NOTICE OF ANNUAL MEETING OF SHAREHOLDERS

TO BE HELD APRIL 22, 2008

 

To the Holders of Class A Common Stock and
Class B Common Stock of ERIE INDEMNITY COMPANY:

 

We will hold our annual meeting of shareholders at 9:30 a.m., local time, on Tuesday, April 22, 2008, at the Auditorium of the F.W. Hirt-Perry Square Building, 100 Erie Insurance Place (Sixth and French Streets), Erie, Pennsylvania 16530 for the following purposes:

 

1. To elect 11 persons to serve as directors until our 2009 annual meeting of shareholders and until their successors are elected; and

 

2. To transact any other business that may properly come before our annual meeting and any adjournment, postponement or continuation thereof.

 

In the event that our annual meeting is adjourned:

 

 

This notice and proxy statement, together with a copy of our annual report to shareholders for the year ended December 31, 2007, are being sent to all holders of Class A common stock and Class B common stock as of the close of business on Friday, February 15, 2008, the record date established by our board of directors. Holders of Class B common stock will also receive a form of proxy in accordance with Securities and Exchange Commission rules. Holders of Class A common stock will not receive proxies because they do not have the right to vote on any of the matters to be acted upon at our annual meeting.

 

Holders of Class B common stock are requested to complete, sign and return the enclosed form of proxy in the envelope provided, whether or not they expect to attend our annual meeting in person.

 

By order of our board of directors,

James J. Tanous

Executive Vice President,

Secretary and General Counsel

 

March 24, 2008

Erie, Pennsylvania

 

ERIE INDEMNITY COMPANY

 

 

 

PROXY STATEMENT

 

 

 

Unless the context indicates otherwise, all references in this proxy statement to “we,” “us,” “our” or the “Company” mean Erie Indemnity Company and our three property and casualty insurance subsidiaries. Our property and casualty insurance subsidiaries are Erie Insurance Company, or “Erie Insurance Co.,” Erie Insurance Company of New York, or “Erie NY,” and Erie Insurance Property & Casualty Company, or “EI P&C.” We sometimes refer to Erie Insurance Exchange as the “Exchange” and to the Exchange, its subsidiary and our three property and casualty insurance subsidiaries as the “Property and Casualty Group.” In addition, we hold investments in both affiliated and unaffiliated entities, including a 21.63% interest in the common stock (“EFL Common Stock”) of Erie Family Life Insurance Company, or “EFL,” a life insurance company. The Exchange owns 78.37% of EFL’s Common Stock.

 

 

 

TABLE OF CONTENTS

 

ERIE INDEMNITY COMPANY

 

100 Erie Insurance Place

Erie, Pennsylvania 16530

 

 

PROXY STATEMENT

 

 

This proxy statement, which is first being mailed to the holders of our Class A common stock and our Class B common stock on or about March 24, 2008, is furnished to such holders to provide information regarding us and our 2008 annual meeting of shareholders. This proxy statement is also being furnished in connection with the solicitation of proxies by our board of directors from holders of Class B common stock to be voted at our 2008 annual meeting of shareholders and at any adjournment, postponement or continuation thereof. Our annual meeting will be held at 9:30 a.m., local time, on Tuesday, April 22, 2008 at the Auditorium of the F.W. Hirt-Perry Square Building, 100 Erie Insurance Place (Sixth and French Streets), Erie, Pennsylvania 16530. Holders of Class B common stock will also receive a form of proxy in accordance with Securities and Exchange Commission, or “SEC,” rules.

 

Shares of Class B common stock represented by proxies in the accompanying form, if properly signed and returned, will be voted in accordance with the specifications made thereon by the holders of Class B common stock. Any proxy representing shares of Class B common stock not specifying to the contrary will be voted for the election of the candidates for director named below, who were nominated by the nominating and governance committee of our board of directors, or our “nominating committee.”

 

See “Other Matters” for a discussion of certain discretionary voting authority. A holder of Class B common stock who signs and returns a proxy in the accompanying form may revoke it at any time before it is voted by giving written notice of revocation to our secretary, by furnishing a duly executed proxy bearing a later date to our secretary or by attending our annual meeting and advising our secretary that such holder intends to vote in person.

 

We will bear the cost of solicitation of proxies in the accompanying form, including expenses in connection with preparing and mailing this proxy statement. Such solicitation will be made by mail and may also be made on our behalf by our officers and regular employees in person, by e-mail or by telephone. None of these persons will receive special compensation for such services. We, upon request therefor, will also reimburse brokers, nominees, fiduciaries and custodians or persons holding shares of Class A common stock and Class B common stock in their names or in the names of nominees for their reasonable expenses in forwarding our proxy material to beneficial owners.

