result of adverse
development related to the pre-1986 automobile massive injury claims.  In the
first nine months of 2011, the increase was primarily due to adverse development
in the business catastrophe liability and commercial multi-peril lines of
business.



Policy acquisition and other underwriting expenses - Our policy acquisition and
other underwriting expense ratio increased 0.5 points to 29.4% in the third
quarter of 2012, compared to 28.9% in the third quarter of 2011, and increased
0.8 points to 29.4% for the nine months ended September 30, 2012, compared to
28.6% for the nine months ended September 30, 2011.  These increases were
primarily due to a decrease in the amount of policy acquisition expenses
deferred under the new accounting guidance effective in 2012.  Additionally, the
nine months ended September 30, 2012 included an adjustment of $4 million which
contributed 0.1 points to the combined ratio.  The adjustment represents the
reimbursement by the North Carolina Reinsurance Facility (NCRF) for commissions
Indemnity paid to agents on the surcharges collected on behalf of the NCRF in
prior periods.  This amount was incorrectly recorded as a benefit to the
Exchange in prior periods.  The management fee rate was 25% for the periods
ending September 30, 2012 and 2011.



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Life Insurance Operations

EFL is a Pennsylvania-domiciled life insurance company which underwrites and
sells individual and group life insurance policies and fixed annuities and
operates in 10 states and the District of Columbia.  A summary of the results of
our life insurance operations is as follows:


                                              Erie Family Life Insurance Company
                                       Three months ended             Nine months ended
                                         September 30,                  September 30,
(in millions)                      2012      2011    % Change     2012     2011    % Change
                                    (Unaudited)                    (Unaudited)
Individual life premiums, net
of reinsurance                      $18      $16       11.9  %   $ 53     $ 48       10.0  %
Group life and other premiums         1        0        3.9         2        2        3.8
Other revenue                         0        1         NM         1        1        6.4
Total net policy revenue             19       17       11.8        56       51        9.7
Net investment income                23       24       (4.2 )      71       70        1.3
Net realized gains on
investments                           2        5      (68.4 )       6       12      (43.1 )
Impairment losses recognized in
earnings                              0        0         NM         0        0         NM
Equity in earnings (losses) of
limited partnerships                  0        0         NM         0        1         NM
Total revenues                       44       46       (1.3 )     133      134       (0.3 )
Benefits and other changes in
policy reserves                      24       26       (4.2 )      74       75       (0.8 )
Amortization of deferred policy
acquisition costs                     3        3       (0.2 )      10       10       (4.3 )
Other operating expenses              5        4       42.0        15       11       47.2
Total benefits and expenses          32       33       (3.0 )      99       96        4.3
Income before income taxes          $12      $13       (8.5 )%   $ 34     $ 38      (11.7 )%
Income before taxes - Indemnity
(1)                                 $ -      $ -                 $  -     $ 

3

Income before taxes - Exchange
(1)                                 $12      $13                 $ 34     $ 35




NM = not meaningful



(1)      Prior to and through March 31, 2011, Indemnity retained a 21.6%
ownership interest in EFL, which accrued to the Indemnity shareholder interest,
and the Exchange retained a 78.4% ownership interest in EFL, which accrued to
the interest of the subscribers (policyholders) of the Exchange, or
noncontrolling interest.  Due to the sale of Indemnity's 21.6% ownership
interest in EFL to the Exchange on March 31, 2011, 100% of EFL's life insurance
results accrue to the interest of the subscribers (policyholders) of the
Exchange, or noncontrolling interest, after March 31, 2011.



Policy revenue


Gross policy revenues increased 5.8% to $29 million in the third quarter 2012,
from $27 million in the third quarter of 2011.  EFL reinsures a large portion of
its traditional products in order to reduce claims volatility.  With the
introduction of its new life products, effective June 1, 2011, EFL reinsures new
individual life business amounts in excess of its $1 million per life retention
limit.  Previously, EFL reinsured 75% of its risk on new term business.  Ceded
reinsurance premiums totaled $9 million in both the third quarters of 2012 and
2011.  For the nine months ended September 30, 2012 compared to 2011, gross
policy revenues totaled $86 million and $82 million, respectively, while ceded
reinsurance premiums totaled $30 million and $31 million, respectively.



Premiums received on annuity and universal life products totaled $18 million and
$19 million in the third quarters of 2012 and 2011, respectively.  Of these
amounts, annuity and universal life premiums, which are recorded as deposits and
therefore not reflected in revenue on the Consolidated Statements of Operations,
totaled $14 million and $15 million in the third quarters of 2012 and 2011,
respectively.  For the nine months ended September 30, 2012 compared to 2011,
premiums received on annuity and universal life products totaled $58 million and
$68 million, respectively, while annuity and universal life deposits totaled $46
million and $56 million, respectively.



Investment revenue

EFL's investment revenue in the third quarter and first nine months of 2012 was primarily impacted by a decrease in net realized gains on investments as a result of the third quarter and first nine months of 2011 having gains on disposals of preferred stocks. See the discussion of investments in the "Investment Operations" segment that follows for further information.

Benefits and expenses


Other operating expenses increased in the third quarter and first nine months of
2012 due to a decrease in the amount of policy acquisition expenses deferred
under the new accounting guidance effective in 2012 and lower ceding
commissions.



