INN Blog

More Posts
 

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

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 audited
financial statements and related notes and all other items contained within this
Annual Report on Form 10-K as they contain important information helpful in
evaluating our financial condition and results of operations.
INDEX
                                                                      Page 

Number

  Cautionary Statement Regarding Forward-Looking Information              

23

  Recent Accounting Pronouncements                                        

24

  Operating Overview                                                      

25

  Critical Accounting Estimates                                           30
  Results of Operations                                                   39
  Management Operations                                                   39
  Property and Casualty Insurance Operations                              41
  Life Insurance Operations                                               47
  Investment Operations                                                   48
  Financial Condition                                                     51
  Investments                                                             51
  Liabilities                                                             54
  Shareholders' Equity                                                    55
  Impact of Inflation                                                     55
  Liquidity and Capital Resources                                         

56

Transactions/Agreements Between Indemnity and Noncontrolling Interest (Exchange)

63



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:

Do your IULs have options like these?

• dependence upon Indemnity's relationship with the Exchange and the

management fee under the agreement with the subscribers at the Exchange;

• 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.




                                       23

--------------------------------------------------------------------------------

Table of Contents


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

Do your IULs have options like these?

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

• dependence 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 8. "Financial Statements and Supplementary Data - Note 2, Significant
Accounting Policies, of Notes to Consolidated Financial Statements" 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.


                                       24

--------------------------------------------------------------------------------

  Table of Contents

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")(1).  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(2).

The Exchange is a reciprocal insurance exchange organized under Article X of
Pennsylvania's Insurance Company Law of 1921 under which individuals,
partnerships and corporations are authorized to exchange reciprocal or
inter-insurance contracts with each other, or with individuals, partnerships,
and corporations of other states and countries, providing indemnity among
themselves from any loss which may be insured against under any provision of the
insurance laws except life insurance.  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.

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).

Do your IULs have options like these?

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% interest in the net underwriting results of the property and casualty

insurance operations after December 31, 2010 (the interest was 5.5% prior to

December 31, 2010)(1);

• a 0% equity interest in the net earnings of EFL after March 31, 2011 (the

interest was 21.6% prior to March 31, 2011)(2);

• net investment income and results on investments that belong to Indemnity(1);

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 after December 31, 2010 (the interest was 94.5% prior to

December 31, 2010)(1);

• a 100% equity interest in the net earnings of EFL after March 31, 2011 (the

interest was 78.4% prior to March 31, 2011)(2);

• net investment income and results on investments that belong to the Exchange

and its subsidiaries, including EFL(1); and

• other income and expenses, including income taxes, that are the

    responsibility of the Exchange and its subsidiaries.




(1)      Prior to and through December 31, 2010, the underwriting results
retained by EIC and ENY and the investment results of EIC, ENY and EPC accrued
to the Indemnity shareholder interest. Due to the sale of Indemnity's property
and casualty insurance subsidiaries to the Exchange on December 31, 2010, all
property and casualty underwriting results and all investment results for these
companies accrue to the interest of the subscribers (policyholders) of the
Exchange, or noncontrolling interest, after December 31, 2010.

(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.



                                       25

--------------------------------------------------------------------------------

Table of Contents


Results of the Erie Insurance Group's Operations by Interest
The following table represents 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(1).

                                                 Indemnity                           Noncontrolling interest                Eliminations of
                                            shareholder interest                           (Exchange)                  related party transactions           Erie Insurance Group
                                                Years ended                                Years ended                        Years ended                        Years ended
(in millions)                                   December 31,                              December 31,                        December 31,                      December 31,
                              Percent     2012      2011      2010      Percent     2012        2011      2010         2012        2011       2010         2012      2011      2010
Management operations:
Management fee revenue, net    100.0%  $  1,157   $ 1,067   $ 1,009         

$ - $ - $ - $ (1,157 ) $ (1,067 ) $ (1,009 ) $ - $ - $ - Service agreement revenue 100.0% 31 33 34

                     -          -         -              -          -          -          31         33       34
Total revenue from
management operations                     1,188     1,100     1,043                     -          -         -         (1,157 )   (1,067 )   (1,009 )        31         33       34
Cost of management
operations                     100.0%       983       892       841                     -          -         -           (983 )     (892 )     (841 )         -          -        -
Income from management
operations before taxes                     205       208       202                     -          -         -           (174 )     (175 )     (168 )        31         33       34
Property and casualty
insurance operations:(2)
Net premiums earned           5.5%(2)         -         -       216     94.5%(2)    4,422      4,149     3,709              -          -          - 

4,422 4,149 3,925 Losses and loss expenses 5.5%(2) - - 155 94.5%(2) 3,384 3,349 2,660

             (5 )       (5 )       (5 )     3,379      3,344    2,810
Policy acquisition and
underwriting expenses         5.5%(2)         -         -        61     94.5%(2)    1,284      1,178     1,052           (182 )     (183 )     (174 )     1,102        995      939
Income (loss) from property
and casualty insurance
operations before taxes                       -         -         0                  (246 )     (378 )      (3 )          187        188        179         (59 )     (190 )    176
Life insurance
operations:(1)
Total revenue                 21.6%(3)        -        10        37     78.4%(3)      178        167       135             (2 )       (2 )       (2

) 176 175 170 Total benefits and expenses 21.6%(3) - 7 26 78.4%(3) 132 120 96

              0          0         (2 )       132        127      120
Income from life insurance
operations before taxes                       -         3        11                    46         47        39             (2 )       (2 )        0          44         48       50
Investment operations:
Net investment income(2)                     16        16        37                   338        335       312            (11 )      (11 )      (11 )       343        340      338
Net realized gains (losses)
on Investments(2)                             5         3        (1 )                 404        (20 )     301              -          -          -         409        (17 )    300
Net impairment losses
recognized in earnings(2)                     0         0        (1 )                   0         (1 )      (3 )            -          -          -           0         (1 )     (4 )
Equity in earnings of
limited partnerships                         15        26        21                   116        119       106              -          -          -         131        145      127
Goodwill impairment                           -         -         -                     -          -       (22 )            -          -          -           -          -      (22 )
Income from investment
operations before taxes(2)                   36        45        56                   858        433       694            (11 )      (11 )      (11 )       883        467      739
Income from operations
before income taxes and
noncontrolling interest                     241       256       269                   658        102       730              -          -          -         899        358      999
Provision for income taxes                   81        87       107                   199          3       232              -          -          -         280         90      339
Net income                             $    160   $   169   $   162              $    459    $    99    $  498     $        -   $      -   $      -     $   619    $   268   $  660




(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 December 31, 2010, the underwriting results retained

by EIC and ENY and the investment results of EIC, ENY and EPC accrued to

the Indemnity shareholder interest. Due to the sale of Indemnity's

property and casualty insurance subsidiaries to the Exchange on

December 31, 2010, all property and casualty underwriting results and all

investment results for these companies accrue to the interest of the

subscribers (policyholders) of the Exchange, or noncontrolling interest,

       after December 31, 2010.


(3) 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.



                                       26

--------------------------------------------------------------------------------

Table of Contents


Net income in 2012 was impacted primarily by increased earnings from our
investment operations compared to 2011 and 2010 and lower losses from our
property and casualty insurance operations compared to 2011.  Our investment
operations improved primarily as a result of net realized gains on investments,
compared to losses in 2011 and a lower level of gains in 2010.  The Exchange's
property and casualty insurance operations experienced a 6.6% increase in earned
premium compared to 2011, driven by increases in policies in force and the
average premium per policy, which also positively impacted Indemnity's
management fee revenue.  The Exchange's 2012 property and casualty insurance
operation's results were positively impacted by lower levels of catastrophe
losses, offset somewhat by lower levels of favorable development on prior
accident year loss reserves compared to 2011.  In 2010, our noncontrolling
interest incurred a charge of $22 million for the impairment of goodwill
relating to its purchase of EFL stock in 2006, and the Indemnity shareholder
interest incurred a charge of $18 million for a deferred tax expense related to
the sale of its 21.6% ownership interest of EFL to the Exchange, which occurred
on March 31, 2011.

Reconciliation of Operating Income to Net Income
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 income generated from management
operations, life insurance operations(1), property and casualty insurance
underwriting operations(2), net investment income(2), and equity in earnings or
losses of limited partnerships, net of related federal income taxes.  It does
not include 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 for the years ended December 31(1) (2):


(in millions, except per share data)                      Indemnity 

Shareholder Interest

                                                      2012              2011             2010
Operating income attributable to Indemnity       $       157       $       167       $      163
Net realized gains (losses) and impairments on
investments                                                5                 3               (2 )
Income tax (expense) benefit                              (2 )              (1 )              1
Realized gains (losses) and impairments, net
of income taxes                                            3                 2               (1 )
Net income attributable to Indemnity             $       160       $       

169 $ 162


Per Indemnity Class A common share-diluted:
Operating income attributable to Indemnity       $      2.92       $      3.04       $     2.88
Net realized gains (losses) and impairments on
investments                                             0.10              0.06            (0.04 )
Income tax (expense) benefit                           (0.03 )           (0.02 )           0.01
Realized gains (losses) and impairments, net
of income taxes                                         0.07              0.04            (0.03 )
Net income attributable to Indemnity             $      2.99       $      3.08       $     2.85




(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.

(2)      Prior to and through December 31, 2010, the underwriting results
retained by EIC and ENY and the investment results of EIC, ENY and EPC accrued
to the Indemnity shareholder interest.  Due to the sale of Indemnity's property
and casualty insurance subsidiaries to the Exchange on December 31, 2010, all
property and casualty underwriting results and all investment results for these
companies accrue to the interest of the subscribers (policyholders) of the
Exchange, or noncontrolling interest, after December 31, 2010.


                                       27

--------------------------------------------------------------------------------

Table of Contents

Summary of Results - Indemnity Shareholder Interest Net income attributable to Indemnity Class A per share-diluted was $2.99 per share in 2012, compared to $3.08 per share in 2011, and $2.85 per share in 2010. The net income for 2011 and 2010 included $0.02 and $0.47 per share-diluted, respectively, related to operations sold to the Exchange.


Operating income attributable to Indemnity Class A per share-diluted (excluding
net realized gains or losses, impairments on investments and related taxes) was
$2.92 per share in 2012, compared to $3.04 in 2011, and $2.88 in 2010.  The 2011
and 2010 operating income amounts included $0.02 and $0.42 per share-diluted,
respectively, related to operations sold to the Exchange.

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 2012, 2011 and 2010.  Our Board of
Directors set the 2013 management fee rate again at 25%, its maximum level.
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 premiums 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 10,200 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.  The Property and
Casualty Group's principal personal lines products based upon 2012 direct
written premiums were private passenger automobile (45%) and homeowners (26%),
and the principal commercial lines products were commercial multi-peril (12%),
commercial automobile (7%) and workers compensation (7%).  Pennsylvania,
Maryland and Virginia made up 62% of the property and casualty lines insurance
business direct written premium in 2012.

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.  Prior to and through December 31, 2010, the underwriting results
retained by EIC and ENY accrued to the Indemnity shareholder interest.  Due to
the sale of Indemnity's property and casualty insurance subsidiaries to the
Exchange on December 31, 2010, all property and casualty underwriting results
accrue to the interest of the subscribers (policyholders) of the Exchange, or
noncontrolling interest, after December 31, 2010.

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.

                                       28

--------------------------------------------------------------------------------

Table of Contents


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.

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.

Our investment operations produced positive results reflecting favorable
conditions in the financial markets during 2012. Net investment income was $438
million in 2012, compared to $433 million in 2011.  During 2012, we incurred
$0.2 million of impairment charges compared to $2 million in 2011.  Net realized
gains were $418 million in 2012, compared to net losses of $4 million in 2011,
primarily reflecting significant valuation adjustments and realized gains from
our common stock portfolio in 2012.  Equity in earnings of limited partnerships
was $131 million in 2012, compared to $149 million in 2011, as market conditions
for these investments have generally remained favorable.  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 2012 partnerships earnings do not reflect the market conditions experienced
in the fourth 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.


                                       29

--------------------------------------------------------------------------------

Table of Contents

CRITICAL ACCOUNTING ESTIMATES


The consolidated financial statements include amounts based upon estimates and
assumptions that have a significant effect on reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period and related disclosures.
Management considers an accounting estimate to be critical if 1) it requires
assumptions to be made that were uncertain at the time the estimate was made,
and 2) different estimates that could have been used, or changes in the estimate
that are likely to occur from period-to-period, could have a material impact on
our Consolidated Statements of Operations or Financial Position.

The following presents a discussion of those accounting policies surrounding
estimates that we believe are the most critical to our reported amounts and
require the most subjective and complex judgment.  If actual events differ
significantly from the underlying assumptions, there could be material
adjustments to prior estimates that could potentially adversely affect our
results of operations, financial condition and cash flows.  The estimates and
the estimating methods used are reviewed continually, and any adjustments
considered necessary are reflected in current earnings.

Property and Casualty Insurance Loss and Loss Expense Reserves
Property and casualty insurance loss and loss expense reserves are established
to provide for the estimated costs of paying claims under insurance policies
written by us.  These reserves include estimates for both claims that have been
reported (case) and those that have been incurred but not reported (IBNR) and
include estimates of all future payments associated with processing and settling
these claims.