 

Only holders of Class B common stock of record at the close of business on February 15, 2008 are entitled to vote at our annual meeting. Each share of Class B common stock is entitled to one vote on each matter to be considered at our annual meeting. Except as is otherwise provided in Sections 1756(b)(1) and (2) of the Pennsylvania Business Corporation Law of 1988, or the “BCL,” in the case of adjourned meetings, a majority of the outstanding shares of Class B common stock will constitute a quorum at our annual meeting for the election of directors. Cumulative voting rights do not exist with respect to the election of directors. Of the 11 candidates for election as a director, only those who receive the affirmative vote of holders of a majority of the shares of Class B common stock will be elected or re-elected to our board of directors. Abstentions and shares of Class B common stock held by brokers and nominees as to which we have not received voting instructions from the beneficial owner of, or other person entitled to vote such shares, and as to which the broker or nominee does not have discretionary voting power, i.e., broker non-votes, are considered outstanding shares of Class B common stock entitled to vote and such shares are counted in determining whether a quorum or a majority is present. Abstentions will be treated as the withholding of authority to vote for nominees for election as directors.

 

As of the close of business on February 15, 2008, we had 52,782,002 shares of Class A common stock outstanding, which are not entitled to vote on any matters to be acted upon at our 2008 annual meeting, and

2,551 shares of Class B common stock outstanding, which have the exclusive right to vote on all matters to be acted upon at our 2008 annual meeting.

 

There are two H.O. Hirt Trusts, one for the benefit of F. William Hirt, the chairman of our board of directors until his death on July 13, 2007, and one for the benefit of Susan Hirt Hagen. The trust established for Mr. Hirt continues for the benefit of certain contingent beneficiaries as provided for in the trust agreement. The H.O. Hirt Trusts collectively own 2,340 shares of Class B common stock, which, because such shares represent 91.73% of the outstanding shares of Class B common stock entitled to vote at our 2008 annual meeting, is sufficient to determine the outcome of any matter submitted to a vote of the holders of our Class B common stock, assuming all of the shares held by the H.O. Hirt Trusts are voted in the same manner. As of the record date for our 2008 annual meeting, the individual trustees of the H.O. Hirt Trusts are Susan Hirt Hagen, or “Mrs. Hagen,” and Elizabeth A. Vorsheck, or “Mrs. Vorsheck” and the corporate trustee is Sentinel Trust Company, L.B.A., or “Sentinel.”

 

Under the provisions of the H.O. Hirt Trusts, the shares of Class B common stock held by the H.O. Hirt Trusts are to be voted as directed by a majority of trustees then in office. If at least a majority of the trustees then in office of both of the H.O. Hirt Trusts vote for the election of the 11 candidates for director named below, such candidates will be elected as directors even if all shares of Class B common stock other than those held by the H.O. Hirt Trusts do not vote for such candidates. We have not been advised as of the date of this proxy statement how the trustees of the H.O. Hirt Trusts intend to vote at our annual meeting.

 

We operate predominantly as a provider of management services to the Exchange. We also operate as a property and casualty insurer through our subsidiaries. Since 1925, we have served as the attorney-in-fact for the policyholders of the Exchange. The Exchange is a reciprocal insurance exchange, which is an unincorporated association of individuals, partnerships and corporations that agree to insure one another. Each applicant for insurance from the Exchange signs a subscriber’s agreement, which appoints us as the attorney-in-fact for the subscriber. As attorney-in-fact, we are required to perform certain services relating to the sales, underwriting and issuance of policies on behalf of the Exchange.

 

The Property and Casualty Group writes personal and commercial lines of property and casualty insurance coverages exclusively through approximately 1,965 independent agencies comprised of more than 8,400 licensed representatives and pool their underwriting results. Our financial results are not consolidated with those of the Exchange. As a result of the Exchange’s 94.5% participation in the underwriting results of the Property and Casualty Group, the underwriting risk of the Property and Casualty Group’s business is largely borne by the Exchange.

 

We charge the Exchange a management fee calculated as a percentage, limited to 25%, of the direct written premiums of the Property and Casualty Group. Management fees accounted for 71.6%, 72.3% and 72.2%, respectively, of our revenues for the three years ended December 31, 2005, 2006 and 2007. The management fee rate was 23.75% during 2005, 24.75% during 2006 and 25% during 2007. Beginning January 1, 2008, the rate has been set at 25%.

 

The following table sets forth as of February 15, 2008 the amount of our outstanding Class B common stock owned by shareholders known by us to own beneficially more than 5% of our Class B common stock.

 

 

 

 

The following table sets forth as of February 15, 2008 the amount of the outstanding shares of Class A common stock and Class B common stock beneficially owned by (i) each director and candidate for director nominated by our nominating committee, (ii) each executive officer named in the Summary Compensation Table and (iii) all of our executive officers and directors as a group.