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Investment Operations


The investment results related to our life insurance operations are included in
the investment operations segment discussion as part of the Exchange's
investment results.  A summary of the results of our investment operations is as
follows:



                                                        Erie Insurance Group
                                           Three months ended          Nine months ended
(in millions)                                 September 30,              September 30,
                                         2012    2011    % Change   2012     2011   % Change
Indemnity                                 (Unaudited)                (Unaudited)
Net investment income                     $  4    $  4     (1.5)%    $ 12    $ 12       1.2%
Net realized gains (losses) on
investments                                  2      (6 )       NM       4       1         NM
Net impairment losses recognized in
earnings                                     0       0         NM       0       0         NM
Equity in earnings of limited
partnerships                                 6       7     (18.0)      10      25     (59.4)
Net revenue from investment operations
- Indemnity                               $ 12    $  5     120.1%    $ 26    $ 38    (30.9)%
Exchange
Net investment income                     $104   $ 106     (1.6)%    $322    $322       0.0%
Net realized gains (losses) on
investments                                167    (416 )       NM     354    (235 )       NM
Net impairment losses recognized in
earnings                                     0       0         NM       0       0         NM
Equity in earnings of limited
partnerships                                35      33       4.9%      89     125    (29.3)%
Net revenue from investment operations
- Exchange (1)                            $306   $(277 )       NM    $765    $212         NM


 NM = not meaningful



 (1)   The Exchange's investment results for the third quarter of 2012 and 2011
include net investment revenues from EFL's operations of $25 million and $29
million, respectively. The Exchange's investment results for the first nine
months of 2012 and 2011 include net investment revenues from EFL's operations of
$77 million and $83 million, respectively.



Net investment income


Net investment income primarily includes interest and dividends on our fixed
maturity and equity security portfolios net of investment expenses.  Indemnity's
net investment income was unchanged in the third quarter of 2012, compared to
the third quarter of 2011, while the Exchange's net investment income decreased
$2 million during the same period.  The decrease in net investment income for
the Exchange in the third quarter of 2012 was due to lower investment yields,
which more than offset higher invested balances.  Net investment income for both
Indemnity and the Exchange was unchanged for the nine months ended September 30,
2012, compared to the nine months ended September 30, 2011.  Net investment
income for the Exchange was unchanged for the first nine months of 2012 as lower
investment yields were offset by higher invested balances.



Net realized gains on investments


Net realized gains and losses on investments include the changes in fair value
of our common stock portfolio, as this portfolio is classified as trading, and
gains and losses resulting from the actual sales of all security categories.
Indemnity generated net realized gains of $2 million in the third quarter of
2012, compared to losses of $6 million in the third quarter of 2011, while the
Exchange generated net realized gains of $167 million, compared to losses of
$416 million during the same periods.  Indemnity generated net realized gains of
$4 million for the nine months ended September 30, 2012, compared to gains of $1
million for the nine months ended September 30, 2011, while the Exchange
generated net realized gains of $354 million, compared to losses of $235 million
for the same respective periods.  Net realized gains for Indemnity and the
Exchange increased in the third quarter and first nine months of 2012 primarily
due to valuation gains on common stocks compared to valuation losses incurred
during the same periods in 2011.



Net impairment losses recognized in earnings


There were no net impairment losses recorded in earnings for Indemnity for the
third quarter and nine months ended September 30, 2012 and 2011.  There were no
net impairment losses for the Exchange in the third quarter of 2012, and net
impairment losses totaled $0.1 million for the nine months ended September 30,
2012, compared to $0.3 million for the third quarter and the nine months ended
September 30, 2011.


Equity in earnings of limited partnerships


Indemnity's equity in earnings of limited partnerships decreased $1 million in
the third quarter of 2012, compared to the third quarter of 2011, while the
Exchange's equity in earnings of limited partnerships increased $2 million
during the same period.  The increase in earnings for the Exchange during the
third quarter of 2012 was primarily due to higher earnings from private equity
investments.  Indemnity's equity in earnings of limited partnerships decreased
$15 million for the nine months ended September 30, 2012, compared to the nine
months ended September 30, 2011, while



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the Exchange's equity in earnings of limited partnerships decreased $36 million
during the same period.  For the first nine months of 2012, the decrease in
earnings for both Indemnity and the Exchange was due primarily to lower earnings
from the private equity and real estate sectors.



A breakdown of our net realized gains (losses) on investments is as follows:



                                                              Erie Insurance Group
                                                 Three months ended          Nine months ended
(in millions)                                       September 30,              September 30,
                                                2012           2011         2012          2011
Indemnity                                            (Unaudited)                (Unaudited)
Securities sold:
Fixed maturities                                $  0          $   0         $  0          $   2
Preferred stock equity securities                  0              0            0              3
Common stock equity securities                     0              0            1              2
Common stock valuation adjustments                 2             (6 )          3             (6 )
Total net realized gains - Indemnity (1)        $  2          $  (6 )       $  4          $   1
Exchange
Securities sold:
Fixed maturities                                $ 16          $  10         $ 35          $  44
Preferred stock equity securities                  0              3            3             18
Common stock equity securities                    13             21           65            124
Common stock valuation adjustments               138           (450 )        251           (421 )

Total net realized gains - Exchange (1) (2) $167 $(416 ) $354 $(235 )

(1) See Item 1. "Financial Statements - Note 7. Investments," contained within this report for additional disclosures regarding net realized gains (losses) on investments.


(2)      The Exchange's results for the third quarter of 2012 and 2011 include
net realized gains from EFL's operations of $2 million and $5 million,
respectively.  The Exchange's results for the first nine months of 2012 and 2011
include net realized gains from EFL of $6 million and $12 million, respectively.



The components of equity in earnings (losses) of limited partnerships are as
follows:



                                                         Erie Insurance Group
                                            Three months ended          Nine months ended
(in millions)                                  September 30,              September 30,
                                          2012    2011   % Change    2012     2011   % Change
Indemnity                                 (Unaudited)                 (Unaudited)
Private equity                              $ 2    $ 2    (40.3 )%     $ 4    $ 13    (66.4)%
Mezzanine debt                                1      2     (7.3 )        4       5     (17.7)
Real estate                                   3      3     (3.6 )        2       7     (75.4)
Total equity in earnings of limited
partnerships - Indemnity                    $ 6    $ 7    (18.0 )%     $10    $ 25    (59.4)%
Exchange
Private equity                              $16    $12     27.0 %      $44    $ 69    (36.5)%
Mezzanine debt                                7      6     23.2         24      21      11.0
Real estate                                  12     15    (20.1 )       21      35     (40.0)
Total equity in earnings of limited
partnerships - Exchange (1)                 $35    $33      4.9 %      $89    $125    (29.3)%




NM = not meaningful



(1)      The Exchange's results include equity in earnings of limited
partnerships from EFL of $0.2 million for the third quarter of 2012 and $0.4
million for the third quarter of 2011.  The Exchange's results for the first
nine months of 2012 did not include any equity in earnings of limited
partnerships from EFL and included earnings of $1.4 million for the first nine
months of 2011.