The process of establishing loss reserves is complex and involves a variety of
actuarial techniques.  The loss reserve estimation process is based largely on
the assumption that past development trends are an appropriate indicator of
future events.  Reserve estimates are based upon our assessment of known facts
and circumstances, review of historical settlement patterns, estimates of trends
in claims frequency and severity, legal theories of liability and other
factors.  Variables in the reserve estimation process can be affected by 1)
internal factors, including changes in claims handling procedures and changes in
the quality of risk selection in the underwriting process, and 2) external
events, such as economic inflation and regulatory and legislative changes.  Due
to the inherent complexity of the assumptions used, final loss settlements may
vary significantly from the current estimates, particularly when those
settlements may not occur until well into the future.

How reserves are established
Case reserves are established by a claims handler on each individual claim and
are adjusted as new information becomes known during the course of handling the
claims.  IBNR reserves represent the difference between the case reserves for
actual reported loss and loss expenses and the estimated ultimate cost of all
claims.

Our loss and loss expense reserves include amounts related to short-tail and
long-tail lines of business.  Tail refers to the time period between the
occurrence of a loss and the final settlement of the claim.  The longer the time
span between the incidence of a loss and the settlement of the claim, the more
the ultimate settlement amount can vary.  Most of our loss and loss expense
reserves relate to long-tail liability lines of business including workers
compensation, bodily injury and other liability coverages, such as commercial
liability.  Short-tail lines of business, which represent a smaller percentage
of our loss reserves, include personal auto physical damage and personal
property.

Our actuaries review all direct reserve estimates on a quarterly basis for both
current and prior accident years using the most current claim data.  Reserves
for massive injury lifetime medical claims, including auto no-fault and workers
compensation claims, are reviewed at a more detailed level semi-annually.  These
massive injury claim reserves are relatively few in number and are very
long-tail liabilities.  In intervening quarters, development on massive injury
reserves is monitored to confirm that the estimate of ultimate losses should not
change.  If an unusual development is observed, a detailed review is conducted
to determine whether the reserve estimate should change.  Significant changes to
the factors discussed above, which are either known or reasonably projected
through analysis of internal and external data, are quantified in the reserve
estimates each quarter.

The quarterly reserve reviews incorporate a variety of actuarial methods and
judgments and involve rigorous analysis.  A comprehensive review is performed of
the various estimation methods and reserve levels produced by each.  The various
methods generate different estimates of ultimate losses by product line and
product coverage combination.  Thus, reserves are comprised of a set of point
estimates of the ultimate losses developed from the various methods.  These
multiple reserve point estimates are reviewed by our reserving actuaries and
reserve best estimates are selected.  The selected reserve estimates are
discussed with management.


                                       30

--------------------------------------------------------------------------------

Table of Contents


Numerous factors are considered in setting reserve levels, including, but not
limited to, the assessed reliability of key loss trends and assumptions that may
significantly influence the current actuarial indications, the maturity of the
accident year, pertinent claims frequency and severity trends observed over
recent years, the level of volatility within a particular line of business and
the improvement or deterioration of actuarial rate indications in the current
period as compared to prior periods.  Certain methods are considered more
credible for each product/coverage combination depending on the maturity of the
accident quarter, the mix of business and the particular internal and external
influences impacting the claims experience or the method.

The following is a discussion of the most common methods used:


Paid development - Paid loss development patterns are generated from historical
data organized by accident quarter and calendar quarter and applied to current
paid losses by accident quarter to generate estimated ultimate losses.  Paid
development techniques do not use information about case reserves and therefore
are not affected by changes in case reserving practices.  These techniques are
generally most useful for short-tailed lines since a high percentage of ultimate
losses are paid in early periods of development.

Incurred development - Incurred loss development patterns (reflecting cumulative
paid losses plus current case reserves) are generated from historical data
organized by accident quarter and calendar quarter.  The patterns are applied to
current incurred losses by accident quarter to generate estimated ultimate
losses.  Incurred methods and/or combinations of the paid and incurred methods
are used in developing estimated ultimate losses for short-tail coverages, such
as personal auto physical damage and personal property claims, and more mature
accident quarters of long-tail coverages, such as personal auto liability,
commercial liability and workers compensation claims.

Weather event paid and reported development - The historical patterns utilized
in paid and reported development methods for weather events are derived from
historical data for the same type of weather event.  Initial weather event
ultimate loss estimates are reviewed with claims management.

Bornhuetter-Ferguson - Bornhuetter-Ferguson is a method of combining the
expected-loss-ratio ultimate losses and the paid-or-incurred development
ultimate losses. It places more weight on the paid-or-incurred development
ultimate losses as an accident quarter matures. The Bornhuetter-Ferguson method
is generally used on the first four to eight accident quarters on long-tail
coverages because a low percentage of losses are paid in the early period of
development. An expected loss ratio is developed through a review of historical
loss ratios by accident quarter, adjusted for changes to earned premium, mix of
business and other factors that are expected to impact the loss ratio for the
accident quarter being evaluated. A preliminary estimate of ultimate losses is
calculated by multiplying this expected loss ratio by earned premium.

Survival ratio - This method measures the ratio of the average loss and loss
expense amount paid annually to the total reserve for the product line or
product coverage.  The survival ratio represents the number of years of payments
that the current level of reserves will cover.  The reserve is established so
that a particular ratio, representing the time to closing of all claims, is
achieved.  This method is also used as a reasonability check of reserve
adequacy.

Individual claim - This method estimates the ultimate losses on a claim-by-claim
basis.  An annual payment assumption is made for each claimant and then
projected into the future based upon a particular assumption of the future
inflation rate and life expectancy of the claimant.  This method is used for
unusual, large claims.

Line of business methods
For each product line and product/coverage combination, certain methods are
given more influence than other methods.  The discussion below gives a general
indication of which methods are preferred for each line of business.  As
circumstances change, the methods that are given greater weight can change.

Massive injury lifetime medical claims (such as certain auto no-fault and
workers compensation claims) - These claims develop over a long period of time
and are relatively few in number.  We utilize the individual claim method to
evaluate each claim's ultimate losses.

Personal auto physical damage and homeowners - These lines are fast-developing,
and paid and incurred development techniques are used.  We rely primarily on
incurred development techniques for the most recent accident months.


                                       31

--------------------------------------------------------------------------------

Table of Contents


Personal auto liability (such as bodily injury and uninsured/underinsured
motorist) - For auto liability, and bodily injury in particular, we review the
results of a greater number of techniques than for physical damage.  We use the
Bornhuetter-Ferguson method for the first four to eight accident quarters and
paid and incurred development methods for the older accident periods.

Workers compensation and long-tailed liability (such as commercial liability) -
We generally rely upon the expected loss ratio, Bornhuetter-Ferguson and
incurred development techniques.  These techniques are generally weighted
together, relying more heavily on the Bornhuetter-Ferguson method at early ages
of development and more on the incurred development method as the accident
periods mature.

The methods used for estimating loss expenses are as follows:

Defense and cost containment expenses (D&CC) - D&CC is analyzed using paid development techniques and an analysis of the relationship between D&CC payments and loss payments.


Adjusting and other expenses (A&O) - A&O reserves are projected based upon an
expected cost per claim year, the anticipated claim closure pattern, and the
ratio of paid A&O to paid loss.

Key assumptions for loss reserving
The accuracy of the various methods used to estimate reserves is a function of
the degree to which underlying assumptions are satisfied.  The most significant
key assumptions are:

Development patterns - Historical paid and incurred amounts contain patterns
which indicate how unpaid and IBNR amounts will emerge in future periods.
Unless reasons or factors are identified that invalidate the extension of
historical patterns into the future, these patterns can be used to make
projections necessary for estimating loss and loss adjustment expense reserves.
This is the most significant assumption and it applies to all methods.

Impact of inflation - Property and casualty insurance reserves are established
before the extent to which inflation may impact such reserves is known.
Consequently, in establishing reserves, 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 and/or 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.

Claims with atypical emergence patterns - Characteristics of certain subsets of
claims, such as those with high severity, have the potential to distort patterns
contained in historical paid loss and reported loss data.  When testing
indicates this to be the case for a particular subset of claims, our actuaries
segregate these claims from the data and analyze them separately.

Future cost increases and claimant mortality - Future cost increase assumptions
are derived from a review of historical cost increases and are assumed to
persist into the future.  Future medical cost increases and claimant mortality
assumptions utilized in the reserve estimates for massive injury lifetime
medical claims are obtained from industry studies adjusted for our own
experience.  Reserve levels are sensitive to these assumptions because they
represent projections over 30 to 40 years into the future.

Changes in loss ratio trends - Prior loss ratio assumptions utilized in the
Bornhuetter-Ferguson method are derived from projections of historical loss
ratios based upon actual experience from more mature accident periods adjusted
for assumed changes in average premiums, frequency and severity.  These
assumptions influence only the most recent accident periods, but the majority of
reserves originate with the most recent accident periods.  Reserve levels are
highly sensitive to these assumptions.

Relationship of loss expense to losses - D&CC-to-loss ratio assumptions utilized
in the Bornhuetter-Ferguson method are initially derived from historical
relationships.  These historical ratios are adjusted according to the impact of
changing internal and external factors.  The A&O-to-loss ratio assumption is
similarly derived from historical relationships and adjusted as required for
identified internal or external changes.

                                       32

--------------------------------------------------------------------------------

Table of Contents


Reserve estimate variability
The property and casualty reserves with the greatest potential for variation are
the massive injury lifetime medical reserves.  The automobile no-fault law in
Pennsylvania before 1986 and workers compensation policies provide for unlimited
medical benefits.  The estimate of ultimate liabilities for these claims is
subject to significant judgment due to variations in claimant health, mortality
over time and health care cost trends.  Workers compensation massive injury
claims have been segregated from the total population of claims.  Ultimate
losses for these claims are estimated on a claim-by-claim basis.  An annual
payment assumption is made for each of the claimants who have sustained massive
injuries.  We are currently reserving for 267 claimants requiring lifetime
medical care, of which 109 involve massive injuries. The annual payment is
projected into the future based upon particular assumptions of the future
inflation rate and life expectancy of the claimant.  The most significant
variable in estimating this liability is medical cost inflation.  The life
expectancy (mortality rate) assumption underlying the estimate reflects the
gender specific disabled pensioner mortality table.  Actual experience, however,
may emerge in a manner that is different relative to the original assumptions,
which could have a significant impact on our reserve estimates.

Loss reserves are set at full expected cost, except for workers compensation
loss reserves, which are discounted on a nontabular basis using an interest rate
of 2.5% and our historical workers compensation payout patterns.  In our workers
compensation discounting methodology, we segregate the workers compensation
massive injury claims that have longer payout patterns from the non-massive
injury workers compensation claims.

Auto no-fault (massive injury lifetime medical claims) - The automobile massive
injury reserve carried by the Property and Casualty Group totaled $351 million
at December 31, 2012, compared to $356 million at December 31, 2011.  The
decrease in the pre-1986 automobile massive injury reserves in 2012, compared to
2011, was primarily due to the death of one claimant.  A 100-basis point
increase in the medical cost inflation assumption would result in an increase in
the Property and Casualty Group's liability of $71 million at December 31, 2012.

Workers compensation (massive injury lifetime medical claims) - The workers
compensation massive injury reserve carried by the Property and Casualty Group
totaled $99 million at both December 31, 2012 and 2011.  The workers
compensation massive injury reserves remained flat in 2012, compared to 2011,
primarily due to the death of one claimant, offset by the addition of one new
claimant.  The discount on these reserves was $36 million at December 31, 2012.
A 100-basis point increase in the medical cost inflation assumption would result
in an increase in the Property and Casualty Group's liability of $22 million and
an increase in the discount of $10 million at December 31, 2012.

Workers compensation reserves, excluding massive injury lifetime medical claims,
are also subject to discounting.  The discount on these reserves was $49 million
at December 31, 2012.  A 100-basis point increase in the discount rate would
decrease these reserves by $24 million.

We also perform analyses to evaluate the adequacy of past total reserve levels
for the Property and Casualty Group.  Using subsequent information, we perform
retrospective reserve analyses to test whether previously established estimates
for reserves were reasonable.  Our 2012 retrospective reserve analysis for the
loss reserve balance at December 31, 2011 indicated that direct reserves,
including salvage and subrogation recoveries, were over-estimated by
approximately $92 million, or 2.6% of the reserve estimate at December 31,
2011.  In 2011, our retrospective reserve analysis indicated that direct
reserves, including salvage and subrogation recoveries, were over-estimated by
approximately $276 million, or 7.7% of the reserve estimate at December 31,
2010; and in 2010, our retrospective reserve analysis indicated that direct
reserves, including salvage and subrogation recoveries, were over-estimated by
approximately $188 million, or 5.2% of the reserve estimate at December 31,
2009.  See an additional discussion of our reserve development in the "Prior
year loss reserve development" section.

Due to the sale of Indemnity's property and casualty insurance subsidiaries to
the Exchange on December 31, 2010, all property and casualty loss and loss
expense reserves accrue to the interest of the subscribers (policyholders) of
the Exchange, or noncontrolling interest, after December 31, 2010.