 

 

 

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Securities Exchange Act of 1934, as amended, or the “Exchange Act,” requires that the officers and directors of a corporation, such as us, that has a class of equity securities registered under Section 12 of the Exchange Act, as well as persons who own 10% or more of a class of equity securities of such a corporation, file reports of their ownership of such securities, as well as statements of changes in such ownership, with the corporation and the SEC. Based upon written representations we received from our officers and directors and 10% or greater shareholders, and our review of the statements of changes of ownership filed with us by our officers and directors and 10% or greater shareholders during 2007, we believe that all such filings required during 2007 were made on a timely basis, except that Timothy G. NeCastro, a senior vice president, untimely filed a Form 4 Statement of Changes in Beneficial Ownership on March 14, 2007 to report the sale of 2,307 shares of Class A common stock on March 8, 2007, and Patricia A. Garrison-Corbin, a director, untimely reported the purchase of 100 shares of Class A common stock acquired on May 23, 2007, which shares were subsequently reported on a Form 5 Annual Statement of Changes in Beneficial Ownership filed on February 6, 2008.

 

Introduction

 

The election of directors by the holders of our Class B common stock is governed by provisions of the Pennsylvania Insurance Holding Companies Act, or the “Holding Companies Act,” in addition to provisions of the BCL, the Pennsylvania Associations Code and our bylaws. The following discussion summarizes these statutory provisions and describes the process undertaken in connection with the nomination of candidates for election as directors by the holders of Class B common stock at our annual meeting.

 

Background of our Nominating Committee

 

Section 1405(c)(4) of the Holding Companies Act, which applies to us, provides that the board of directors of a domestic insurer must establish one or more committees comprised solely of directors who are not officers or employees of the insurer or of any entity controlling, controlled by or under common control with the insurer and who are not beneficial owners of a controlling interest in the voting stock of the insurer or any such entity. Such committee or committees must have responsibility for, among other things, nominating candidates for election as directors by the shareholders.

 

Section 3.09 of our bylaws is consistent with this statutory provision and provides that (i) our board of directors must appoint annually a nominating committee that consists of not less than three directors who are not officers or employees of us or of any entity controlling, controlled by or under common control with us and who are not beneficial owners of a controlling interest in our voting securities and (ii) our nominating committee must, prior to each annual meeting of shareholders, determine and nominate candidates for the office of director to be elected by the holders of Class B common stock to serve terms as established by our bylaws and until their successors are elected.

 

In accordance with this bylaw provision, on April 17, 2007 our board of directors designated a nominating committee consisting of Patricia A. Garrison-Corbin, chair, Kaj Ahlmann, Jonathan Hirt Hagen and Thomas W. Palmer. Consistent with the Holding Companies Act, none of these persons is an officer or employee of us or of any entity controlling, controlled by or under common control with us or a beneficial owner of a controlling interest in our voting stock or any such entity. Each member of our nominating committee is an independent director as defined in the rules applicable to companies listed on the NASDAQ Global Select Market^®, or “NASDAQ.”

 

Nominating Procedures

 

Under Section 2.07(a) of our bylaws, nominations of persons for election to our board of directors may be made at any meeting at which directors are to be elected (i) by or at the direction of our nominating committee or (ii) by any holder of our Class B common stock.

 

With respect to nominations by or at the direction of our nominating committee, except as is required by rules promulgated by NASDAQ, the SEC or the Holding Companies Act, there are no specific, minimum qualifications that must be met by a candidate for our board of directors, and our nominating committee may take into account such factors as it deems appropriate. Our nominating committee generally bases its nominations on our general needs as well as the specific attributes of candidates that would add to the overall effectiveness of our board of directors. Specifically, among the significant factors that our nominating committee may take into consideration are judgment, skill, diversity, experience with businesses and other organizations of comparable size, the interplay of the candidate’s experience with the experience of other directors and the extent to which the candidate would be a desirable addition to our board of directors and any committee of our board of directors.

 

In identifying and evaluating the individuals that it selects, or recommends that our board of directors select, as director nominees, our nominating committee utilizes the following process:

 

 

 

Actions Taken for Nominations

 

Our nominating committee met on March 4, 2008 for the purpose of evaluating the performance and qualifications of the current or proposed members of our board of directors and nominating candidates for election as directors by the holders of Class B common stock at our annual meeting.

 

Our bylaws provide that our board of directors shall consist of not less than 7, nor more than 16, directors, with the exact number to be fixed from time to time by resolution of our board of directors. Our nominating committee recommended at its March 4, 2008 meeting that the size of our board of directors be set at 11 persons and that all directors as of such date, with the exception of Kaj Ahlmann and John T. Baily, be nominated for re-election. Mr. Ahlmann and Mr. Baily previously notified our nominating committee that they do not intend to stand for re-election to our board of directors.