Limited partnership earnings pertain to investments in U.S. and foreign private
equity, mezzanine debt and real estate partnerships.  Valuation adjustments are
recorded to reflect the changes in fair value of the underlying investments held
by the limited partnerships.  These adjustments are recorded as a component of
equity in earnings of limited partnerships in the Consolidated Statements of
Operations.  Limited partnership earnings tend to be cyclical based upon market
conditions, the age of the partnership, and the nature of the investments.
Generally, limited partnership earnings are recorded on a quarter lag from
financial statements we receive from our general partners.  As a consequence,
earnings from limited partnerships reported at September 30, 2012 reflect
investment valuation changes resulting from the financial markets and the
economy in the second quarter of 2012 and not the third quarter of 2012.



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FINANCIAL CONDITION



Investments

Our investment strategy takes a long-term perspective emphasizing investment
quality, diversification, and superior investment returns.  Investments are
managed on a total return approach that focuses on current income and capital
appreciation.  Our investment strategy also provides for liquidity to meet our
short- and long-term commitments.



Distribution of investments



                                                                     Erie Insurance Group
                                            Carrying value at                     Carrying value at
(in millions)                                 September 30,                         December 31,
                                                  2012           % to total             2011           % to total
Indemnity                                              (Unaudited)
Fixed maturities                                      $   547         68 %                  $   548         68 %
Equity securities:
Preferred stock                                            29          4                         25          3
Common stock                                               30          4                         27          4
Limited partnerships:
Private equity                                             76          9                         82         10
Mezzanine debt                                             30          4                         35          4
Real estate                                                89         11                         91         11
Real estate mortgage loans                                  1          0                          1          0
Total investments - Indemnity                         $   802        100 %                  $   809        100 %
Exchange
Fixed maturities                                     $  7,623         64 %                 $  7,292         65 %
Equity securities:
Preferred stock                                           624          5                        564          5
Common stock                                            2,639         22                      2,308         21
Limited partnerships:
Private equity                                            504          4                        495          4
Mezzanine debt                                            193          2                        201          2
Real estate                                               386          3                        386          3
Life policy loans                                          16          0                         15          0
Real estate mortgage loans                                  4          0                          4          0
Total investments - Exchange                          $11,989        100 %                  $11,265        100 %
Total investments - Erie Insurance Group              $12,791                               $12,074




We continually review our investment portfolio to evaluate positions that might
incur other-than-temporary declines in value.  For all investment holdings,
general economic conditions and/or conditions specifically affecting the
underlying issuer or its industry, including downgrades by the major rating
agencies, are considered in evaluating impairment in value.  In addition to
specific factors, other factors considered in our review of investment valuation
are the length of time the fair value is below cost and the amount the fair
value is below cost.



We individually analyze all positions with emphasis on those that have, in
management's opinion, declined significantly below cost.  In compliance with
impairment guidance for debt securities, we perform further analysis to
determine if a credit-related impairment has occurred.  Some of the factors
considered in determining whether a debt security is credit impaired include
potential for the default of interest and/or principal, level of subordination,
collateral of the issue, compliance with financial covenants, credit ratings and
industry conditions.  We have the intent to sell all credit-impaired debt
securities, therefore the entire amount of the impairment charges are included
in earnings and no credit impairments are recorded in other comprehensive
income.  For available-for-sale equity securities, a charge is recorded in the
Consolidated Statements of Operations for positions that have experienced
other-than-temporary impairments due to credit quality or other factors.  (See
the "Investment Operations" section herein for further information.)  Management
believes its investment valuation philosophy and accounting practices result in
appropriate and timely measurement of value and recognition of impairment.



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Fixed maturities


Under our investment strategy, we maintain a fixed maturity portfolio that is of
high quality and well diversified within each market sector.  This investment
strategy also achieves a balanced maturity schedule.  Our fixed maturity
portfolio is managed with the goal of achieving reasonable returns while
limiting exposure to risk.  Our municipal bond portfolio accounts for $195
million, or 36%, of the total fixed maturity portfolio for Indemnity and $1.3
billion, or 18%, of the fixed maturity portfolio for the Exchange at
September 30, 2012.  The overall credit rating of the municipal portfolio
without consideration of the underlying insurance is AA.  Although some of our
municipal holdings are insured, the underlying insurance does not improve the
overall credit rating.



Fixed maturities classified as available-for-sale are carried at fair value with
unrealized gains and losses, net of deferred taxes, included in shareholders'
equity.  Indemnity's net unrealized gains on fixed maturities, net of deferred
taxes, amounted to $11 million at September 30, 2012, compared to $8 million at
December 31, 2011.  At September 30, 2012, the Exchange had net unrealized gains
on fixed maturities of $464 million, compared to net unrealized gains of $301
million at December 31, 2011.



The following table presents a breakdown of the fair value of our fixed
maturities portfolio by sector and rating for Indemnity and the Exchange,
respectively:



                                              Erie Insurance Group (1)
                                                At September 30, 2012
(in millions)                                        (Unaudited)
                                                                Non-investment    Fair
      Industry Sector         AAA      AA       A       BBB         grade        value
Indemnity
Basic materials               $  0   $    0   $    5   $   14             $  0   $   19
Communications                   0        0       18        0                0       18
Consumer                         0        0       28       16                0       44
Energy                           0        0       10       20                0       30
Financial                        0       34       80       43                4      161
Government-municipal            89       78       19        9                0      195
Industrial                       0        4        6        0                0       10
Structured securities (2)       13        0        1        2                0       16
Technology                       0        0        5       14                0       19
Utilities                        0        0        8       27                0       35
Total - Indemnity             $102   $  116   $  180   $  145             $  4   $  547
Exchange
Basic materials               $  0   $    0   $   48   $  171             $ 19   $  238
Communications                   0        0      218      310               25      553
Consumer                         0       31      296      540               20      887
Diversified                      0        0       22        0                0       22
Energy                          16       17      154      391               19      597
Financial                        1      215    1,099    1,097              160    2,572
Foreign government               0        0       16        0                0       16
Funds                            0        0        0        6                0        6
Government-municipal           411      764      140       33                0    1,348
Government sponsored entity      0        9        2        0                0       11
Industrial                       0        6       75      215               15      311
Structured securities (2)       59      242       34       19                2      356
Technology                       0        0       45      103                0      148
U.S. Treasury                    0        6        0        0                0        6
Utilities                        0        0       89      421               42      552
Total - Exchange              $487   $1,290   $2,238   $3,306             $302   $7,623



(1) Ratings are supplied by S&P, Moody's, and Fitch. The table is based upon the lowest rating for each security.