Life Insurance and Annuity Policy Reserves
Reserves for traditional life insurance future policy benefits are computed
primarily by the net level premium method.  Generally, benefits are payable over
an extended period of time and related reserves are calculated as the present
value of future expected benefits to be paid reduced by the present value of
future expected net premiums.  Such reserves are established based upon methods
and underlying assumptions in accordance with GAAP and applicable actuarial
standards.  Principal assumptions used in the establishment of policy reserves
are mortality, lapses, expenses and investment yields.  Mortality assumptions
are based upon tables typically used in the industry, modified to reflect actual
experience and to include a provision for the risk of adverse deviation where
appropriate.  Lapse, expense and investment yield assumptions are based upon
actual company experience and may include a provision for the risk of adverse
deviation.  Assumptions on these policies are locked in at the time of issue and
are not subject to change unless a premium deficiency exists.  A premium
deficiency exists if, based upon

                                       33

--------------------------------------------------------------------------------

Table of Contents


revised assumptions, the existing contract liabilities together with the present
value of future gross premiums are not sufficient to cover the present value of
future expected benefits and maintenance costs and to recover unamortized
acquisition costs.  Historically, our reserves plus expected gross premiums have
been demonstrated to be sufficient.  There were no premium deficiencies in 2012,
2011 or 2010.

Reserves for income-paying annuity future policy benefits are computed as the
present value of future expected benefits.  Principal assumptions used in the
establishment of policy reserves are mortality and investment yields.  Interest
rates used to discount future expected benefits are set at the policy level and
range from 2.25% to 9.0%.  The equivalent aggregate interest rate is 5.7%.  If
the aggregate interest rate was reduced by 100 basis points, the present value
of future expected benefits would increase by $18 million at December 31, 2012.

Reserves for universal life and deferred annuity plans are based upon the contract account balance without reduction for surrender charges.


Investment Valuation
Available-for-sale and trading securities
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:

• 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 assess 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

                                       34

--------------------------------------------------------------------------------

Table of Contents


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.

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.

Other-than-temporary impairments
Investments are evaluated monthly for other-than-temporary impairment loss.
Some factors considered in evaluating whether or not a decline in fair value is
other-than-temporary include:

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

• historical operating performance and financial condition of the issuer;

• short- and long-term prospects of the issuer and its industry based upon

analysts' recommendations;

• specific events that occurred affecting the issuer, including rating

downgrades;

• our intent to sell or more likely than not be required to sell (debt

securities); and

• our ability and intent to retain the investment for a period of time

sufficient to allow for a recovery in value (equity securities).




For debt securities in which we do not expect full recovery of amortized cost,
the security is deemed to be credit-impaired.  Credit-related impairments and
impairments on securities we intend to sell or more likely than not will be
required to sell are recorded in the Consolidated Statements of Operations. 

It

is our intention to sell all debt securities with credit impairments. 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.

                                       35

--------------------------------------------------------------------------------

Table of Contents


Limited partnerships
The primary basis for the valuation of limited partnership interests is
financial statements prepared by the general partner.  Because of the timing of
the preparation and delivery of these financial statements, the use of the most
recently available financial statements provided by the general partners
generally result in a quarter delay in the inclusion of the limited partnership
results in our Consolidated Statements of Operations.  Due to this delay, these
financial statements do not reflect the market conditions experienced in the
fourth quarter of 2012.

The majority of our limited partnership holdings are considered investment
companies where the general partners record assets at fair value. These limited
partnerships are recorded using the equity method of accounting. We also own
some real estate limited partnerships that do not meet the criteria of an
investment company. These partnerships prepare their audited financial
statements on a cost basis. We have elected to report these limited partnerships
under the fair value option, which is based on the net asset value (NAV) from
our partner's capital statement reflecting the general partner's estimate of
fair value for the fund's underlying assets. Fair value provides consistency in
the evaluation and financial reporting for these limited partnerships and
limited partnerships accounted for under the equity method.

We have three types of limited partnership investments: private equity,
mezzanine debt, and real estate.  Our private equity and mezzanine debt
partnerships are diversified among numerous industries and geographies to
minimize potential loss exposure. Nearly all of the underlying investments in
our limited partnerships are valued using a source other than quoted prices in
active markets. The fair value amounts for our private equity and mezzanine debt
partnerships are based upon the financial statements prepared by the general
partners, who use various methods to estimate fair value including the market
approach, income approach and the cost approach.  The market approach uses
prices and other pertinent information from market-generated transactions
involving identical or comparable assets or liabilities.  Such valuation
techniques often use market multiples derived from a set of comparables.  The
income approach uses valuation techniques to convert future cash flows or
earnings to a single discounted present value amount.  The measurement is based
upon the value indicated by current market expectations about those future
amounts.  The cost approach is derived from the amount that is currently
required to replace the service capacity of an asset.  If information becomes
available that would impair the cost of investments owned by the partnerships,
then the general partner would adjust to the net realizable value.

The fair value of investments in real estate limited partnerships is determined
by the general partner based upon independent appraisals and/or internal
valuations.  Real estate projects under development are generally valued at cost
and impairment tested by the general partner.  We minimize the risk of market
decline by avoiding concentration in a particular geographic area and are
diversified across residential, commercial, industrial and retail real estate
investments.

We perform various procedures in review of the general partners' valuations.
While we rely on the general partners' financial statements as the best
available information to record our share of the partnership unrealized gains
and losses resulting from valuation changes, we adjust our financial statements
for impairments of the partnership investments where appropriate.  As there is a
limited market for these investments, they have the greatest potential for
variability.  We survey each of the general partners quarterly about expected
significant changes (plus or minus 10% compared to previous quarter) to
valuations prior to the release of the fund's quarterly and annual financial
statements. Based upon that information from the general partner, we consider
whether additional disclosure is warranted. For limited partnerships measured at
fair value based upon NAV, these values are then analyzed to determine if they
represent NAV at the balance sheet date, with an adjustment being made where
appropriate.

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 2012 related to
life insurance and investment-type contracts totaled $17 million. The amount of
acquisition costs that would have been capitalized during 2012 using the
previous policy totaled $19 million. Prior to 2012, certain of these acquisition
costs were deferred regardless of whether a contract was acquired.

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.

                                       36

--------------------------------------------------------------------------------

Table of Contents


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
2012, 2011 or 2010.

Deferred Taxes
Deferred tax assets represent the tax benefit of future deductible temporary
differences and operating loss and tax credit carry-forwards.  Deferred tax
assets are measured using the enacted tax rates expected to be in effect when
such benefits are realized.  We perform an analysis of our deferred tax assets
to determine recoverability on a quarterly basis for each legal entity, by
character of the income (ordinary or capital).  Deferred tax assets are reduced
by a valuation allowance, if based upon the weight of available evidence, it is
more likely than not that some portion, or all, of the deferred tax assets will
not be realized.  In determining the need for a valuation allowance, we consider
carry-back capacity, reversal of existing temporary differences, future taxable
income and tax planning strategies.  The determination of the valuation
allowance for our deferred tax assets requires management to make certain
judgments and assumptions regarding future operations that are based upon our
historical experience and our expectations of future performance.  Our judgments
and assumptions are subject to change given the inherent uncertainty in
predicting future performance, which is impacted by such things as financial
market conditions, policyholder behavior, competitor pricing, new product
introductions and specific industry and economic conditions.

Indemnity had a net deferred tax asset of $37 million at December 31, 2012 and
$19 million at December 31, 2011.  There was no valuation allowance recorded on
Indemnity at December 31, 2012 or 2011.

The Exchange had a net deferred tax liability of $365 million at December 31,
2012 and $147 million at December 31, 2011.  There was no valuation allowance
recorded on the Exchange at December 31, 2012 or 2011.

Retirement Benefit Plan for Employees
Our pension plan for employees is the largest and only funded benefit plan we
offer.  Our pension obligation is developed from actuarial estimates.  Several
statistical and other factors, which attempt to anticipate future events, are
used in calculating the expense and liability related to the plans.  Key factors
include assumptions about the discount rates and expected rates of return on
plan assets.  We review these assumptions annually and modify them considering
historical experience, current market conditions, including changes in
investment returns and interest rates and expected future trends.

Accumulated and projected benefit obligations are expressed as the present value
of future cash payments.  We discount those cash payments based upon a yield
curve developed from corporate bond yield information with maturities that
correspond to the payment of benefits.  Lower discount rates increase present
values and subsequent year pension expense; higher discount rates decrease
present values and subsequent year pension expense.  The discount rate
assumption used to determine the benefit obligation for 2012 was determined
based upon a yield curve developed from corporate bond yield information.  The
construction of this yield curve is based upon yields of corporate bonds rated
Aa quality.  Target yields are developed from bonds at various maturity points
and a curve is fitted to those targets.  Spot rates (zero coupon bond yields)
are developed from the yield curve and used to discount benefit payment amounts
associated with each future year.  The present value of plan

                                       37

--------------------------------------------------------------------------------

Table of Contents


benefits is calculated by applying the spot/discount rates to projected benefit
cash flows.  A single discount rate is then developed to produce the same
present value.  This represents the suggested discount rate.  The cash flows
from the yield curve were matched against our projected benefit payments in the
pension plan, which have a duration of about 19 years.  This yield curve
supported the selection of a 4.19% discount rate for the projected benefit
obligation at December 31, 2012 and for the 2013 pension expense.  The same
methodology was used to develop the 4.99% and 5.69% discount rates used to
determine the projected benefit obligation for 2011 and 2010, respectively, and
the pension expense for 2012 and 2011, respectively.  A change of 25 basis
points in the discount rate assumption, with other assumptions held constant,
would have an estimated $3 million impact on net pension and other retirement
benefit costs in 2013.

Unrecognized actuarial gains and losses are being recognized over a 14-year
period, which represents the expected remaining service period of the employee
group.  Unrecognized actuarial gains and losses arise from several factors,
including experience and assumption changes in the obligations and from the
difference between expected returns and actual returns on plan assets.  These
unrecognized gains and losses are recorded in the pension plan obligation and
accumulated other comprehensive income (loss) on the Consolidated Statements of
Financial Position.  These amounts are systematically recognized to net periodic
pension expense in future periods, with gains decreasing and losses increasing
future pension expense.

The expected long-term rate of return for the pension plan represents the
average rate of return to be earned on plan assets over the period the benefits
included in the benefit obligation are to be paid.  The expected long-term rate
of return is less susceptible to annual revisions, as there are typically no
significant changes in the asset mix.  To determine the expected long-term rate
of return assumption, we utilized models based upon rigorous historical analysis
and forward-looking views of the financial markets based upon key factors such
as historical returns for the asset class' applicable indices, the correlations
of the asset classes under various market conditions and general market trends.
The expected future return for each asset class is then weighted based upon the
plan's asset allocation to produce a reasonable range of asset return results
within which our expected long-term rate of return assumption falls. A
reasonably possible change of 25 basis points in the expected long-term rate of
return assumption, with other assumptions held constant, would have an estimated
$1 million impact on net pension benefit cost.

We use a four year averaging method to determine the market-related value of
plan assets, which is used to determine the expected return component of pension
expense.  Under this methodology, asset gains or losses that result from returns
that differ from our long-term rate of return assumption are recognized in the
market-related value of assets on a level basis over a four year period.  The
market-related asset experience during 2012 that related to the actual
investment return being different from that assumed during the prior year was a
gain of $29 million. Recognition of this gain will be deferred and recognized
over a four year period, consistent with the market-related asset value
methodology.  Once factored into the market-related asset value, these
experience gains and losses will be amortized over a period of 14 years, which
is the remaining service period of the employee group.

Estimates of fair values of the pension plan assets are obtained primarily from
our trustee and custodian of our pension plan.  Our Level 1 category includes a
money market fund that is a mutual fund for which the fair value is determined
using an exchange traded price provided by the trustee and custodian.  Our Level
2 category includes commingled pools.  Estimates of fair values for securities
held by our commingled pools are obtained primarily from the trustee and
custodian.  The methodologies used by the trustee and custodian that support a
financial instrument Level 2 classification include multiple verifiable,
observable inputs including benchmark yields, reported trades, broker/dealer
quotes, issuers spreads, two-sided markets, benchmark securities, bids, offers
and reference data.  There were no Level 3 investments during 2012 or 2011.

The actuarial assumptions we used in determining our pension obligation may
differ materially from actual results due to changing market and economic
conditions, higher or lower withdrawal rates, or longer or shorter life spans of
participants.  While we believe that the assumptions used are appropriate,
differences in actual experience or changes in assumptions may materially affect
our financial position, results of operations or cash flows.