 

On March 7, 2008, our board of directors accepted the report of our nominating committee, set the number of directors to be elected at our annual meeting at 11 and approved the nomination of J. Ralph Borneman, Jr., Patricia A. Garrison-Corbin, Jonathan Hirt Hagen, Susan Hirt Hagen, Thomas B. Hagen, C. Scott Hartz, Claude C. Lilly, III, Lucian L. Morrison, Thomas W. Palmer, Elizabeth A. Vorsheck and Robert C. Wilburn for election as directors by the holders of Class B common stock at our annual meeting. On March 7, 2008, we issued a press release and filed a current Report on Form 8-K with the SEC for the purpose of announcing publicly our nominating committee’s slate of director nominees in accordance with Section 2.07(a)(3) of our bylaws.

 

Candidates for Election

 

Unless otherwise instructed, the proxy holders will vote the proxies received by them for the election of the nominees named below. All of the nominees are currently directors. If a nominee becomes unavailable for any reason, it is intended that the proxies will be voted for a substitute nominee selected by our nominating committee. Our board of directors has no reason to believe the nominees named will be unable to serve if elected.

The names of the candidates for director nominated pursuant to the procedures discussed above, together with certain information regarding them, are as follows:

 

 

 

*Previous Board service, 1979-1998

 

 

Our board of directors has determined that each of the following directors is an “independent director” as defined under the rules promulgated by NASDAQ:

 

Kaj Ahlmann*
John T. Baily*
Patricia A. Garrison-Corbin
Jonathan Hirt Hagen
Susan Hirt Hagen
Thomas B. Hagen
C. Scott Hartz
Claude C. Lilly, III
Lucian L. Morrison
Thomas W. Palmer
Elizabeth A. Vorsheck
Robert C. Wilburn

 

 

*Not standing for re-election as a director.

 

Our Board of Directors and its Committees

 

Our board of directors met seven times in 2007. The standing committees of our board of directors are our executive committee, our audit committee, our compensation committee, our nominating committee, our charitable giving committee, our investment committee, our technology committee and our strategy committee.

 

Our executive committee, which met once during 2007, has the authority, subject to certain limitations, to exercise the power of our board of directors between regular meetings.

 

Our audit committee met seven times in 2007. Consistent with Section 1405(c)(4) of the Holding Companies Act and the Sarbanes-Oxley Act of 2002, or “Sarbanes-Oxley,” our audit committee has

responsibility for the selection of independent registered public accountants, reviewing the scope and results of their audit and reviewing the adequacy of our accounting, financial, internal and operating controls. Our audit committee operates pursuant to a written charter, a copy of which may be viewed on our website at: http://www.erieinsurance.com.

 

Our compensation committee met nine times in 2007. Consistent with Section 1405(c)(4) of the Holding Companies Act and our bylaws, our compensation committee has responsibility for recommending to our board of directors, at least annually, the competitiveness and appropriateness of the salaries, variable compensation, short- and long-term incentive plan awards, terms of employment, non-qualified retirement plans, severance benefits and perquisites of our chief executive officer and our executive vice presidents and such other named executives as required by rules of the SEC or NASDAQ listing standards and such other responsibilities as our board of directors may designate. See “Executive Compensation — Compensation Committee Interlocks and Insider Participation.”

 

Our compensation committee operates pursuant to a written charter, a copy of which may be viewed on our website at: http://www.erieinsurance.com.

 

Our nominating committee met four times in 2007. Consistent with Section 1405(c)(4) of the Holding Companies Act and our bylaws, our nominating committee has responsibility for:

 

 

Our nominating committee operates pursuant to a written charter, a copy of which may be viewed on our website at: http://www.erieinsurance.com.

 

Our charitable giving committee, which met five times in 2007, has responsibility for recommending to our board of directors and our chief executive officer charitable gifts by us within a budgetary limit established by our board of directors. The members of our charitable giving committee voluntarily do not accept meeting fees for their services on this committee.

 

Our investment committee, which met six times in 2007, has responsibility for assisting our board of directors in its general oversight of our investments.

 

Our technology committee, which met five times in 2007, provides strategic oversight of our development and use of technology and the related electronic information security issues.

 

Our strategy committee, which met seven times in 2007, has responsibility for oversight of our strategic plan including the establishment of goals and periodic evaluation of the plan within the financial and operating objectives approved by our board of directors.

 

All directors hold office until their respective successors are elected or until their earlier death, resignation or removal. Officers serve at the discretion of our board of directors, subject to the provisions of certain employment agreements discussed under “Executive Compensation — Agreements with Executive Officers.” There are no family relationships between any of our directors or executive officers, except that:

 

 

During 2007, each director attended more than 75% of the number of meetings of our board of directors and the standing committees of our board of directors of which such director was a member.

In 2007, our board of directors adopted corporate governance guidelines recommended by our nominating committee, a copy of which may be viewed on our website at: http://www.erieinsurance.com.