(2) Structured securities include asset-backed securities, collateral, lease and debt obligations, commercial mortgage-backed securities and residential mortgage-backed securities.

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Equity securities


Our equity securities consist of common stock and nonredeemable preferred
stock.  Investment characteristics of common stock and non-redeemable preferred
stock differ from one another.  Our nonredeemable preferred stock portfolio
provides a source of current income that is competitive with investment-grade
bonds.


The following table presents an analysis of the fair value of our preferred and common stock securities by sector for Indemnity and Exchange, respectively:



                               Erie Insurance Group
                                  Fair value at:
(in millions)        September 30, 2012     December 31, 2011
                        (Unaudited)
                     Preferred    Common   Preferred    Common
 Industry sector       stock      stock      stock      stock
Indemnity
Communications             $  1   $    2         $  1    $   2
Consumer                      0       16            0       15
Diversified                   0        1            0        1
Energy                        0        1            0        1
Financial                    15        5           11        4
Industrial                    0        4            0        3
Technology                    3        1            3        1
Utilities                    10        0           10        0
Total - Indemnity          $ 29   $   30        $  25   $   27
Exchange
Basic materials            $  0   $   96         $  0   $   72
Communications               10      223            9      168
Consumer                      6      865            5      763
Diversified                   0       19            0       18
Energy                        0      190            0      203
Financial                   486      377          408      340
Funds                         0      175            0      105
Government                    0        0            0        0
Industrial                    0      384            0      350
Technology                    6      274           15      246
Utilities                   116       36          127       43
Total - Exchange           $624   $2,639         $564   $2,308




Our preferred stock equity securities are classified as available-for-sale and
are carried at fair value on the Consolidated Statements of Financial Position
with all changes in unrealized gains and losses reflected in other comprehensive
income.  At September 30, 2012, the unrealized gain on preferred stock
classified as available-for-sale securities, net of deferred taxes, amounted to
$1 million for Indemnity and $52 million for the Exchange, compared to $1
million for Indemnity and $21 million for the Exchange at December 31, 2011.



Our common stock portfolio is classified as a trading portfolio and is measured
at fair value with all changes in unrealized gains and losses reflected in the
Consolidated Statements of Operations.



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Limited partnerships


In the third quarter of 2012, investments in limited partnerships decreased
modestly for Indemnity and remained relatively flat for the Exchange from the
investment levels at December 31, 2011.  Changes in partnership values are a
function of contributions and distributions, adjusted for market value changes
in the underlying investments.  The results from our limited partnerships are
based upon financial statements received from our general partners, which are
generally received on a quarter lag.  As a result, the market values and
earnings recorded during the third quarter of 2012 reflect the partnership
activity experienced in the second quarter of 2012.



The components of limited partnership investments are as follows:



                                                  Erie Insurance Group
(in millions)                             At September 30,     At December 31,
                                                2012                 2011
Indemnity                                   (Unaudited)
Private equity                                  $   76                 $   82
Mezzanine debt                                      30                     35
Real estate                                         89                     91
Total limited partnerships - Indemnity          $  195                 $  208
Exchange
Private equity                                  $  504                 $  495
Mezzanine debt                                     193                    201
Real estate                                        386                    386
Total limited partnerships - Exchange           $1,083                 $1,082




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Liabilities

Property and casualty losses and loss expense reserves


Loss reserves are established to account for the estimated ultimate costs of
losses and loss expenses for claims that have been reported but not yet settled
and claims that have been incurred but not reported.  While we exercise
professional diligence to establish reserves at the end of each period that are
fully reflective of the ultimate value of all claims incurred, these reserves
are, by their nature, only estimates and cannot be established with
absolute certainty.



The factors which may potentially cause the greatest variation between current
reserve estimates and the actual future paid amounts include unforeseen changes
in statutory or case law altering the amounts to be paid on existing claim
obligations, new medical procedures and/or drugs with costs significantly
different from those seen in the past, and claims patterns on current business
that differ significantly from historical claims patterns.



Losses and loss expense reserves are presented on the Consolidated Statements of
Financial Position on a gross basis.  The following table represents the direct
and assumed losses and loss expense reserves by major line of business for our
property and casualty insurance operations.  The reinsurance recoverable amount
represents the related ceded amounts which results in the net liability
attributable to the Property and Casualty Group.



                                           Property and Casualty Group
                                      At September 30,     At December 31,
(in millions)                               2012                 2011
                                         (Unaudited)
Gross reserve liability (1):
Personal auto                                 $1,121               $1,093
Automobile massive injury                        354                  356
Homeowners                                       328                  313
Workers compensation                             507                  461
Workers compensation massive injury              107                   99
Commercial auto                                  337                  303
Commercial multi-peril                           565                  565
All other lines of business                      279                  309
Gross reserves                                 3,598                3,499
Reinsurance recoverable                          151                  151
Net reserve liability - Exchange              $3,447               $3,348




(1)      Loss reserves are set at full expected cost, except for workers
compensation loss reserves which have been discounted using an interest rate of
2.5%.  This discounting reduced unpaid losses and loss expenses by $88 million
at September 30, 2012 and $84 million at December 31, 2011.