                                       38

--------------------------------------------------------------------------------

Table of Contents

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
                                                          Years ended December 31,
(dollars in millions)                                     %                        %
                                           2012        Change       2011        Change       2010
Management fee revenue, net             $  1,157      8.5   %    $  1,067      5.7   %    $  1,009
Service agreement revenue                     31     (5.9 )            33     (3.6 )            34
Total revenue from management
operations                                 1,188      8.1           1,100      5.4           1,043
Cost of management operations                983     10.2             892      6.1             841
Income from management operations -
Indemnity(1)                            $    205     (1.3 ) %    $    208      2.7   %    $    202
Gross margin                                17.3 %   (1.6 ) pts.     18.9 %   (0.5 ) pts.     19.4 %


(1) The Indemnity shareholder interest 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
                                                         Years ended December 31,
(dollars in millions)                                   %                       %
                                           2012       Change       2011       Change       2010
Property and Casualty Group direct
written premium                         $  4,631        8.4 %   $  4,271        5.9 %   $  4,035
Management fee rate                           25 %                    25 %                    25 %
Management fee revenue, gross              1,157        8.3        1,068        5.9        1,009
Change in allowance for management
fee returned on cancelled policies(1)          0        NM            (1 )      NM             0
Management fee revenue, net of
allowance                               $  1,157        8.4 %   $  1,067        5.7 %   $  1,009



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 8.4% in
2012, compared to 2011, due to a 3.9% increase in policies in force and a 4.3%
increase in the year-over-year average premium per policy for all lines of
business.  The year-over-year policy retention ratio was 90.9% at December 31,
2012 and 90.7% at December 31, 2011 and 2010.  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 2012, 2011 and
2010.  The management fee rate for 2013 was set at 25% by our Board of
Directors.  Changes in the management fee rate can affect the Indemnity
shareholder interest's revenue and net income from this segment significantly.
See also, the "Transactions/Agreements between Indemnity and Noncontrolling
Interest (Exchange), Board Oversight" section within this report.

                                       39

--------------------------------------------------------------------------------

Table of Contents


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 $31 million, $33 million and $34 million in 2012, 2011
and 2010, respectively.  The decrease in service agreement revenue in 2012 and
2011 resulted from 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 services charges and to take
advantage of the discount in pricing offered for paid-in-full policies.

Cost of management operations
                                                Indemnity Shareholder Interest
                                                   Years ended December 31,
(in millions)                                           %                  %
                                          2012       Change     2011    Change     2010
Commissions                           $   635          8.5 %   $ 586      3.9 %   $ 564
Non-commission expense                    348         13.6       306    

10.6 277 Total cost of management operations $ 983 10.2 % $ 892 6.1 % $ 841





Commissions - Commissions increased $49 million in 2012 compared to 2011, and
increased $22 million in 2011 compared to 2010, primarily as a result of the
8.4% and 5.9%, respectively, increase in direct written premiums of the Property
and Casualty Group.  In 2012, agent bonuses also increased due to an increase in
the profitability component of the bonus as a result of factoring in the most
recent year's underwriting data, and other agent incentives increased due to
policy growth. Impacting these increases in 2012 was an adjustment that reduced
commission expense by $6 million. 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. Impacting the increase in 2011 was a
decrease in agent bonuses due to a reduction in the profitability component of
the bonus as a result of factoring in the most recent year's underwriting data.

Non-commission expense - Non-commission expense increased $42 million in 2012
compared to 2011. Sales, policy issuance, advertising and underwriting costs
increased $11 million primarily due to increased levels of applications and
policies and increased agent related advertising and support. Information
technology costs increased $14 million, which included $4 million of personnel
costs, $8 million of software costs and $2 million of professional fees.
Personnel and all other operating costs, excluding information technology
related costs, increased $17 million as a result of an $8 million increase
related to higher staffing levels primarily associated with policy acquisition
and customer service functions, a $6 million increase in pension and medical
costs, and a $3 million increase in the estimate for annual incentive plan
compensation related to growth and underwriting performance.

In 2011, non-commission expense increased $29 million compared to 2010. Sales,
policy issuance and advertising costs increased $2 million primarily due to
increased levels of policies and agent related support. Information technology
costs increased $21 million, which included $7 million of personnel costs, $7
million of software costs and $7 million of professional fees. Personnel and all
other operating costs, excluding information technology related costs, increased
$6 million as a result of a $1 million increase related to higher staffing
levels primarily associated with the customer service function, and due to 2010
including a $5 million reduction due to a favorable court ruling.

Gross margin
The gross margin in 2012 was 17.3%, compared to 18.9% in 2011 and 19.4% in 2010.
The gross margin of 17.3% in 2012 was positively impacted by an adjustment that
reduced commission expense by $6 million related to the reimbursement by the
NCRF for commissions Indemnity paid to agents on the surcharges collected on
behalf of the NCRF in prior periods, and the gross margin of 19.4% in 2010 was
positively impacted by a $5 million reduction to non-commission expense due to a
favorable court ruling.  Excluding these adjustments that reduced the total cost
of management operations, the gross margin would have been 16.8% in 2012,
compared to 18.9% in 2011 and 18.9% in 2010.

                                       40

--------------------------------------------------------------------------------

Table of Contents


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
                                                            Years ended December 31,
(dollars in millions)                                      %                          %
                                           2012          Change       2011          Change       2010
Premiums:
Direct written premium                  $  4,631        8.4      % $  4,271        5.9      % $  4,035
Reinsurance - assumed and ceded              (28 )    (74.2 )           (16 )     (6.0 )           (16 )
Net written premium                        4,603        8.2           4,255        5.9           4,019
Change in unearned premium                   181       71.3             106       12.2              94
Net premiums earned                        4,422        6.6           4,149        5.7           3,925
Losses and loss expenses:
Current accident year, excluding
catastrophe losses                         3,010        5.7           2,848        2.8           2,771
Current accident year catastrophe
losses                                       489      (36.7 )           773         NM             288
Prior accident years, including prior
year catastrophe losses                     (115 )     57.7            (272 )    (11.8 )          (244 )
Losses and loss expenses                   3,384        1.0           3,349       19.0           2,815
Policy acquisition and other
underwriting expenses                      1,284        9.0           1,178        5.8           1,113
Total losses and expenses                  4,668        3.1           4,527       15.2           3,928
Underwriting loss - Erie Insurance
Group                                   $   (246 )     34.7      % $   (378 )       NM        $     (3 )
Underwriting loss - Indemnity(1)        $      -                   $      -                   $      0
Underwriting loss - Exchange(1)         $   (246 )                 $   (378 )                 $     (3 )

Loss and loss expense ratios:

 Current accident year loss ratio,
excluding catastrophe losses                68.1  %    (0.5 ) pts.     68.6 

% (2.0 ) pts. 70.6 %

 Current accident year catastrophe
loss ratio                                  11.0       (7.6 )          18.6       11.3             7.3
Prior accident year loss ratio,
including prior year catastrophe
losses                                      (2.6 )      3.9            (6.5 

) (0.3 ) (6.2 )

Total loss and loss expense ratio 76.5 (4.2 ) 80.7

        9.0            71.7
 Policy acquisition and other
underwriting expense ratio                  29.1        0.7            28.4        0.0            28.4
 Combined ratio                            105.6  %    (3.5 ) pts.    109.1  %     9.0   pts.    100.1  %



NM = not meaningful

(1)      Prior to and through December 31, 2010, the underwriting results
retained by EIC and ENY accrued to the Indemnity shareholder interest.  Due to
the sale of Indemnity's property and casualty insurance subsidiaries to the
Exchange on December 31, 2010, all property and casualty underwriting results
accrue to the interest of the subscribers (policyholders) of the Exchange, or
noncontrolling interest, after December 31, 2010.


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 8.4% to $4.6 billion in 2012, from $4.3 billion in 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
3.9% in 2012 as the result of continuing strong policyholder retention and an
increase in new policies written, compared to an increase of 2.5% in 2011.  The
year-over-year average premium per policy for all lines of business increased
4.3% at December 31, 2012, compared to 3.3% at December 31, 2011.

Premiums generated from new business increased 22.2% to $568 million in 2012,
compared to 1.9%, or $465 million, in 2011.  Underlying the trend in new
business premiums was a 13.4% increase in new business policies written in 2012,
compared to the same period in 2011, while the year-over-year average premium
per policy on new business increased 7.8% at December 31, 2012, compared to 5.9%
at December 31, 2011.

                                       41

--------------------------------------------------------------------------------

Table of Contents


Premiums generated from renewal business increased 6.7% to $4.1 billion in 2012,
compared to 6.4%, or $3.8 billion, in 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 3.9% at December 31, 2012, compared to 2.9% at December 31, 2011. 

The

Property and Casualty Group's year-over-year policy retention ratio was 90.9% at December 31, 2012 and 90.7% at December 31, 2011, and 2010.

The Property and Casualty Group implemented rate increases in 2012, 2011 and
2010 in order to meet loss cost expectations.  Our rate increases in 2010 were
offset somewhat by the Property and Casualty Group's economically sensitive
lines, predominantly workers compensation and commercial auto, which, as a
result of unfavorable economic conditions at that time, experienced reduced
exposures and changes in the mix of business that reduced the average premium
per policy for these lines.

The Property and Casualty Group primarily writes only one-year policies.
Consequently, rate actions take 12 months to be fully recognized in written
premium and 24 months to be fully recognized in earned premiums.  Since rate
changes are realized at renewal, it takes 12 months to implement a rate change
to all policyholders and another 12 months to earn the decreased or increased
premiums in full.  As a result, certain rate actions approved in 2011 were
reflected in 2012, and recent rate actions in 2012 will be reflected in 2013.

Personal lines - Total personal lines premiums written increased 7.5% to $3.3
billion in 2012, from $3.1 billion in 2011, driven by an increase of 3.8% in
total personal lines policies in force and an increase of 3.6% in the total
personal lines year-over-year average premium per policy.

New business premiums written on personal lines increased 20.9% in 2012,
compared to a decrease of 0.7% in 2011, driven by increases in new business
policies written and average premium per policy.  Personal lines new business
policies written increased 15.1% in 2012, compared to the same period in 2011,
while the year-over-year average premium per policy on personal lines new
business increased 5.1% at December 31, 2012, compared to 4.2% at December 31,
2011.

• Private passenger auto new business premiums written increased 15.7% in

2012, compared to a decrease of 1.4% in 2011. New business policies

written for private passenger auto increased 11.0% in 2012, compared to

the same period in 2011, while the new business year-over-year average

       premium per policy for private passenger auto increased 4.2% at
       December 31, 2012, compared to an increase of 2.0% at December 31, 2011.


• Homeowners new business premiums written increased 30.4% in 2012, compared

to a decrease of 0.9% in 2011. New business policies written for

homeowners increased 18.8% in 2012, compared to the same period in 2011.

The new business year-over-year average premium per policy for homeowners

       increased 9.8% at December 31, 2012, compared to 6.5% at December 31,
       2011.



Renewal premiums written on personal lines increased 6.1% in 2012, compared to
5.5% in 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 3.5% at December 31, 2012, compared to
2.2% at December 31, 2011.  The personal lines year-over-year policy retention
ratio was 91.6% at December 31, 2012, and 91.5% at December 31, 2011 and 2010.

• Private passenger auto renewal premiums written increased 3.2% in 2012,

compared to 2.8% in 2011. The year-over-year average premium per policy

on private passenger auto renewal business increased 1.1% at December 31,

       2012, compared to 0.7% at December 31, 2011.  The private passenger auto
       year-over-year policy retention ratio was 92.1% at December 31, 2012,
       91.6% at December 31, 2011 and 91.8% at December 31, 2010.


• Homeowners renewal premiums written increased 11.5% in 2012, compared to

11.1% in 2011. The year-over-year average premium per policy on

homeowners renewal business increased 8.7% at December 31, 2012, compared

to 7.7% in 2011. The homeowners year-over-year policyholder retention

       ratio was 90.9% at December 31, 2012, and 91.0% at December 31, 2011 and
       90.9% at December 31, 2010.



Commercial lines - Total commercial lines premiums written increased 10.9%, to
$1.3 billion in 2012, from $1.2 billion in 2011, driven by a 4.7% increase in
total commercial lines policies in force and a 5.9% increase in the total
commercial lines year-over-year average premium per policy.

New business premiums written on commercial lines increased 24.5% in 2012,
compared to 6.7% in 2011, driven by increases in new business policies written
and average premium per policy.  The 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

                                       42

--------------------------------------------------------------------------------

Table of Contents

increased 6.5% in 2012, compared to the same period in 2011, while the year-over-year average premium per policy on commercial lines new business increased 16.9% at December 31, 2012, compared to 6.7% at December 31, 2011.


Renewal premiums for commercial lines increased 8.6% in 2012, compared to 8.8%
in 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 4.1% in 2012, compared to 4.4% in 2011.  The year-over-year policy
retention ratio for commercial lines was 86.2% at December 31, 2012, 85.5% at
December 31, 2011 and 85.3% at December 31, 2010.

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 book of business with the Property and Casualty Group.  At December 31,
2012, we had nearly 2,200 agencies with almost 10,200 licensed property and
casualty representatives.

Changes in premium levels attributable to the growth in policies in force
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
has contributed to the Property and Casualty Group's growth in new policies in
force and steady policy retention ratios.  The continued growth of our policy
base is dependent upon the Property and Casualty Group's ability to retain
existing policyholders and attract new policyholders.  A lack of new policy
growth or the inability to retain existing customers could have an adverse
effect on the Property and Casualty Group's premium level growth, and
consequently Indemnity's management fee.

Changes in premium levels attributable to rate changes also directly affect the
profitability of the Property and Casualty Group and have a direct bearing on
Indemnity's management fee.  Pricing actions contemplated or taken by the
Property and Casualty Group are subject to various regulatory requirements of
the states in which our insurers operate.  The pricing actions already
implemented, or to be implemented, have an effect on the market competitiveness
of our insurance products.  Such pricing actions, and those of competitors,
could affect the ability of our agents to retain and attract new business.  We
expect the Property and Casualty Group's pricing actions to result in a net
increase in direct written premium in 2013, however, exposure reductions and/or
changes in our mix of business as a result of economic conditions could impact
the average premium written by the Property and Casualty Group, as customers may
reduce coverages.