 

OUR BOARD OF DIRECTORS RECOMMENDS A VOTE “FOR” THE 11 CANDIDATES FOR DIRECTOR NOMINATED BY OUR NOMINATING COMMITTEE, AND THE ENCLOSED PROXY CARD WILL BE SO VOTED UNLESS A HOLDER OF CLASS B COMMON STOCK SPECIFIES OTHERWISE.

 

Our shareholders may communicate with our board of directors through our secretary. Shareholders who wish to express any concerns to any of our directors may do so by sending a description of those concerns in writing addressed to a particular director, or in the alternative, to “Non-management Directors” as a group, care of our secretary at our headquarters, 100 Erie Insurance Place, Erie, Pennsylvania 16530. All such communications that are received by our secretary will be promptly forwarded to the addressee or addressees set forth in the communication.

 

Recognizing that director attendance at our annual meeting can provide our shareholders with an opportunity to communicate with directors about issues affecting us, we actively encourage our directors to attend our annual meeting. In 2007, 14 of our directors attended our annual meeting.

 

Overview

 

Our executive compensation program is developed and monitored by our compensation committee. A complete description of the committee’s function and responsibilities is set forth in its charter, a copy of which may be viewed on our website at: http://www.erieinsurance.com. Our compensation committee determines the compensation philosophy and policies for our executive officers. In fulfilling this role, the committee is responsible for establishing principles that guide the design of compensation programs for all executives. In so doing, the committee reviews the performance results of each executive and establishes individual compensation levels. Although Douglas F. Ziegler is included hereafter as a Named Executive Officer or “NEO,” as a senior vice president, his compensation is reviewed and set by our chief executive officer.

 

Our compensation committee regularly meets without officers or employees present to discuss executive compensation matters. Our compensation committee meets annually without the chief executive officer present and evaluates his performance compared to previously established company financial and personal, non-financial goals. Our compensation committee discusses its performance evaluation with the independent members of our board of directors in executive session before making appropriate compensation adjustments. Our chief executive officer annually evaluates the performance of our executive officers named in the Summary Compensation Table other than himself, and recommends to our compensation committee any merit increases to base salaries.

 

In 2007, our compensation department prepared an analysis using the same methodology used by the outside consultant we retained to prepare the analysis in 2004. The compensation committee also retained the consulting firm Watson Wyatt to prepare a compensation benchmark analysis based on the data and background information provided by our compensation department.

 

In preparing the 2007 benchmark and survey data for our compensation committee’s consideration, we followed the methodology below:

 

 

 

Overall Program Objectives

 

The goals of our executive compensation program are to attract, motivate, retain and reward executives in a fiscally responsible manner. To achieve these objectives, we design executive compensation programs that support our business strategy by clearly communicating our expectations of our executives through goals that reward achievement. We also believe that our program is aligned with the interests of our primary stakeholders: our shareholders and the policyholders of the Exchange. We structure our compensation program to align actual compensation with performance, delivering more compensation to executives when we achieve higher performance and thereby delivering increased value to our shareholders and policyholders of the Exchange, with an inverse relationship occurring when we achieve lower financial performance results. The members of our compensation committee deliberate and consult with their independent compensation advisor to ensure that thresholds, targets, weightings and maximum performance goals are sufficiently robust to warrant an incentive payout or a superior award.

 

We seek to achieve these objectives by providing several different elements of executive compensation:

 

 

Executive Compensation Elements

 

Total Compensation

 

Each element of compensation is set independently for each NEO against our peer group described above. As a result, the allocation of each compensation component varies by NEO.

 

Base Salary

 

Purpose:  The purpose of base salary is to provide compensation based on an executive’s job responsibilities, individual performance and externally-competitive compensation levels.

Considerations:  Our compensation committee annually reviews and determines the base salaries of each of our executive officers. Our compensation program seeks to establish each NEO’s base salary range at the 50th percentile, or median, of the competitive market comprised of the companies in our peer group. In each case, the committee takes into account the base salary range for each executive based on job duties and authority. Individual base salary levels are based upon an executive’s years of experience and individual performance. This amount is not at risk and may be adjusted annually based on merit and external market conditions.

 

2007 Discussion and Analysis:  All of our NEO base salaries were within the salary range set against our peer group in 2007, including for Mr. Brinling, whose salary for serving as president and CEO was set at the same level as for our former president and CEO.

 

Annual Incentive Plan

 

Purpose:  The purpose of our Annual Incentive Plan, or “AIP,” is to align executive performance with our annual strategic goals while enhancing our shareholder value and promoting the health of the Exchange. We accomplish this objective by providing incentives in the form of an annual cash bonus to executives upon the attainment of certain performance goals.