The reserves that have the greatest potential for variation are the massive
injury lifetime medical claim reserves.  The Property and Casualty Group is
currently reserving for 263 claimants requiring lifetime medical care, of which
111 involve massive injuries.  The reserve carried by the Property and Casualty
Group for the massive injury claimants, which includes automobile massive injury
and workers compensation massive injury reserves, totaled $320 million at
September 30, 2012, which is net of $141 million of anticipated reinsurance
recoverables, compared to $315 million at December 31, 2011, which is net of
$140 million of anticipated reinsurance recoverables.



Life insurance reserves


EFL's primary commitment is its obligation to pay future policy benefits under
the terms of its life insurance and annuity contracts.  To meet these future
obligations, EFL establishes life insurance reserves based upon the type of
policy, the age, gender and risk class of the insured and the number of years
the policy has been in force.  EFL also establishes annuity and universal life
reserves based upon the amount of policyholder deposits (less applicable
insurance and expense charges) plus interest earned on those deposits.  Life
insurance and annuity reserves are supported primarily by EFL's long-term, fixed
income investments as the underlying policy reserves are generally also of a
long-term nature.



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IMPACT OF INFLATION



Property and casualty insurance premiums are established before losses occur and
before loss expenses are incurred, and therefore, before the extent to which
inflation may impact such costs is known. Consequently, in establishing premium
rates, we attempt to anticipate the potential impact of inflation, including
medical cost inflation, construction and auto repair cost inflation and tort
issues.  Medical costs are a broad element of inflation that impacts personal
and commercial auto, general liability, workers compensation and commercial
multi-peril lines of insurance written by the Property and Casualty Group.
Inflation assumptions take the form of explicit numerical values in the survival
ratio, individual claim, and massive injury lifetime medical reserving methods.
Inflation assumptions are implicitly derived through the selection of applicable
loss development patterns for all other reserving methods.  Occasionally,
unusual aberrations in loss development patterns are caused by external and
internal factors such as changes in claim reporting, settlement patterns,
unusually large losses, process changes, legal or regulatory changes, and other
influences.  In these instances, analyses of alternate development factor
selections are performed to evaluate the effect of these factors and actuarial
judgment is applied to make appropriate assumptions needed to develop a best
estimate of ultimate losses.


LIQUIDITY AND CAPITAL RESOURCES

Sources and Uses of Cash


Liquidity is a measure of a company's ability to generate sufficient cash flows
to meet the short- and long-term cash requirements of its business operations
and growth needs.  Our liquidity requirements have been met primarily by funds
generated from premiums collected and income from investments.  Our insurance
operations provide liquidity in that premiums are collected in advance of paying
losses under the policies purchased with those premiums.  Cash outflows for the
property and casualty insurance business are generally variable since settlement
dates for liabilities for unpaid losses and the potential for large losses,
whether individual or in the aggregate, cannot be predicted with absolute
certainty.  Accordingly, after satisfying our operating cash requirements,
excess cash flows are used to build our investment operation's portfolios in
order to increase future investment income, which then may be used as a source
of liquidity if cash from our insurance operations would not be sufficient to
meet our obligations.  Cash provided from these sources is used primarily to
fund losses and policyholder benefits, fund the costs of our management
operations including commissions, salaries and wages, pension plans, share
repurchases, dividends to shareholders and the purchase and development of
information technology.  We expect that our operating cash needs will be met by
funds generated from operations.



Volatility in the financial markets presents challenges to us as we do
occasionally access our investment portfolio as a source of cash.  Some of our
fixed income investments, despite being publicly traded, are illiquid.
Volatility in these markets could impair our ability to sell certain of our
fixed income securities or cause such securities to sell at deep discounts.
Additionally, our limited partnership investments are significantly less
liquid.  We believe we have sufficient liquidity to meet our needs from other
sources even if market volatility persists throughout 2012.



Cash flow activities - Erie Insurance Group

The following table provides condensed consolidated cash flow information for the nine months ended September 30:



(in millions)                                             Erie Insurance Group
                                                          2012            2011
Net cash provided by operating activities               $   365        $    

225

Net cash used in investing activities                       (34 )           (395 )
Net cash used in financing activities                      (112 )           

(184 ) Net increase (decrease) in cash and cash equivalents $ 219 $ (354 )





Net cash provided by operating activities totaled $365 million and $225 million
for the first nine months of 2012 and 2011, respectively.  Increased cash from
operating activities for the first nine months of 2012 was driven primarily by
an increase in the premiums collected by the Exchange driven by the increase in
premiums written, a decrease in losses and loss expenses paid, and a slight
increase in net investment income received.  Offsetting this increase somewhat
was an increase in income taxes paid and other underwriting and acquisition
costs paid compared to the first nine months of 2011.



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At September 30, 2012, we recorded a net deferred tax liability of $351 million
on our Consolidated Statements of Financial Position.  Of this amount, $16
million is a net deferred tax asset attributable to Indemnity and $367 million
is a net deferred tax liability attributable to the Exchange.  There was no
deferred tax valuation allowance recorded at September 30, 2012.



Net cash used in investing activities totaled $34 million and $395 million for
the first nine months of 2012 and 2011, respectively.  The first nine months of
2012 investing activities included decreased cash used to purchase certain
common stocks and increased cash received from calls and maturities of fixed
maturity securities, offset somewhat by decreased cash generated from the sale
of other common stocks compared to the first nine months of 2011.  At
September 30, 2012, we had contractual commitments to invest up to $374 million
related to our limited partnership investments to be funded as required by the
partnerships' agreements.  Of this amount, the total remaining commitment to
fund limited partnerships that invest in private equity securities was $160
million, mezzanine debt securities was $120 million, and real estate activities
was $94 million.



For a discussion of net cash used in financing activities, see the following
"Cash flow activities - Indemnity," for the primary drivers of financing cash
flows related to Indemnity.


Cash flow activities - Indemnity


The following table is a summary of cash flows for Indemnity for the nine months
ended September 30:



(in millions)                                            Indemnity Shareholder Interest
                                                         2012                      2011
Net cash provided by operating activities             $      144               $        113
Net cash used in investing activities                         (8 )                     (180 )
Net cash used in financing activities                       (135 )                     (209 )
Net increase (decrease) in cash and cash
equivalents                                           $        1               $       (276 )





See Item 1. "Financial Statements - Note 14. Indemnity Supplemental Information," contained within this report for more detail on Indemnity's cash flows.