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 68.1% in 2012, compared to 68.6% in 2011 and 70.6% in 2010. The
personal lines loss and loss expense ratio related to the current accident year,
excluding catastrophe losses, was 68.5% in 2012, compared to 69.4% in 2011 and
70.4% in 2010. The commercial lines loss and loss expense ratio related to the
current accident year, excluding catastrophe losses, was 67.1% in 2012, compared
to 66.6% in 2011 and 71.3% in 2010.

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. The property catastrophe reinsurance coverage during 2012
included a first treaty that provided coverage of up to 90% of a loss of $500
million in excess of the Property and Casualty Group's loss retention of $350
million per occurrence, a second treaty that provided coverage of up to 70% of a
loss of $275 million in excess of $850 million, and a third treaty that provided
coverage of up to 70% of a loss of $25 million in excess of $1.125 billion. 

The

property catastrophe reinsurance treaties were renewed effective for January 1,
2013, with the first property catastrophe reinsurance treaty providing coverage
of up to 90% of a loss of $550 million in excess of the
Property and Casualty Group's loss retention of $350 million per occurrence, the
second treaty providing coverage of up to 70% of a loss of $225 million in
excess of $900 million, and a third treaty providing coverage of up to 70% of a
loss of $25 million in excess of $1.125 billion.


                                       43

--------------------------------------------------------------------------------

Table of Contents


While the Property and Casualty Group is exposed to terrorism losses in
commercial lines, including workers compensation, these lines are afforded a
limited backstop above insurer deductibles for foreign acts of terrorism under
the federal Terrorism Risk Insurance Program Reauthorization and Extension Act
of 2007 that continues through December 31, 2014.  There is no federal
assistance for personal lines terrorism losses.  Although current models suggest
the most likely occurrences would not have a material impact on the Property and
Casualty Group, there is a chance that if future terrorism attacks occur, the
Property and Casualty Group could incur large losses.

Catastrophe losses for the current accident year, as defined by the Property and
Casualty Group, totaled $489 million in 2012, $773 million in 2011 and $288
million in 2010, and contributed 11.0 points, 18.6 points and 7.3 points to the
respective loss ratios.

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
(in millions)                                              Years ended December 31,
                                                        2012           2011         2010
Direct business including salvage and subrogation   $     (92 )     $    (276 )   $ (188 )
Assumed reinsurance business                              (14 )           (22 )      (51 )
Ceded reinsurance business                                 (9 )            26         (5 )
Total prior year loss development                   $    (115 )     $    

(272 ) $ (244 )

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 - The following table presents the overall prior year loss development of direct reserves, including reserves for catastrophe losses and the effects of salvage and subrogation recoveries, for our personal and commercial lines' operations by accident year:

                      Property and Casualty Group
(in millions)          Years ended December 31,
                    2012           2011         2010
2011             $    (46 )     $       -     $    -
2010                  (27 )           (26 )        -
2009                   (7 )           (31 )      (60 )
2008                   (6 )           (14 )      (47 )
2007                   (5 )            (7 )      (39 )
2006                   (4 )            (8 )      (17 )
2005                   (3 )            (5 )      (17 )
2004                    1             (11 )        0
2003                   (4 )            (4 )       (9 )
2002 and prior          9            (170 )        1
Total            $    (92 )     $    (276 )   $ (188 )


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



The 2012 direct business favorable development, including reserves for
catastrophe losses and salvage and subrogation recoveries, totaled $92 million,
improved the combined ratio by 2.1 points and represented 2.6% of the net loss
reserves at December 31, 2011.  The most significant factors contributing to the
2012 favorable development were:

• Favorable development of $54 million related to the homeowners line of

business primarily resulting from improved claims frequency trends, which

impacted the 2011 accident year, better than expected severity trends,

       which impacted the 2007 through 2011 accident years, and the closing of
       one large claim which impacted the 2010 accident year.

• Favorable development of $42 million related to the commercial multi-peril

line of business primarily resulting from better than expected severity

trends, which impacted the 2007 through 2011 accident years, and the

closing of two large claims which impacted the 2006 through 2010 accident

       years.



                                       44

--------------------------------------------------------------------------------

Table of Contents

• Favorable development of $11 million related to the commercial auto line

of business primarily resulting from better than expected severity trends,

which impacted the 2007 through 2011 accident years.

• Adverse development of $15 million related to the workers compensation

       line of business primarily resulting from increased severity trends, which
       impacted accident years 2000 through 2008.



The 2011 direct business favorable development, including reserves for
catastrophe losses and salvage and subrogation recoveries, totaled $276 million,
improved the combined ratio by 6.7 points and represented 7.7% of the net loss
reserves at December 31, 2010.  The most significant factors contributing to the
2011 favorable development were:

• Favorable development of $125 million related to the personal auto line of

business, primarily resulting from better than expected severity trends on

automobile bodily injury and uninsured/underinsured motorist bodily injury

improved annual claims cost expectations, which impacted the more recent

accident years, and the closing of four pre-1986 automobile massive injury

lifetime medical claims.

• Favorable development of $95 million related to the workers compensation

line of business primarily resulting from the closing of seven massive

injury lifetime medical claims and better than expected severity trends,

which primarily impacted accident years related to 2001 and prior.

• Favorable development of $24 million related to the commercial multi-peril

line of business primarily resulting from better than expected severity

trends, which impacted the 2009 and 2010 accident years.

• Favorable development of $12 million related to the homeowners line of

business primarily resulting from better than expected severity trends,

which impacted the more recent accident years.




The 2010 direct business favorable development, including reserves for
catastrophe losses and salvage and subrogation recoveries, totaled $188 million,
improved the combined ratio by 4.8 points and represented 5.2% of the net loss
reserves at December 31, 2009.  The most significant factors contributing to the
2010 favorable development were:

• Favorable development of $64 million related to the commercial multi-peril

line of business and resulted primarily from improvements in severity

trends on both property and liability lines, which impacted various recent

       accident years.



• Favorable development of $60 million related to the personal auto line of

business and primarily resulted from better than expected severity trends

on automobile bodily injury and uninsured/underinsured motorist bodily

injury, which impacted the more recent accident years. An additional $8

       million of favorable development stems from the settlement of three
       pre-1986 automobile massive injury lifetime medical claims.


• Favorable development of $45 million related to the workers compensation

line of business and resulted primarily from improvements in severity

trends and the settlement of four workers compensation massive injury

lifetime medical claims, which impacted the more recent accident years.

• Adverse development of $39 million was experienced in 2010 as a result of

reserve strengthening on commercial liability claims which impacted the

2002 accident year. Of this amount, $9 million related to the commercial

multi-peril line of business and $30 million related to other commercial

       lines.



Additional information on direct loss reserve development is provided in Item 1.
"Business, Reserves for losses and loss expenses."  The variability in reserve
development over the ten year period illustrates the uncertainty of the loss
reserving process.  Conditions and trends that have affected reserve development
in the past will not necessarily recur in the future.  It is not appropriate to
extrapolate future favorable or unfavorable reserve development based upon
amounts experienced in prior years.

Assumed reinsurance - The Property and Casualty Group experienced favorable
development on prior accident year loss reserves for its assumed reinsurance
business totaling $14 million in 2012, compared to $22 million in 2011 and $51
million in 2010.  The favorable development in 2012, 2011 and 2010 was due to
less than anticipated growth in involuntary reinsurance.

Ceded reinsurance - The Property and Casualty Group's ceded reinsurance reserves
increased $9 million during 2012, compared to a decrease of $26 million in 2011
and an increase of $5 million in 2010. Ceded reinsurance reserves primarily
relate to the pre-1986 automobile massive injury claims.  An 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, while a decrease in ceded recoveries is reflected as adverse loss
development as it represents a decrease in recoveries resulting from

                                       45

--------------------------------------------------------------------------------

Table of Contents


favorable development on our direct loss reserves.  The increase in ceded
recoveries in 2012 was primarily the result of adverse development related to
the pre-1986 automobile massive injury claims. In 2011, the decrease in ceded
recoveries was primarily the result of the closing of four massive injury
lifetime medical claims.  In 2010, the increase in ceded recoveries was
primarily the result of adverse development related to the business catastrophe
liability line, offset by favorable development related to the pre-1986
automobile massive injury claims.

Policy acquisition and other underwriting expenses - Our policy acquisition and
other underwriting expense ratio increased 0.7 points to 29.1% in 2012 from
28.4% in 2011, and remained flat at 28.4% in 2011 compared to 2010.  The
increase in 2012 was primarily due to a decrease in the amount of policy
acquisition expenses deferred under the new accounting guidance effective in
2012.  Additionally, the year ended December 31, 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 25.0% in 2012,
2011 and 2010.

                                       46

--------------------------------------------------------------------------------

Table of Contents


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
                                                              Years ended December 31,
(in millions)                                                   %                      %
                                                 2012         Change      2011       Change      2010
Individual life premiums, net of
reinsurance                                 $     70          10.0 %    $    64       5.1 %    $    61
Group life and other premiums                      3           3.7            3       2.2            3
Other revenue                                      1          14.3            1      (4.8 )          1
Total net policy revenue                          74           9.9           68       4.8           65
Net investment income                             95           1.7           93      (1.1 )         94
Net realized gains on investments                  9         (33.8 )         13      (7.7 )         14
Impairment losses recognized in earnings           0          90.5           (1 )    57.9           (2 )
Equity in earnings (losses) of limited
partnerships                                       0            NM            4        NM            1
Total revenues                                   178           0.4          177       3.3          172
Benefits and other changes in policy
reserves                                         101           1.3          100      10.7           90
Amortization of deferred policy
acquisition costs                                 10         (12.3 )         12     (30.3 )         17
Other operating expenses                          21          32.5           15       3.4           15
Total benefits and expenses                      132           3.9          127       4.1          122
Income before income taxes                        46          (8.3 )%        50       1.2  %        50
Income before taxes - Indemnity(1)          $      0                    $     3                $    11
Income before taxes - Exchange(1)           $     46                    $    47                $    39



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 4.8% to $116 million in 2012, compared to $110
million in 2011, and $106 million in 2010.  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 $42 million in 2012, $43 million in 2011, and $42
million in 2010.

Premiums received on annuity and universal life products totaled $74 million,
$84 million, and $113 million in 2012, 2011 and 2010, 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 $58 million, $68 million, and $97 million in 2012, 2011 and 2010,
respectively.

Investment revenue
EFL's investment revenue in 2012 was primarily impacted by a decrease in net
realized gains on investments, as a result of 2011 having gains related to the
sale of preferred stock securities, and a decrease in equity in earnings of
limited partnerships resulting from a decline in the performance related to real
estate investments, compared to 2011. Offsetting these decreases in 2012 was a
slight increase in net investment income and low levels of impairments compared
to 2011. EFL's investment revenue in 2011 experienced an increase in equity in
earnings of limited partnerships compared to 2010, and continued to experience
an elevated level of realized gains on investments and low levels of impairments
in 2011, consistent with 2010.  See the discussion of investments in the
"Investment Operations" segment that follows for further information.

Benefits and expenses
Other operating expenses increased in 2012, compared to 2011, due to a decrease
in the amount of EFL's policy acquisition expenses deferred under the new
accounting guidance effective in 2012 and lower ceding commissions. In 2011,
EFL's benefits and other changes in policy reserves were primarily impacted by
increases in interest on annuity deposits, death benefits and future life policy
benefits, while the amortization of deferred policy acquisition costs decreased
as a result of declines in the earned and credited interest rates, compared to
2010.

                                       47

--------------------------------------------------------------------------------

Table of Contents


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
                                                           Years ended December 31,
(in millions)                                              %                     %
                                               2012      Change      2011      Change      2010
Indemnity
Net investment income(1)                     $   16       2.6 %    $   16     (56.8 )%   $   37
Net realized gains (losses) on
investments(1)                                    5      64.1           3        NM          (1 )
Net impairment losses recognized in
earnings(1)                                       0        NM           0        NM          (1 )
Equity in earnings of limited partnerships       15     (44.4 )        26      21.3          21
Net revenue from investment operations -
Indemnity(1)                                 $   36     (19.8 )%   $   45     (19.8 )%   $   56
Exchange
Net investment income(1)                     $  433       0.8 %    $  428       1.6 %    $  407
Net realized gains (losses) on
investments(1)                                  413        NM          (7 )      NM         314
Net impairment losses recognized in
earnings(1)                                       0        NM          (2 )   (52.8 )        (5 )
Equity in earnings of limited partnerships      116      (5.4 )       123      14.9         107
Goodwill impairment                               0        NM           0        NM         (22 )
Net revenue from investment operations -
Exchange(1)(2)                               $  962      77.4  %   $  542     (35.4 )%   $  801



NM = not meaningful

(1) As a result of the sale of Indemnity's property and casualty insurance

subsidiaries, EIC, ENY and EPC, to the Exchange on December 31, 2010,

investment revenue and losses generated from these entities will no longer

accrue to the Indemnity shareholder interest after this date. Investment

       revenue from these entities totaled $30 million in 2012, $28 million in
       2011, and $29 million in 2010. These components of investment income now

accrue to the interest of the subscribers (policyholders) of the Exchange,

       or noncontrolling interest, in 2011 and thereafter.