 

Considerations:  At the beginning of each year, our compensation committee establishes for each executive a target AIP award expressed as a percentage of annual base salary. These target AIP awards are established after the identification and discussion by our compensation committee and our board of directors of key measures that drive strong organizational performance. The performance criteria used in 2007 were submitted property/casualty application growth and adjusted operating ratio. Adjusted operating ratio is considered to be an industry-standard benchmark used to measure an insurer’s performance. We define adjusted operating ratio as the total profitability of the Property and Casualty Group, us and EFL. This ratio measures profitability by calculating operating and investment results in relation to premiums earned. We established one additional performance measure (asset class returns) for Mr. Ziegler based upon his functional responsibilities as our chief investment officer. We established one additional performance measure (property/casualty adjusted combined ratio) for Mr. Morgan based upon his functional responsibilities as our executive vice president of insurance operations.

 

Our board of directors and management consider our current performance, including our strengths and performance gaps, to determine which areas need to be incented to help us achieve our strategic objectives for the year. The combination of benchmark insurance measures and our performance are the basis from which measures and targets are determined. With the appropriate measures selected, we apply an internal modeling analysis to each measure resulting in a statistical probability confidence range of attaining a target point for each measure.

 

From this analysis, our compensation committee benchmarks target goals for each measure. The committee then sets a maximum and minimum (or ’threshold’) for each measure. The maximum is intended to incent a participant’s performance to achieve a maximum performance payout; the threshold provides a partial payout when a portion of the goal is achieved.

 

The bonus determinations for our president and CEO, and Messrs. Garcia and Krahe, were based upon actual performance against our performance measures. In addition to the targets established by our compensation committee, we may introduce additional, functional performance measures for each NEO. These functional performance measures allow our compensation committee to reward specific responsibilities of the NEO. We develop these individual, functional performance measures for each NEO using a multi-year trend incorporating peer group survey data. For Mr. Morgan, we based 75% of his bonus determination on performance against our measures and the remaining 25% on functional measures. For Mr. Ziegler, we based 20% of his bonus determination on performance against our measures and the remaining 80% on functional measures.

 

Upon completion of the fiscal year, our compensation committee determines and certifies in writing the extent to which company and individual incentive targets were satisfied. The AIP payouts have a cap of 200% of incentive target. In addition, the maximum annual AIP award payable in cash to any one executive under the AIP is $3.0 million. Our compensation committee has no discretion to increase any company or individual

incentive target, nor any company or individual incentive award that would otherwise be due upon attainment of company or individual incentive targets, or otherwise modify any company or individual incentive targets associated with a performance period. We typically pay AIP awards after the prior year’s audited financial results are available and our compensation committee certifies earned amounts. See “Incentive Plans and Deferred Compensation” in our notes to consolidated financial statements contained in our 2007 annual report.

 

2007 Discussion and Analysis:  The two company performance measures established for 2007 were based upon our submitted property/casualty application growth and adjusted operating ratio targets. We selected submitted property/casualty application growth as one of the measures for 2007 to incent management to grow applications received during a period of softening market conditions in the insurance industry. We selected the adjusted operating ratio for 2007 to help balance the underwriting profitability of our property/casualty insurance operations.

 

We weighted the adjusted operating ratio for Mr. Garcia and Mr. Krahe at 50% of target AIP award while submitted property/casualty application growth received 50% of the weighting. We set Mr. Morgan’s weighting as follows: adjusted operating ratio — 25%; submitted property/casualty application growth — 50%; and property/casualty adjusted combined ratio — 25%. Mr. Ziegler’s weighting was set as follows: adjusted operating ratio — 10%; submitted property/casualty application growth — 10%; and asset class return — 80%. The excellent underwriting profitability of the Property and Casualty Group led to a strong adjusted operating ratio, driving the AIP award disclosed in the Summary Compensation Table. However, due to increased competition, submitted property/casualty application growth did not meet the threshold, thus performance for this measure did not warrant a payout.

 

Mr. Ludrof resigned as our president and CEO effective August 8, 2007, and will not receive any portion of the 2007 AIP award. Mr. Brinling did not officially participate in the AIP for 2007 because his service began too late in the year to qualify. However, in accordance with his compensation arrangement, he will receive a payment outside the plan using the same measurements and criteria that would have been used for Mr. Ludrof had he not resigned, which criteria conform with the targets for Messrs. Garcia and Krahe as described above.

 

Long-term Incentive Plan

 

Purpose:  The purpose of our Long-term Incentive Plan, or “LTIP,” is to enhance our growth and profitability and that of the Exchange and its affiliates by providing longer term rewards to executives who are capable of having a significant impact on our performance. We accomplish this objective by providing incentives over a multi-year period in the form of restricted stock unit grants of our Class A common stock to executives upon the attainment of certain performance goals. We use stock in this plan to further align the interests of our executives with those of our shareholders.