Net cash provided by Indemnity's operating activities increased to $144 million
for the first nine months of 2012, compared to $113 million for the first nine
months of 2011.  Increased cash from operating activities for the first nine
months of 2012 was primarily due to an increase in management fee revenue
received and reimbursements collected from affiliates.  Offsetting this increase
were increases in commissions paid to agents, general operating expenses paid,
cash paid for the pension contribution and employee benefits, and cash paid for
salaries and wages.  Management fee revenues were higher reflecting the increase
in the premiums written or assumed by the Exchange.  Cash paid for agent
commissions and bonuses increased to $470 million in the first nine months of
2012, compared to $450 million for the first nine months of 2011, as a result of
an increase in cash paid for ordinary commissions.  Indemnity made a $16 million
contribution to its pension plan in the first quarter of 2012, compared to $15
million in the third quarter of 2011.  Indemnity's policy for funding its
pension plan is generally to contribute an amount equal to the greater of the
IRS minimum required contribution or the target normal cost for the year plus
interest to the date the contribution is made.  Indemnity is generally
reimbursed approximately 60% of the net periodic benefit cost of the pension
plan from its affiliates.


At September 30, 2012, Indemnity recorded a net deferred tax asset of $16 million. There was no deferred tax valuation allowance recorded at September 30, 2012. Indemnity's capital gain and loss strategies take into consideration its ability to offset gains and losses in future periods, carry-back of capital loss opportunities to the three preceding years, and capital loss carry-forward opportunities to apply against future capital gains over the next five years.




Net cash used in Indemnity's investing activities totaled $8 million for the
first nine months of 2012, compared to cash used of $180 million for the first
nine months of 2011.  Indemnity's first nine months of 2012 investing activities
included decreased cash used to purchase certain fixed maturities and increased
cash generated from the sales of other fixed maturities, compared to the first
nine months of 2011.  Also impacting Indemnity future investing activities are
limited partnership commitments, which totaled $36 million at September 30,
2012, and will be funded as required by the partnerships' agreements.  Of this
amount, the total remaining commitment to fund



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limited partnerships that invest in private equity securities was $16 million,
mezzanine debt securities was $10 million, and real estate activities was $10
million.



In the first quarter of 2011, Indemnity received cash consideration from the
Exchange of $82 million as a result of the sale of Indemnity's 21.6% ownership
interest in EFL to the Exchange on March 31, 2011, which was based upon an
estimated purchase price.  Final settlement of this transaction was made on
April 25, 2011 for a final purchase price of $82 million.  Net after-tax cash
proceeds to Indemnity from this sale were $58 million.  Also in the first
quarter of 2011, Indemnity paid $8 million to the Exchange as final settlement
of the sale of Indemnity's wholly owned property and casualty insurance
subsidiaries, EIC, ENY and EPC, to the Exchange on December 31, 2010, which was
based upon the final purchase price.



Net cash used in Indemnity's financing activities totaled $135 million for the
first nine months of 2012, compared to $209 million for the first nine months of
2011.  The decrease in cash used in financing activities for the first nine
months of 2012 was driven primarily by a decrease in the cash outlay for the
purchase of treasury stock.  Indemnity repurchased 0.2 million shares, based
upon settlement date, of its Class A nonvoting common stock in conjunction with
its stock repurchase program at a total cost of $11 million in the third quarter
of 2012.  During the first nine months of 2012, shares repurchased under this
program totaled 0.8 million at a total cost of $55 million.  In the first nine
months of 2011, shares repurchased under this program totaled 1.9 million at a
total cost of $132 million.  In October 2011, our Board of Directors approved a
continuation of the current stock repurchase program for a total of $150
million, with no time limitation.  This repurchase authority included, and was
not in addition to, any unspent amounts remaining under the prior
authorization.  Indemnity had approximately $84 million of repurchase authority
remaining under this program at September 30, 2012, based upon trade date.



In January and June 2012, Indemnity also purchased 669 and 1,134 shares,
respectively, of our outstanding Class A nonvoting common stock outside of our
publicly announced share repurchase program at a total cost of $50,724, or
$75.82 per share, and $79,125, or $69.78 per share, respectively, to settle
payments due to two retired senior vice presidents under our long-term incentive
plan.  These shares were delivered to the plan participants in January and
June 2012, respectively.  In July 2011, Indemnity repurchased 64,095 shares of
its outstanding Class A nonvoting common stock outside of its publicly announced
share repurchase program at a total cost of $5 million.  Of this amount, 57,695
shares were purchased for $4.3 million, or $73.72 per share, in conjunction with
our long-term incentive plan, and 6,400 shares were purchased for $0.5 million,
or $73.74 per share, for the vesting of stock-based awards for executive
management.  These shares were delivered to plan participants and executive
management, respectively, in July 2011.



Dividends paid to shareholders totaled $80 million for the first nine months of
2012, compared to $77 million for the first nine months of 2011.  Indemnity
increased both its Class A and Class B shareholder quarterly dividends by 7.3%
for 2012, compared to 2011.  There are no regulatory restrictions on the payment
of dividends to Indemnity's shareholders.



Capital Outlook


We regularly prepare forecasts evaluating the current and future cash
requirements of Indemnity and the Exchange for both normal and extreme risk
events.  Should an extreme risk event result in a cash requirement exceeding
normal cash flows, we have the ability to meet our future funding requirements
through various alternatives available to us.



Indemnity


Outside of Indemnity's normal operating and investing cash activities, future
funding requirements could be met through: 1) Indemnity's cash and cash
equivalents, which total approximately $12 million at September 30, 2012, 2) a
$100 million bank revolving line of credit held by Indemnity, and 3) liquidation
of assets held in Indemnity's investment portfolio, including common stock,
preferred stock and investment grade bonds which totaled approximately $491
million at September 30, 2012.  Volatility in the financial markets could impair
Indemnity's ability to sell certain of its fixed income securities or cause such
securities to sell at deep discounts.  Additionally, Indemnity has the ability
to curtail or modify discretionary cash outlays such as those related to
shareholder dividends and share repurchase activities.



