Beyond Baffling
The arcane but significant accounting drama simmering beneath the surface at Erie Indemnity.
There’s something about Erie Indemnity ERIE 0.00%↑ that is beyond baffling…
When I first wrote about the company in September, my focus was on how nuts the rise in its stock was – and how vulnerable it was to tumbling. It was around $500 at the time, up 40% in a mere two months.
Its shares have since done a near-complete round-trip, but there’s an element to the story I didn’t touch on the first time around that’s worthy of watching now if for no other reason: it shows how arbitrary and seemingly random and irrational changes in accounting rules can appear be.
That’s especially true when those changes can significantly help improve a company’s reported financial results.
Before you go thinking this is all too wonky, well, if you dig deeply enough – it is. And that’s very likely why nobody has ever questioned it before. Not only does this deal with the depths of arcane accounting, but it’s a company that until fairly recently had little to no coverage on Wall Street and was off most everybody’s radar.
Now You See It, Now You Don’t…
But if you strip away the accounting and legal gobbledygook, in its simplest form it really amounts to this: How can one day Erie or any company be forced to consolidate the financials of a related party, and the next day – with a change in “standards” – it doesn’t? And how can it be that one day the related party is not a Variable Interest Entity, or VIE; the next day it is… and then a few years later it isn’t?
As a favor, my friend Francine McKenna, who writes The Dig newsletter – and knows more about the ins-and-outs of the accounting world than most people have forgotten, not to mention where the bodies are buried – took a peek at the situation.
Her view, and more, in a second; but first a reminder of the nuts and bolts about what Erie is…
Erie is a so-called “attorney-in-fact” for an insurance company.
It’s REAL Business
In reality, it’s kind of like a glorified third-party agent, except with some power of attorney, doing all of the back-office work for its one and only customer, the Erie Mutual Exchange. The Exchange, as it’s known, is a related entity owned by Erie policyholders, or “subscribers,” who bought insurance through a half-dozen-related insurance companies that operate in 12 states and the District of Columbia.
In its role, Erie takes no actuarial risk, but instead does administrative services, such as issuing policies, handling claims, managing investments and providing customer service for the Exchange.
In return, it gets a management fee of as high as 25%. That administrative fee, for a single customer, is its entire business model. It lives and dies by that fee. I lay all of that out in my prior report..
Therein Lies Our Story…
But simmering beneath the surface there has been a nagging question, which reveals a dark comedy surrounding the seemingly arbitrary whims and interpretations of the accounting industry…