 

Considerations:  We had two LTIP plans in effect at December 31, 2007: a LTIP we adopted in 1997 (the “Pre-2004 LTIP”) and a LTIP we adopted in 2004 (the “Post-2004 LTIP”). The Pre-2004 LTIP awards were determined based upon the achievement of predetermined financial performance goals compared to the actual growth in our retained earnings; this initial plan did not benchmark us against a peer group. In 2004, after review by our compensation committee, we adopted the Post-2004 LTIP. The Post-2004 LTIP allowed us to better align our long-term goals with the executive reward by utilizing comparisons to a board-selected peer group, for a reward tied more closely to performance outcomes for stronger reinforcement of desired behaviors. The Post-2004 LTIP award is based on the achievement of objective performance measures — adjusted combined ratio, growth in direct written premiums, and total return on invested assets — over a three-year period compared to a peer group of property and casualty insurance companies that write predominantly personal lines insurance. The peer group we use for the Post-2004 LTIP has remained the same since the plan’s inception and consists of: Allstate Insurance Group, Farmers Insurance Group, Government Employees Group (GEICO), Nationwide Insurance Group, Progressive Group of Insurance Companies, State Farm Insurance Group and USAA Group. This peer group was selected because, as a group, it represents the majority of personal lines business written in the United States and is considered to be our competition in all the markets in which we do business. We calculate and pay actual awards earned after performance level certification by our compensation committee following the performance period. See “Incentive Plans and Deferred Compensation” in our notes to consolidated financial statements contained in our 2007 annual report.

2007 Discussion and Analysis: Target LTIP awards were established for each NEO at the beginning of 2007 utilizing a methodology similar to that used to set AIP awards for each NEO as described above. The performance measures selected reflect the strategic business objectives of the Property and Casualty Group. As in 2006, the 2007 awards were based on the adjusted combined ratio, growth in direct written premiums and total return on invested assets of the Property and Casualty Group compared to the same performance measures of our peer group. Given the nature of our business, underwriting profitability is important to long-term financial strength. The Property and Casualty Group’s direct written premium growth is also important to our financial results as it is the primary driver of the management fee revenue we earn from the Exchange. In 2007, our compensation committee awarded long-term incentive compensation to each NEO in the form of restricted stock units. See the Summary Compensation Table, Supplemental Stock Awards Table, Grants of Plan Based Awards Table, Outstanding Equity Awards Table and Option Exercises and Stock Vested Table herein.

 

Because Mr. Ludrof resigned as president and CEO effective August 8, 2007, he will receive a pro rata portion of his LTIP awards based on having served 7 months of the 36-month performance period — see the Grants of Plan Based Awards table for further discussion. Mr. Brinling is precluded from officially participating in the LTIP for the 2007-2009 performance period because he was not enrolled during the first 90 days of the performance period. However, pursuant to his employment arrangement described below, Mr. Brinling is entitled to receive cash payments upon the attainment of certain LTIP performance goals that were in effect for our former president and CEO.

 

Additional Benefits

 

We believe retirement benefits are an important part of a competitive reward opportunity, which enables us to attract and retain top-tier managerial talent. Accordingly, we maintain a tax-qualified defined benefit pension. The tax-qualified defined benefit pension plan is available to all of our salaried employees. The Internal Revenue Code of 1986, as amended, or “the Code” limits the maximum annual pension award that we can pay to any eligible employee. Therefore, effective December 31, 1986, we implemented a supplemental retirement plan or “SERP” to provide benefits to certain employees of the Company in excess of earnings limitations imposed by the Code. As illustrated in the Pension Benefits Table, an older NEO can produce a significantly higher present value compared to a younger, more highly paid NEO. This result occurs primarily because the nearer a NEO is to normal retirement age, the shorter the discount period used in calculating the present value of the benefits.

 

In December 2007, in connection with its review of our employment agreements with executive officers and with Mr. Ziegler, or our “Officer Employment Agreements” for purposes of determining what modifications were needed to comply with recently adopted changes to the federal tax laws regarding deferred compensation, our board of directors decided that it would not renew or extend the term of the Officer Employment Agreements with Messrs. Garcia, Krahe, Morgan and Ziegler, nor replace them with new agreements. Accordingly, the Company and each of these NEOs entered into an Amendment and Payment Designation Agreement dated December 31, 2007. This new agreement sets a specific date and method of payment of SERP benefits (as required by the new tax rules on deferred compensation) by providing that each of these NEOs shall be paid his accrued and additional SERP benefits in a lump sum on December 12, 2008, at which time the Company will also pay a tax gross-up on those amounts on behalf of each officer. If the executive’s employment terminates, other than as a result of a termination by the Company for cause, before the expiration of the Amendment and Payment Designation Agreement on December 11, 2008, his SERP benefit (including any additional present value referred to in Note (6) to the table below disclosing the salary and benefits expected under various termination scenarios) will be paid in a lump sum on the first day of the seventh month after the date of termination. See “Agreements with Executives Including Termination and Change in Control” for discussion on the payout of SERP benefits for certain NEOs.