(2)    The Exchange's investment results include net investment revenues from
       EFL's operations of $104 million in 2012, $109 million in 2011, and $107
       million in 2010.




Net investment income
Net investment income primarily includes interest and dividends on our fixed
maturity and equity security portfolios.  Indemnity's net investment income was
unchanged in 2012, compared to 2011, and decreased by $21 million in 2011,
compared to 2010, while net investment income for the Exchange increased by $5
million and $21 million during the same respective periods.  The increase in net
investment income for the Exchange in 2012 was primarily due to higher invested
balances and higher dividend income from equity securities which more than
offset a decrease in income from fixed maturities due to lower reinvestment
yields.  The fluctuations in 2011 for both Indemnity and the Exchange were
primarily caused by the sale of EIC, ENY and EPC from Indemnity to the Exchange
on December 31, 2010.  These entities generated net investment income of $25
million in 2010.

Net realized gains (losses) on investments
Net realized gains and losses on investments include the changes in fair value
of common stocks designated as trading securities, and gains and losses
resulting from the actual sales of all security categories. Indemnity generated
net realized gains of $5 million in 2012, compared to gains of $3 million in
2011, and losses of $1 million in 2010.  The Exchange generated net realized
gains of $413 million in 2012, compared to losses of $7 million in 2011, and
gains of $314 million in 2010. In 2012, Indemnity's net realized gains were
primarily due to the favorable performance of its common stock portfolio
classified as trading securities, while realized gains for the Exchange were
primarily due to valuations adjustments and realized gains on the sale of common
stock securities reflecting favorable market performance. In 2011, Indemnity
recorded $6 million of realized gains on the sale of securities which was offset
by $3 million in valuation losses on its common stock portfolio, while the
Exchange recorded $240 million of realized gains on the sale of securities which
was offset by $247 million in valuation losses on its common stock portfolio.
 In 2010, Indemnity and the Exchange recognized losses on the sale of limited
partnerships of $12 million and $46 million, respectively.  These partnerships
were sold to recapture tax paid on previous period capital gains that were due
to expire. Losses on the sale of limited partnerships in 2010 were partially
offset by gains of $11 million from the sale of securities for Indemnity, which
included net realized gains of $5 million generated by EIC, ENY and EPC. The
Exchange recorded net gains of $314 million in 2010 despite losses on the sale
of limited partnerships due to valuation adjustments on common stocks of $254
million and realized gains of $106 million from the sale of securities.

                                       48

--------------------------------------------------------------------------------

Table of Contents


Net impairment losses recognized in earnings
Net impairment losses recognized in earnings for Indemnity were $0.1 million in
2012, compared to no impairments in 2011, and $1 million in 2010.  Impairment
losses for the Exchange totaled $0.1 million in 2012, compared to $2 million in
2011, and $5 million in 2010. Low levels of impairment losses are due to
continued improvements in market conditions for fixed maturity and preferred
stock securities since 2010.  EIC, ENY and EPC generated net impairment losses
of $1 million in 2010.
Equity in earnings of limited partnerships
Indemnity's equity in earnings of limited partnerships decreased by $11 million
in 2012, compared to 2011, and increased by $5 million in 2011, compared to
2010, while earnings for the Exchange decreased by $7 million and increased by
$16 million during the same respective periods. These changes in earnings for
both Indemnity and the Exchange were primarily due to the performance of real
estate investments.
A breakdown of our net realized gains (losses) on investments is as follows:
                                                              Erie Insurance Group
(in millions)                                               Years ended December 31,
                                                           2012           2011      2010
Indemnity
Securities sold:
Fixed maturities                                       $       0         $   2     $   5
Preferred stock equity securities                              0             3         1
Common stock equity securities                                 8             1         5
Common stock valuation adjustments                            (3 )          (3 )       0
Limited partnerships                                           0             0       (12 )
Total net realized gains (losses) - Indemnity (1)      $       5         $   3     $  (1 )
Exchange
Securities sold:
Fixed maturities                                       $      58         $  48     $  25
Preferred stock equity securities                              9            27        11
Common stock equity securities                               125           165        70
Common stock valuation adjustments                           221          (247 )     254
Limited partnerships                                           0            

0 (46 ) Total net realized gains (losses) - Exchange (1) (2) $ 413 $ (7 ) $ 314

(1) See Item 8. "Financial Statements and Supplementary Data - Note 7,

Investments, of Notes to Consolidated Financial Statements" contained

       within this report for additional disclosures regarding net realized gains
       (losses) on investments.


(2) The Exchange's results include net realized gains from EFL's operations of

$9 million in 2012, $13 million in 2011, and $14 million in 2010.




The components of equity in earnings of limited partnerships are as follows:
                                                                  Erie Insurance Group
(in millions)                                                   Years ended December 31,
                                                            2012             2011          2010
Indemnity
Private equity                                       $         7          $      10     $      14
Mezzanine debt                                                 5                  7             7
Real estate                                                    3                  9             0
Total equity in earnings of limited partnerships
- Indemnity                                          $        15          $      26     $      21
Exchange
Private equity                                               $61                $54           $77
Mezzanine debt                                                32                 24            27
Real estate                                                   23                 45             3
Total equity in earnings of limited partnerships
- Exchange (1)                                       $       116          $     123     $     107


(1) The Exchange's results include equity in earnings of limited partnerships from EFL's operations of $0.1 million in 2012, $4 million in 2011, and $0.5 million in 2010.




                                       49

--------------------------------------------------------------------------------

Table of Contents


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 December 31, 2012 reflect investment
valuation changes resulting from the financial markets and the economy through
September 30, 2012.

Goodwill impairment
Goodwill is reviewed for impairment at least annually or more frequently if
events occur or circumstances change that would indicate that a triggering event
has occurred.  Goodwill impairment testing follows a two step process.  In the
first step, the fair value of a reporting unit is compared to its carrying
value.  If the carrying value of a reporting unit exceeds its fair value, the
second step of the impairment test is performed for purposes of measuring the
impairment.

Prior to December 31, 2010, the Exchange had $22 million of goodwill
attributable to its purchase of EFL stock in 2006.  In the fourth quarter of
2010, the Exchange entered into an agreement to purchase Indemnity's 21.6%
ownership interest in EFL, and a valuation of EFL was performed by an external
independent third party in preparation for the sale, which occurred on March 31,
2011.  The valuation resulted in a purchase price determination of 95% of book
value.  In response to the valuation and sale price, management concluded that
the possibility for impairment existed and step two of the goodwill impairment
test was completed to determine the impairment amount.  Step two of the
impairment test compared the value of new business for EFL to the current
goodwill balance.  The analysis determined that the value of EFL's new business
did not support the $22 million goodwill, and an impairment entry was made to
write down the entire balance at December 31, 2010.  The charge of $22 million
decreased the net income attributable to the Exchange in 2010.


                                       50

--------------------------------------------------------------------------------

Table of Contents


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 December 31,
(in millions)                                                   % to                 % to
                                                 2012          total      2011      total
Indemnity
Fixed maturities                           $       452           66 %   $    548      68 %
Equity securities:
Preferred stock                                     29            4           25       3
Common stock                                        26            4           27       4
Limited partnerships:
Private equity                                      73           11           82      10
Mezzanine debt                                      27            4           35       4
Real estate                                         80           11           91      11
Real estate mortgage loans                           1            0            1       0
 Total investments - Indemnity             $       688          100 %   $    809     100 %
Exchange
Fixed maturities                           $     7,707           64 %   $  7,292      65 %
Equity securities:
Preferred stock                                    631            5          564       5
Common stock                                     2,731           22        2,308      21
Limited partnerships:
Private equity                                     482            4          495       4
Mezzanine debt                                     196            2          201       2
Real estate                                        359            3          386       3
Life policy loans                                   16            0           15       0
Real estate mortgage loans                           4            0            4       0
Total investments - Exchange               $    12,126          100 %   $ 11,265     100 %
Total investments - Erie Insurance Group   $    12,814                  $ 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.


                                       51

--------------------------------------------------------------------------------

Table of Contents


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 $185
million, or 41%, of the total fixed maturity portfolio for Indemnity and $1.3
billion, or 17%, of the fixed maturity portfolio for the Exchange at
December 31, 2012.  The overall credit rating of the municipal portfolio without
consideration of the underlying insurance is AA.

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 $10 million at December 31, 2012, compared to $8 million at
December 31, 2011.  At December 31, 2012, the Exchange had net unrealized gains
on fixed maturities of $449 million, compared to $301 million at December 31,
2011.

The following table presents a breakdown of the fair value of our fixed maturity
portfolio by sector and rating for Indemnity and the Exchange, respectively:
                                                     Erie Insurance Group (1)
(in millions)                                           December 31, 2012
                                                                         Non-investment       Fair
Industry Sector                AAA        AA         A         BBB            grade          value
Indemnity
Basic materials               $   0    $     0    $     0    $    10    $              0    $    10
Communications                    0          0         21          0                   0         21
Consumer                          0          0         19         18                   0         37
Energy                            0          0          5         24                   0         29
Financial                         0         34         39         36                  10        119
Government-municipal             84         74         20          7                   0        185
Industrial                        0          4          1          1                   0          6
Structured securities (2)         3          0          1          2                   0          6
Technology                        0          0          0         14                   0         14
Utilities                         0          0          3         22                   0         25
Total - Indemnity             $  87    $   112    $   109    $   134    $             10    $   452
Exchange
Basic materials               $   0    $     0    $    45    $   182    $              5    $   232
Communications                    0          0        187        340                  15        542
Consumer                          0         31        270        608                   9        918
Diversified                       0          0         22          0                   0         22
Energy                           16         43        146        374                  12        591
Financial                         1        200      1,108        985                 166      2,460
Foreign government                0          0         16          0                   0         16
Government-municipal            412        757        118         34                   0      1,321
Government sponsored entity       0         34          2          0                   0         36
Industrial                        0         11         73        230                  15        329
Structured securities (2)        33        294         55         19                   2        403
Technology                        0         10         54         88                   0        152
U.S. Treasury                     0        155          0          0                   0        155
Utilities                         0          0         74        419                  37        530
Total - Exchange              $ 462    $ 1,535    $ 2,170    $ 3,279    $            261    $ 7,707


(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.

                                       52

--------------------------------------------------------------------------------

Table of Contents


Equity securities
Our equity securities consist of common stock and nonredeemable preferred
stock.  Investment characteristics of common stock and nonredeemable 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 the Exchange, respectively:

                                     Erie Insurance Group
(in millions)                            Fair value at
                        December 31, 2012            December 31, 2011
                       Preferred       Common       Preferred       Common
 Industry sector         stock         stock          stock         stock
Indemnity
Communications      $      1          $     0    $      1          $     2
Consumer                   0                0           0               15
Diversified                3                0           0                1
Energy                     0                0           0                1
Financial                 15                0          11                4
Funds (1)                  0               26           0                0
Industrial                 0                0           0                3
Technology                 0                0           3                1
Utilities                 10                0          10                0
Total - Indemnity   $     29          $    26    $     25          $    27
Exchange
Basic materials     $      0          $    94    $      0          $    72
Communications            10              190           9              168
Consumer                   5              765           5              763
Diversified                2               21           0               18
Energy                     0              177           0              203
Financial                495              423         408              340
Funds (1)                  0              436           0              105
Government                 1                0           0                0
Industrial                 0              390           0              350
Technology                 0              197          15              246
Utilities                118               38         127               43
Total - Exchange    $    631          $ 2,731    $    564          $ 2,308


(1)     Includes certain exchange traded funds with underlying holdings of fixed
maturity securities totaling $26 million for Indemnity and $314 million for the
Exchange at December 31, 2012. These securities meet the criteria of a common
stock under U.S. GAAP, and are included on the balance sheet as
available-for-sale equity securities. Remaining common stock investments are
classified as trading securities.


Equity securities classified as available-for-sale include preferred and certain
common stock securities, 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 December 31, 2012, the unrealized
gain on equity securities classified as available-for-sale, net of deferred
taxes, amounted to $1 million for Indemnity and $48 million for the Exchange,
compared to an unrealized gain, net of deferred taxes, of $1 million for
Indemnity and $21 million for the Exchange at December 31, 2011.

Common stocks classified as trading securities are measured at fair value with all changes in unrealized gains and losses reflected in the Consolidated Statements of Operations.

                                       53

--------------------------------------------------------------------------------

Table of Contents


Limited partnerships
In 2012, investments in limited partnerships decreased modestly for Indemnity
and 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 decrease in limited
partnership investments was due to net distributions received from the
partnerships which were partially offset by increases in underlying asset
values. 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 at
December 31, 2012 reflect the partnership activity experienced through
September 30, 2012.