Indemnity had no borrowings under its line of credit at September 30, 2012.

At

September 30, 2012, bonds with fair values of $111 million were pledged as
collateral.  These securities have no trading restrictions.  The bank requires
compliance with certain covenants, which include minimum net worth and leverage
ratios.  Indemnity was in compliance with its bank covenants at September 30,
2012.



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Exchange

Outside of the Exchange's normal operating and investing cash activities, future
funding requirements could be met through: 1) the Exchange's cash and cash
equivalents, which total approximately $392 million at September 30, 2012, 2) a
$300 million bank revolving line of credit held by the Exchange, and 3)
liquidation of assets held in the Exchange's investment portfolio, including
common stock, preferred stock and investment grade bonds which totaled
approximately $10.3 billion at September 30, 2012.  Volatility in the financial
markets could impair the Exchange's ability to sell certain of its fixed income
securities or cause such securities to sell at deep discounts.



The Exchange had no borrowings under its line of credit at September 30, 2012.
At September 30, 2012, bonds with fair values of $328 million were pledged as
collateral.  These securities have no trading restrictions.  The bank requires
compliance with certain covenants, which include statutory surplus and risk
based capital ratios.  The Exchange was in compliance with its bank covenants at
September 30, 2012.



Indemnity has no rights to the assets, capital, or line of credit of the
Exchange and, conversely, the Exchange has no rights to the assets, capital, or
line of credit of Indemnity.  We believe we have the funding sources available
to us to support our cash flow requirements in 2012.



Off-Balance Sheet Arrangements


Off-balance sheet arrangements include those with unconsolidated entities that
may have a material current or future effect on our financial condition or
results of operations, including material variable interests in unconsolidated
entities that conduct certain activities.  We have no material off-balance sheet
obligations or guarantees, other than our limited partnership investment
commitments.



Surplus Notes

Indemnity holds a surplus note for $25 million from EFL that is payable on
demand on or after December 31, 2018; however, no principal or interest payments
may be made without prior approval of the Pennsylvania Insurance Commissioner.
Interest payments are scheduled to be paid semi-annually.  For the nine month
period ended September 30, 2012 and 2011, Indemnity recognized interest income
on the note of $1.3 million.



The Exchange holds a surplus note for $20 million from EFL that is payable on
demand on or after December 31, 2025; however, no principal or interest payments
may be made without prior approval of the Pennsylvania Insurance Commissioner.
Interest payments are scheduled to be paid semi-annually.  For the nine month
period ended September 30, 2012 and 2011, the Exchange recognized interest
income on the note of $0.9 million.





CRITICAL ACCOUNTING ESTIMATES



We make estimates and assumptions that have a significant effect on the amounts
and disclosures reported in the financial statements.  The most significant
estimates relate to the property and casualty insurance losses and loss expense
reserves, life insurance and annuity policy reserves, investment valuation,
deferred acquisition costs related to life insurance and investment-type
contracts, deferred taxes and retirement benefit plans.  While management
believes its estimates are appropriate, the ultimate amounts may differ from
estimates provided.  Our most critical accounting estimates are described in
Item 7. "Management's Discussion and Analysis of Financial Condition and Results
of Operations," for the year ended December 31, 2011 of our Annual Report on
Form 10-K as filed with the Securities and Exchange Commission on February 27,
2012.  See Item 1. "Financial Statements - Note 6. Fair Value," contained within
this report for additional information on our valuation of investments.



Investment Valuation


We make estimates concerning the valuation of all investments.  Valuation
techniques are used to derive the fair value of the available-for-sale and
trading securities we hold.  Fair value is the price that would be received to
sell an asset in an orderly transaction between willing market participants at
the measurement date.



Fair value measurements are based upon observable and unobservable inputs.
Observable inputs reflect market data obtained from independent sources, while
unobservable inputs reflect our view of market assumptions in the absence of
observable market information.  We utilize valuation techniques that maximize
the use of observable inputs and minimize the use of unobservable inputs.



For purposes of determining whether the market is active or inactive, the classification of a financial instrument was based upon the following definitions:




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†          An active market is one in which transactions for the assets being
valued occur with sufficient frequency and volume to provide reliable pricing
information.



†          An inactive (illiquid) market is one in which there are few and
infrequent transactions, where the prices are not current, price quotations vary
substantially, and/or there is little information publicly available for the
asset being valued.


We continually assess whether or not an active market exists for all of our investments and as of each reporting date re-evaluate the classification in the fair value hierarchy. All assets carried at fair value are classified and disclosed in one of the following three categories:




†          Level 1 - Quoted prices (unadjusted) in active markets for identical
assets or liabilities that the reporting entity can access at the measurement
date.


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



†          Level 3 - Unobservable inputs for the asset or liability.


Level 1 primarily consists of publicly traded common stock, nonredeemable preferred stock and certain government securities and reflects market data obtained from independent sources, such as prices obtained from an exchange or a nationally recognized pricing service for identical instruments in active markets.




Level 2 includes those financial instruments that are valued using
industry-standard models that consider various inputs, such as the interest rate
and credit spread for the underlying financial instruments.  All significant
inputs are observable, or derived from observable information in the
marketplace, or are supported by observable levels at which transactions are
executed in the marketplace.  Financial instruments in this category primarily
include municipal securities, asset backed securities, collateralized-mortgage
obligations, foreign and domestic corporate bonds and redeemable preferred stock
and certain nonredeemable preferred stock.



Level 3 securities are valued based upon unobservable inputs, reflecting our
estimates of value based upon assumptions used by market participants.
Securities are assigned to Level 3 in cases where non-binding broker quotes are
significant to the valuation and there is a lack of transparency as to whether
these quotes are based upon information that is observable in the marketplace.
Fair value estimates for securities valued using unobservable inputs require
significant judgment due to the illiquid nature of the market for these
securities and represent the best estimate of the fair value that would occur in
an orderly transaction between willing market participants at the measurement
date under current market conditions.  Fair value for these securities are
generally determined using comparable securities or non-binding broker quotes
received from outside broker dealers based upon security type and market
conditions.  Remaining securities, where a price is not available, are valued
using an estimate of fair value based upon indicative market prices that include
significant unobservable inputs not based upon, nor corroborated by, market
information, including the utilization of discounted cash flow analyses which
have been risk-adjusted to take into account illiquidity and other market
factors.  This category primarily consists of certain private preferred stock
and bond securities as well as collateralized debt and loan obligations.