The components of limited partnership investments are as follows:

                                              Erie Insurance Group
(in millions)                                   At December 31,
                                                2012             2011
Indemnity
Private equity                           $        73           $    82
Mezzanine debt                                    27                35
Real estate                                       80                91
Total limited partnerships - Indemnity   $       180           $   208

Exchange

Private equity                           $       482           $   495
Mezzanine debt                                   196               201
Real estate                                      359               386
Total limited partnerships - Exchange    $     1,037           $ 1,082




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, inflation 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
(in millions)                                      At December 31,
                                                   2012                  2011
Gross reserve liability (1):
Personal auto                         $         1,169                  $ 1,093
Automobile massive injury                         351                      356
Homeowners                                        299                      313
Workers compensation                              512                      461
Workers compensation massive injury                99                       99
Commercial auto                                   340                      303
Commercial multi-peril                            557                      565
All other direct lines of business                166                      190
Assumed reinsurance                               105                      119
Gross reserves                                  3,598                    3,499
Less:  reinsurance recoverable                    154                      

151

Net reserve liability - Exchange      $         3,444                  $ 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 $85 million
and $84 million at December 31, 2012 and 2011, respectively.

                                       54

--------------------------------------------------------------------------------

Table of Contents


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 267 claimants requiring lifetime medical care, of which
109 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 $305 million at
December 31, 2012, which is net of $145 million of anticipated reinsurance
recoverables, compared to $315 million at December 31, 2011, which was net of
$140 million of anticipated reinsurance recoverables.  The pre-1986 automobile
massive injury gross reserves decreased at December 31, 2012, compared to
December 31, 2011, primarily due to the death of one claimant, while the workers
compensation massive injury gross reserves remained flat due to the death of one
claimant offset by the addition of one new claimant.

The estimation of ultimate liabilities for these claims is subject to
significant judgment due to variations in medical cost inflation, claimant
health and mortality over time.  It is anticipated that these massive injury
lifetime medical claims will require payments over the next 30 to 40 years.
Actual experience, however, may emerge in a manner that is different relative to
the original assumptions, which could have a significant impact on our reserve
estimates.  A 100-basis point change in the medical cost inflation assumption
would result in a change in the combined automobile and workers compensation
massive injury reserves of $57 million.  Massive injury claims payments totaled
$13 million, $15 million, and $21 million in 2012, 2011 and 2010, respectively.

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.

Shareholders' Equity
Pension plan
The funded status of our postretirement benefit plans is recognized in the
statement of financial position, with a corresponding adjustment to accumulated
other comprehensive income, net of tax. At December 31, 2012, shareholders'
equity decreased by $30 million, net of tax, of which $8 million represents
amortization of the prior service cost and net actuarial loss and $38 million
represents the current period actuarial loss.  The 2012 actuarial loss was
primarily due to the change in the discount rate assumption used to measure the
future benefit obligations to 4.19% in 2012, from 4.99% in 2011. At December 31,
2011, shareholders' equity decreased by $41 million, net of tax, of which $5
million represents amortization of the prior service cost and net actuarial loss
and $46 million represents the current period actuarial loss.  The 2011
actuarial loss was primarily due to the change in the discount rate assumption
used to measure the future benefit obligations to 4.99% in 2011, from 5.69% in
2010. Although Indemnity is the sponsor of these postretirement plans and
records the funded status of these plans, the Exchange and EFL reimburse
Indemnity for approximately 58% of the annual benefit expense of these plans,
which represents pension benefits for Indemnity employees performing claims and
life functions.

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.

                                       55

--------------------------------------------------------------------------------

Table of Contents

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 operations 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 2013.

Cash flow activities - Erie Insurance Group
The following table provides condensed consolidated cash flow information for
the years ended December 31:

(in millions)                                    Erie Insurance Group
                                              2012        2011      2010

Net cash provided by operating activities $ 577$ 360$ 721 Net cash used in investing activities

           (85 )     (375 )    (405 )

Net cash used in financing activities (277 ) (230 ) (120 ) Net increase (decrease) in cash

             $   215     $ (245 )   $ 196




Net cash provided by operating activities totaled $577 million in 2012, $360
million in 2011, and $721 million in 2010.  Increased cash from operating
activities in 2012 was driven primarily by an increase in 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 2011. The decrease in 2011,
compared to 2010, was primarily driven by increased losses paid to policyholders
related to catastrophic events and commissions paid to agents, offset by
increases in premiums collected by the Exchange and limited partnership
distributions received.

At December 31, 2012, we recorded a net deferred tax asset of $37 million
related to Indemnity and a net deferred tax liability of $365 million related to
the Exchange.  There was no valuation allowance at December 31, 2012.  In the
fourth quarter of 2012 we received tax refunds of $17 million and $32 million
related to the overpayment of taxes for tax years 2010 and 2011, respectively.
In the fourth quarter of 2011 we received a tax refund of $8 million related to
the carry-back of 2010 capital losses and a refund of $1 million related to the
2010 return.  Our 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 investing activities totaled $85 million in 2012, $375 million
in 2011, and $405 million in 2010.  Investing activities in 2012 primarily
included increased cash used to purchase fixed maturities, offset somewhat by
increased cash generated from the sale of other fixed maturities compared to
2011.  At December 31, 2012, we had contractual commitments to invest up to $427
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 $172
million, mezzanine debt securities was $155 million, and real estate activities
was $100 million.  In 2011, cash used in investing activities decreased compared
to 2010 as we generated more proceeds from the sale of common stocks offset
somewhat by an increase in cash used to purchase other common stock investments.


                                       56

--------------------------------------------------------------------------------

Table of Contents


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 years ended
December 31:

(in millions)                                                  Indemnity Shareholder Interest
                                                           2012              2011             2010
Net cash provided by operating activities             $       205       $       169       $       193
Net cash provided by (used in) investing activities            95              (211 )             196
Net cash used in financing activities                        (299 )            (257 )            (155 )
Net increase (decrease) in cash                       $         1       $      (299 )     $       234



See Item 8. "Financial Statements and Supplementary Data - Note 23, Indemnity Supplemental Information, of Notes to Consolidated Financial Statements" contained within this report for more detail on Indemnity's cash flows.


Net cash provided by Indemnity's operating activities increased to $205 million
in 2012, compared to $169 million in 2011, and $193 million in 2010.  Increased
cash from operating activities in 2012 was primarily due to increases in
management fee revenue and net investment income received. Offsetting these
increases were increases in commissions paid to agents, general operating
expenses paid, and cash paid for salaries and wages compared to 2011.
Management fee revenues were higher reflecting the increase in premiums written
or assumed by the Exchange.  Cash paid for agent commissions and bonuses
increased to $617 million in 2012, compared to $583 million in 2011, as a result
of an increase in cash paid for ordinary commissions.  Indemnity made a $16
million contribution to its pension plan in 2012, compared to $15 million in
2011.  Additionally, Indemnity made a contribution to its pension plan for $17
million in January 2013.  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 reimbursed approximately 58% of
the net periodic benefit cost of the pension plan from its affiliates, which
represents pension benefits for Indemnity employees performing claims and life
functions.  In 2011, decreased cash from operating activities, compared to 2010,
was primarily due to increases in commissions paid to agents, salaries and
benefits paid to employees and income taxes paid, combined with less net
investment income received, offset somewhat by an increase in management fee
revenue received.

At December 31, 2012, Indemnity recorded a net deferred tax asset of $37 million. There was no valuation allowance at December 31, 2012.


Net cash provided by Indemnity's investing activities totaled $95 million in
2012, compared to cash used of $211 million in 2011, and cash provided of $196
million in 2010.  Indemnity's 2012 investing activities included increased cash
generated from the sale of fixed maturities and common stocks combined with
decreased cash used to purchase other fixed maturities compared to 2011.  Also
impacting Indemnity's future investing activities are limited partnership
commitments, which totaled $38 million at December 31, 2012, and will 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 $15 million, mezzanine debt securities was $10 million, and real
estate activities was $13 million.  Indemnity's investing activities in 2011
included increased cash used to purchase fixed maturities, offset somewhat by
increased cash from the sale of other fixed maturities and common stocks as
compared to 2010.

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, on March 18, 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.  In the fourth quarter of 2010,
Indemnity received cash consideration from the Exchange of $281 million, net of
$12 million cash disposed, as a result of the sale of EIC, ENY and EPC, to the
Exchange on December 31, 2010, which was based upon an estimated purchase
price.  At this time, Indemnity recorded an $8 million liability to the Exchange
for the difference between the GAAP book value and the deferred tax asset, which
was payable to the Exchange by March 31, 2011.  Net after-tax cash proceeds to
Indemnity from this sale were $285 million.


                                       57

--------------------------------------------------------------------------------

Table of Contents


Net cash used in Indemnity's financing activities totaled $299 million in 2012,
$257 million in 2011, and $155 million in 2010.  The increase in cash used in
financing activities in 2012 was primarily driven by an increase in the cash
outlay for dividends paid to shareholders and the purchase of treasury stock.
Dividends paid to shareholders totaled $229 million, $102 million and $98
million in 2012, 2011 and 2010, respectively. Indemnity increased both its Class
A and Class B shareholder regular quarterly dividends for 2012 and 2011.  In
addition to the regular quarterly dividend declared in November 2012, the Board
also declared a special one-time cash dividend of $2.00 on each Class A share
and $300.00 on each Class B share, totaling $95 million. The payment of both the
regular and special dividend was made in December 2012 due to the potential
significant increases in tax rates on 2013 dividend income pending at the time
of declaration. In prior years, the regular quarterly dividend was declared by
the Board at its December meeting and paid in January of the following year.
There are no regulatory restrictions on the payment of dividends to Indemnity's
shareholders.  Dividends have been approved at a 7.2% increase for 2013.
Indemnity repurchased 1.0 million shares of its Class A nonvoting common stock
in conjunction with its stock repurchase program at a total cost of $70 million
in 2012, based upon settlement date.  In 2011, shares repurchased under this
program totaled 2.2 million at a total cost of $155 million, compared to 1.1
million shares at a total cost of $57 million in 2010.  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 includes, and is not in addition to, any unspent amounts remaining
under the prior authorization.  Indemnity had approximately $68 million of
repurchase authority remaining under this program at December 31, 2012, based
upon trade date.

In 2012, we also repurchased 1,803 shares of our outstanding Class A nonvoting
common stock outside of our publicly announced share repurchase program at a
total cost of $129,849 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 2012 and June 2012, respectively.

In July 2011, we repurchased 64,095 shares of our outstanding Class A nonvoting
common stock outside of our publicly announced share repurchase program at a
total cost of $5 million in conjunction with our long-term incentive plan, and
for the vesting of stock-based awards for executive management.  These shares
were delivered to plan participants and executive management, respectively, in
July 2011.

In 2010, we repurchased 44,206 shares of our outstanding Class A nonvoting
common stock outside of our publicly announced share repurchase program at a
total cost of $2 million in conjunction with our long-term incentive plan, and
for the vesting of stock-based awards for executive management.  These shares
were delivered to plan participants and executive management, respectively, in
July 2010.
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 December 31, 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 $389
million at December 31, 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 December 31, 2012.  At
December 31, 2012, bonds with fair values of $108 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 December 31,
2012.

Prior to and through December 31, 2010, the underwriting results retained by EIC
and ENY and the investment results of EIC, ENY and EPC accrued to the Indemnity
shareholder interest.  Due to the sale of Indemnity's property and casualty
insurance subsidiaries to the Exchange on December 31, 2010, all property and
casualty underwriting results and all investment results for these companies
accrue to the interest of the subscribers (policyholders) of the Exchange, or
noncontrolling interest, after December 31, 2010.  The net cash provided from
these entities by operating activities totaled $30 million in 2010.  These
operating cash flows accrue to the interest of the subscribers (policyholders)
of the Exchange, or noncontrolling interest, in 2011 and thereafter.

                                       58

--------------------------------------------------------------------------------

Table of Contents

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 $388 million at December 31, 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 $10.5 billion at December 31, 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 December 31, 2012.
At December 31, 2012, bonds with fair values of $323 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
December 31, 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 2013.

Contractual Obligations
Cash outflows for the Property and Casualty Group are variable because the
fluctuations in settlement dates for claims payments vary and cannot be
predicted with absolute certainty.  While volatility in claims payments could be
significant for the Property and Casualty Group, the cash flow requirements for
claims have not historically had a significant effect on our liquidity.  Based
upon a historical 15 year average, approximately 30% of losses and loss expenses
included in reserves for the Property and Casualty Group are paid out within the
first 12 months, and approximately 70% are paid out within the first five
years.  Amounts that are paid out after the first five years reflect long-tail
lines such as workers compensation and auto bodily injury.


                                       59

--------------------------------------------------------------------------------

Table of Contents


We have certain obligations and commitments to make future payments under
various contracts.  As of December 31, 2012, the aggregate obligations were as
follows:

                                                                          Erie Insurance Group
(in millions)                                                            Payments due by period
                                                                                                             2018 and
                                                 Total       2013        2014- 2015       2016- 2017        thereafter
Fixed obligations:
Indemnity:
Limited partnership commitments(1)             $    38     $    38     $          0     $          0     $            0
Pension contribution(2)                             17          17                0                0                  0
Other commitments(3)                                51          23               27                1                  0
Operating leases - vehicles                         15           4                8                3                  0
Operating leases - real estate(4)                    5           2                2                1                  0
Operating leases - computer equipment                2           1                1                0                  0
Financing arrangements                               1           1                0                0                  0
Total fixed contractual obligations -
Indemnity                                          129          86               38                5                  0
Noncontrolling interest:
Limited partnership commitments(1)                 389         242               38               98                 11
Total fixed contractual obligations -
Exchange                                           389         242               38               98                 11

Total fixed contractual obligations - Erie
Insurance Group                                    518         328               76              103                 11
Gross property and casualty loss and loss
expense reserves - Exchange                      3,598       1,151            1,043              432                972
Life gross long-term liabilities(5)              4,548         198              422              420              3,508
Gross contractual obligations - Erie
Insurance Group                                $ 8,664     $ 1,677     $      1,541     $        955     $        4,491




Gross contractual obligations net of estimated reinsurance recoverables are as
follows:

                                                                          Erie Insurance Group
(in millions)                                                            Payments due by period
                                                                                                             2018 and
                                                 Total       2013        2014- 2015       2016- 2017        thereafter
Gross contractual obligations - Erie
Insurance Group                                $ 8,664     $ 1,677     $      1,541     $        955     $        4,491
Estimated reinsurance recoverables -
property and casualty                              154           6               14               12                122

Estimated reinsurance recoverables - life(6) 482 26

      50               53                353
Net contractual obligations - Erie Insurance
Group                                          $ 8,028     $ 1,645     $      1,477     $        890     $        4,016



(1) Limited partnership commitments will be funded as required for capital

contributions at any time prior to the agreement expiration date. The

commitment amounts are presented using the expiration date as the factor

by which to age when the amounts are due. At December 31, 2012,

Indemnity's total commitment to fund limited partnerships that invest in

private equity securities is $15 million, mezzanine debt of $10 million,

and real estate activities $13 million. At December 31, 2012, the

Exchange's total commitment to fund limited partnerships that invest in

private equity securities is $157 million, mezzanine debt of $145 million,

       and real estate activities $87 million.


(2)    The pension contribution for 2013 was estimated in accordance with the

Pension Protection Act of 2006. Contributions anticipated in future years

depend upon certain factors that cannot be reasonably predicted. If

contributions become required in future years, they will be in an amount

at least equal to the IRS minimum required contribution in accordance with

this Act. The obligations for our unfunded benefit plans, including the

Supplemental Employee Retirement Plan (SERP) for our executive and senior

       management, are not included in gross contractual obligations.  The
       recorded accumulated benefit obligation for this plan at December 31,
       2012, is $8 million. We expect to have sufficient cash flows from
       operations to meet the future benefit payments as they become due.


(3)    Other commitments include various agreements for service, including such
       things as computer software, telephones and maintenance.


(4)    Operating leases-real estate are for 16 of our 24 field offices that are
       operated in the states in which the Property and Casualty Group does

business and two operating leases are for warehousing facilities leased

from unaffiliated parties.

(5) Life gross long-term liabilities represent estimated benefit payments from

insurance policies and annuity contracts including claims currently

payable. Actual obligations in any single year will vary based upon

actual mortality, morbidity, lapse and withdrawal experience. The sum of

these obligations exceeds the liability on the Consolidated Statements of

       Financial Position of $1.7 billion due to expected future premiums and
       investment income that, along with invested assets backing the
       liabilities, will be used to fund these obligations.


(6)    Reinsurance recoverables on life business includes estimated amounts from
       reinsurers on long-term liabilities that are subject to the credit
       worthiness of the reinsurer.



                                       60

--------------------------------------------------------------------------------

Table of Contents


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 limited partnership investment
commitments.

Financial Ratings
Our property and casualty insurers are rated by rating agencies that provide
insurance consumers with meaningful information on the financial strength of
insurance entities.  Higher ratings generally indicate financial stability and a
strong ability to pay claims.  The ratings are generally based upon factors
relevant to policyholders and are not directed toward return to investors.  The
insurers of the Property and Casualty Group are currently rated by AM Best
Company as follows:

  Erie Insurance Exchange                      A+
  Erie Insurance Company                       A+
  Erie Insurance Property and Casualty Company A+
  Erie Insurance Company of New York           A+
  Flagship City Insurance Company              A+
  Erie Family Life Insurance Company           A



The outlook for all ratings is stable.  According to AM Best, a "Superior"
rating (A+), the second highest of their financial strength rating categories,
is assigned to those companies that, in AM Best's opinion, have achieved
superior overall performance when compared to the standards established by AM
Best and have a superior ability to meet their obligations to policyholders over
the long term.  Only 9.4% of insurance groups are rated A+ or higher, and we are
included in that group.  By virtue of its affiliation with the Property and
Casualty Group, EFL is typically rated one level lower, or an "Excellent" rating
(A), than our property and casualty insurance companies by AM Best Company. 

The

insurers of the Property and Casualty Group are also rated by Standard & Poor's,
but this rating is based solely on public information.  Standard & Poor's rates
these insurers Api, "strong." Financial strength ratings continue to be an
important factor in evaluating the competitive position of insurance companies.

Regulatory Risk-Based Capital
The standard set by the National Association of Insurance Commissioners (NAIC)
for measuring the solvency of insurance companies, referred to as Risk-Based
Capital (RBC), is a method of measuring the minimum amount of capital
appropriate for an insurance company to support its overall business operations
in consideration of its size and risk profile.  The RBC formula is used by state
insurance regulators as an early warning tool to identify, for the purpose of
initiating regulatory action, insurance companies that potentially are
inadequately capitalized.  In addition, the formula defines minimum capital
standards that will supplement the current system of low fixed minimum capital
and surplus requirements on a state-by-state basis.  At December 31, 2012, the
members of the Property and Casualty Group and EFL had RBC levels substantially
in excess of levels that would require regulatory action.

Regulatory Restrictions on Surplus
The members of the Property and Casualty Group and EFL are subject to various
regulatory restrictions that limit the maximum amount of dividends available to
be paid without prior approval by insurance regulatory authorities.  The
Exchange's property and casualty insurance subsidiaries have a maximum of $31
million available for such dividends in 2013 without prior approval by the
Pennsylvania Insurance Commissioner for Pennsylvania-domiciled subsidiaries and
the New York Superintendent of Insurance for the New York domiciled subsidiary.
No dividends were paid from the property and casualty insurance subsidiaries in
2012, 2011 or 2010.

The maximum dividend EFL could pay the Exchange in 2013 without prior approval
is $28 million.  No dividends were paid to Indemnity or the Exchange in 2012,
2011 or 2010.

The Exchange is operated for the interest of its subscribers (policyholders) and
any distributions it might declare would only be payable to them.  The Exchange
did not make any distributions to its subscribers (policyholders) in 2012, 2011
or 2010.

                                       61

--------------------------------------------------------------------------------

Table of Contents


Enterprise Risk Management
We are exposed to many risks as a large property and casualty insurer with
supplemental life insurance operations.  The role of our Enterprise Risk
Management (ERM) function is to ensure that all significant risks are clearly
identified, understood, proactively managed and consistently monitored to
achieve strategic objectives for all stakeholders of the Erie Insurance Group.
As an insurance company, we are in the business of taking risks from our
policyholders, managing these risks in a cost-effective manner and ensuring long
term stability for policyholders as well as shareholders.  Since risk is
integral to our business, we strive to manage the multitude of risks we face in
an optimal manner.

Our risks can be broadly classified into insurance, investment and operational
risks.  These risks are a consequence of our chosen business segments, the
market and regulatory environment within which we operate, and unplanned
operational events that can impact any business.  Since certain risks can occur
simultaneously or be correlated with other risks, an event or a series of events
has the potential to impact multiple areas of our business and materially affect
our operations, financial position or liquidity.  Therefore our ERM program
takes a holistic view of risk and ensures implementation of risk responses to
mitigate potential impacts across our entire group of companies.

Our ERM process is founded on a governance framework that includes oversight at
multiple levels of our organization, including our Board of Directors and risk
committees made up of senior management.  Accountability to identify, manage and
mitigate risk is embedded within all functions and areas of our business.  We
have defined risk tolerances to monitor and manage significant risks within
acceptable levels.  In addition to identifying, evaluating, prioritizing,
monitoring and mitigating significant risks, our ERM process includes extreme
event analyses and scenario testing.  Dynamic Financial Analysis (DFA) and
catastrophe modeling enable us to quantify risk within our property and casualty
insurance operations and investment portfolio.  Model output is used to quantify
the potential variability of future performance and the sufficiency of capital
levels given our defined tolerance for risk.  These models provide insight into
capital management, allocation of capital by product lines, catastrophe exposure
management and reinsurance purchasing decisions.  Additionally, ERM tools have
been developed and modified to enhance our ability to assess project level risk
and to provide senior management with pertinent risk information, enabling them
to make better informed decisions.

                                       62

--------------------------------------------------------------------------------

Table of Contents

TRANSACTIONS / AGREEMENTS BETWEEN INDEMNITY AND NONCONTROLLING INTEREST (EXCHANGE)


Board Oversight
Our Board of Directors has a broad oversight responsibility over our
intercompany relationships within and among the Property and Casualty Group.  As
a consequence, our Board of Directors may be required to make decisions or take
actions that may not be solely in the interest of our shareholders, such as
setting the management fee rate paid by the Exchange to Indemnity and ratifying
any other significant intercompany activity.

Subscriber's Agreement
Indemnity serves as attorney-in-fact for the policyholders at the Exchange, a
reciprocal insurance exchange.  Each applicant for insurance to a reciprocal
insurance exchange signs a subscriber's agreement that contains an appointment
of an attorney-in-fact.  Through the designation of attorney-in-fact, Indemnity
is required to provide sales, underwriting and policy issuance services to the
policyholders of the Exchange, as discussed previously.  Pursuant to the
subscriber's agreement, Indemnity earns a management fee for these services
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.

Intercompany Agreements
Pooling
Members of the Property and Casualty Group participate in an intercompany
reinsurance pooling agreement.  Under the pooling agreement, all insurance
business of the Property and Casualty Group is pooled in the Exchange.  The Erie
Insurance Company and Erie Insurance Company of New York share in the
underwriting results of the reinsurance pool through retrocession.  Since 1995,
the Board of Directors has set the allocation of the pooled underwriting results
at 5.0% participation for Erie Insurance Company, 0.5% participation for Erie
Insurance Company of New York, and 94.5% participation for the Exchange.

Prior to and through December 31, 2010, the underwriting results retained by
Erie Insurance Company and Erie Insurance Company of New York accrued to the
Indemnity shareholder interest.  Due to the sale of Indemnity's property and
casualty insurance subsidiaries to the Exchange on December 31, 2010, all
property and casualty underwriting results for these companies accrue to the
interest of the subscribers (policyholders) of the Exchange, or noncontrolling
interest, after December 31, 2010.

Service agreements
Indemnity makes certain payments on behalf of the Erie Insurance Group's related
entities.  These amounts are reimbursed to Indemnity on a cost basis in
accordance with service agreements between Indemnity and the individual entities
within the Erie Insurance Group.  These reimbursements are settled on a monthly
basis.

Leased property
The Exchange leases certain office space to Indemnity, including the home office
and three field office facilities.  Rents are determined considering returns on
invested capital and building operating and overhead costs.  Rental costs of
shared facilities are allocated based upon square footage occupied.

Cost Allocation
The allocation of costs affects the financial condition of the Erie Insurance
Group companies.  Management's role is to determine that allocations are
consistently made in accordance with the subscriber's agreements with the
policyholders at the Exchange, intercompany service agreements and applicable
insurance laws and regulations.  Allocation of costs under these various
agreements requires judgment and interpretation, and such allocations are
performed using a consistent methodology, which is intended to adhere to the
terms and intentions of the underlying agreements.


                                       63

--------------------------------------------------------------------------------

Table of Contents

Intercompany Receivables of Indemnity

                                                            Indemnity Shareholder Interest
                                                  Percent of               Percent of               Percent of
                                                   Indemnity                Indemnity                Indemnity
                                                     total                    total                    total
(in millions)                            2012       assets        2011       assets        2010       assets
Receivables from the Exchange and
other affiliates (management fees,
costs and reimbursements)              $  281         24.2 %    $  254         20.5 %    $  232         17.7 %
Note receivable from EFL                   25          2.2          25      

2.0 25 1.9

Total intercompany receivables $ 306 26.4 % $ 279

   22.5 %    $  257         19.6 %




Indemnity has significant receivables from the Exchange that result in a
concentration of credit risk.  These receivables include management fees due for
services performed by Indemnity for the Exchange under the subscriber's
agreement, and costs Indemnity pays on behalf of the Exchange. Credit risks
related to the receivables from the Exchange are evaluated periodically by
management. Indemnity also pays certain costs for, and is reimbursed monthly by,
EFL. The receivable from the Exchange for management fees and costs Indemnity
pays on behalf of the Exchange is settled monthly.

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 by the Pennsylvania Insurance Commissioner.
Interest payments are scheduled to be paid semi-annually. Indemnity recognized
interest income on the note of $2 million in both 2012 and 2011.

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 by the Pennsylvania Insurance Commissioner.
Interest payments are scheduled to be paid semi-annually. The Exchange
recognized interest income on the note of $1 million in both 2012 and 2011.

                                       64

--------------------------------------------------------------------------------

Table of Contents

Wordcount: 27151



USER COMMENTS:

comments powered by Disqus

  More Newswires

More Newswires >>
  Most Popular Newswires

More Popular Newswires >>
Hot Off the Wires  Hot off the Wires

More Hot News >>

insider icon Denotes premium content. Learn more about becoming an Insider here.
Do your IULs have options like these?