As of each reporting period, financial instruments recorded at fair value are
classified based upon the lowest level of input that is significant to the fair
value measurement.  The presence of at least one unobservable input would result
in classification as a Level 3 instrument.  Our assessment of the significance
of a particular input to the fair value measurement requires judgment, and
considers factors specific to the asset, such as the relative impact on the fair
value as a result of including a particular input and market conditions.  We did
not make any other significant judgments except as described above.



Estimates of fair values for our investment portfolio are obtained primarily
from a nationally recognized pricing service.  Our Level 1 category includes
those securities valued using an exchange traded price provided by the pricing
service.  The methodologies used by the pricing service that support a Level 2
classification of a financial instrument include multiple verifiable, observable
inputs including benchmark yields, reported trades, broker/dealer quotes, issuer
spreads, two-sided markets, benchmark securities, bids, offers and reference
data.  Pricing service valuations for Level 3 securities are based upon
proprietary models and are used when observable inputs are not available in
illiquid markets.  In limited circumstances we adjust the price received from
the pricing service when, in our judgment, a better reflection of fair value is
available based upon corroborating information and our knowledge and monitoring
of market conditions such as a disparity in price of comparable securities
and/or non-binding broker quotes.  In other circumstances, certain securities
are internally priced because prices are not provided by the pricing service.



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We perform continuous reviews of the prices obtained from the pricing service.
This includes evaluating the methodology and inputs used by the pricing service
to ensure we determine the proper classification level of the financial
instrument.  Price variances, including large periodic changes, are investigated
and corroborated by market data.  We have reviewed the pricing methodologies of
our pricing service as well as other observable inputs, such as benchmark
yields, reported trades, issuer spreads, two-sided markets, benchmark
securities, bids, offers, reference data, and transaction volumes and believe
that their prices adequately consider market activity in determining fair
value.  Our review process continues to evolve based upon accounting guidance
and requirements.



When a price from the pricing service is not available, values are determined by
obtaining non-binding broker quotes and/or market comparables.  When available,
we obtain multiple quotes for the same security.  The ultimate value for these
securities is determined based upon our best estimate of fair value using
corroborating market information.  Our evaluation includes the consideration of
benchmark yields, reported trades, issuer spreads, two-sided markets, benchmark
securities, bids, offers and reference data.



Deferred Acquisition Costs Related to Life Insurance and Investment-Type Contracts


Acquisition costs that vary with and relate to the production of life insurance
and investment-type contracts are deferred.  Deferred acquisition costs ("DAC")
are incremental direct costs of contract acquisition.  As a result of new
accounting guidance effective in 2012, these costs are limited to the successful
acquisition of new and renewal contracts.  Such costs consist principally of
commissions, premium taxes and policy issuance expenses.  The change does not
affect the Indemnity shareholder interest nor does it affect Indemnity earnings
per share.  The amount of acquisition costs capitalized during the quarter and
nine months ended September 30, 2012 related to life insurance and
investment-type contracts totaled $4.0 million and $11.7 million, respectively.
The amount of acquisition costs that would have been capitalized during the
quarter and nine months ended September 30, 2012 using the previous policy
totaled $4.6 million and $13.3 million, respectively.



DAC on life insurance and investment-type contracts are amortized in proportion
to gross premiums, gross margins or gross profits, depending on the type of
contract.  DAC related to traditional life insurance products is amortized in
proportion to premium revenues over the premium-paying period of related
policies using assumptions consistent with those used in computing policy
liability reserves.  These assumptions are not revised after policy issuance
unless the DAC balance is deemed to be unrecoverable from future expected
profits.  In any period where the actual policy terminations are higher (lower)
than anticipated policy terminations, DAC amortization will be accelerated
(decelerated) in that period.



DAC related to universal life products and deferred annuities is amortized over
the estimated lives of the contracts in proportion to actual and expected future
gross profits, which include investment, mortality and expense margins and
surrender charges.  Both historical and anticipated investment returns,
including realized gains and losses, are considered in determining the
amortization of DAC.  When the actual gross profits change from previously
estimated gross profits, the cumulative DAC amortization is re-estimated and
adjusted by a cumulative charge or credit to current operations.  When actual
gross profits exceed those previously estimated, DAC amortization will increase,
resulting in a current period charge to earnings.  The opposite result occurs
when the actual gross profits are below the previously estimated gross profits.
DAC is also adjusted for the impact of unrealized gains or losses on investments
as if these gains or losses had been realized, with corresponding credits or
charges, net of income taxes, included in EFL's accumulated other comprehensive
income, which is presented in the "Noncontrolling interest in consolidated
entity - Exchange," amount in the Consolidated Statements of Financial Position.



The actuarial assumptions used to determine investment, mortality and expense
margins and surrender charges are reviewed periodically, are based upon best
estimates and do not include any provision for the risk of adverse deviation.
If actuarial analysis indicates that expectations have changed, the actuarial
assumptions are updated and the investment, mortality and expense margins and
surrender charges are unlocked.  If this unlocking results in a decrease in the
present value of future expected gross profits, DAC amortization for the period
will increase.  If this unlocking results in an increase in the present value of
future expected gross profits, DAC amortization for the current period will
decrease.



DAC is periodically reviewed for recoverability.  For traditional life products,
if the benefit reserves plus anticipated future premiums and interest earnings
for a line of business are less than the current estimate of future benefits and
expenses (including any unamortized DAC), a charge to income is recorded for
additional DAC amortization or for increased benefit reserves.  For universal
life products and deferred annuities, if the current present value of future
expected gross profits is less than the unamortized DAC, a charge to income is
recorded for additional DAC amortization.  There were no impairments to DAC in
the third quarter of 2012 or 2011.



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