 

Our defined benefit pension plan and SERP amounts reflected in the “Change in Pension Value” column within the Summary Compensation Table result from the use of various actuarial assumptions. One of the assumptions that can have a significant impact on the pension values is the discount rate selected. Upon completing our annual bond matching study with our independent consulting actuarial firm, Watson Wyatt, we supported the selection of a 6.62% discount rate for the 2008 pension and SERP expense for financial

statement purposes and we used this same discount rate in determining the present value of benefits under these plans for each NEO. “See Agreements with Executives Including Termination and Change in Control” for a discussion regarding the expected payout of Mr. Ludrof’s SERP.

 

Our executives also participate in the broad-based benefit plans offered generally to all of our full-time employees (e.g., the pension plan, 401(k) plan, health insurance and other employee benefits). Their participation in these benefit plans is on the same terms as all of our other employees.

 

Director Compensation

 

2007 Discussion and Analysis

 

The goals of our director compensation program are to attract, motivate and retain directors of outstanding competence and ability and reward them in a fiscally responsible manner. Director performance is a key influencing factor in organizational performance. Accordingly, director compensation is reviewed periodically and adjusted, as appropriate, to align the interests of directors with our strategic objectives.

 

The periodic review of director compensation is the responsibility of our compensation committee and our board of directors. In undertaking this responsibility, the compensation committee reviews compensation surveys of the financial services industry. The committee also engages, from time to time, independent advisors who provide supplemental data that is considered in setting director compensation levels. After reviewing the data, the compensation committee formulates a recommendation for review by our board of directors.

 

In 2006, our compensation committee engaged Watson Wyatt to evaluate the components of our director compensation, including retainer fees, committee fees, stock grants, committee chair fees and presiding director fees. Our compensation committee determined that, except for the retainer fee and stock-based pay, the remaining elements of our directors’ compensation were appropriately positioned and would not be changed. Effective March 1, 2007, the annual cash retainer was increased from $25,000 to $30,000, and the annual stock-based pay was increased from $35,000 to $40,000.

 

We make adjustments to maintain each director’s compensation at market median or about the 50^th percentile of our peer group. Added responsibilities or additional duties, such as committee chairperson or chairman of the board, may cause variations in each director’s total compensation earned.

 

Director Education Program

 

In 2005, we implemented a director education program in which all of our directors are entitled to participate. The program provides each director with access to various resources to assist him or her with enhancing the skills and strategies that drive effective directorship. We pay for the cost of each director’s membership in the National Association of Corporate Directors, underwrite the cost of attendance at certain educational seminars and conferences and provide subscriptions to relevant business news journals, magazines and on-line resources.

 

Agreements with Executives Including Termination and Change in Control

 

Our compensation committee periodically reviews the use and material terms of employment agreements with our key executives. In 2005, in conjunction with our compensation committee’s independent advisor, we revised the employment agreements of all of our NEOs. The term of our employment agreements with Messrs. Garcia, Ziegler and Krahe will expire on December 11, 2008 and, as described above, our board of directors has determined that it will not renew or extend the term of these employment agreements, nor replace them with new agreements.

 

Effective August 8, 2007, Mr. Ludrof voluntarily resigned as president and CEO of the Company. On December 27, 2007, Mr. Ludrof entered into a Post-Employment Agreement with the Company which provides for the resolution of all matters relating to Mr. Ludrof’s employment, including all obligations of the Company under his employment agreement. The Post-Employment Agreement contained the following material terms:

 

 

 

On October 11, 2007, the Company entered into an arrangement with Mr. Brinling regarding his compensation and benefits. Mr. Brinling assumed the position of president and CEO of the Company on August 8, 2007, upon Mr. Ludrof’s resignation. The material terms of Mr. Brinling’s arrangement are as follows:

 

 

Mr. Morgan resigned as our executive vice president of insurance operations, effective February 29, 2008. On February 28, 2008, the Company entered into a severance agreement with Mr. Morgan (the “Severance Agreement”) which provides for the resolution of all matters relating to Mr. Morgan’s employment, including all obligations of the Company to Mr. Morgan under his employment agreement, as amended by the

Amendment and Payment Designation Agreement discussed below. The Severance Agreement contained the following material terms:

 

 

For the NEOs other than the chief executive officers and Mr. Morgan, salary and benefits expected under various termination scenarios are disclosed below. If any of the NEOs terminated his employment due to disability, no compensation or benefits would be awarded in addition to amounts already disclosed in the Summary Compensation Table. We developed the compensation and benefit amounts disclosed in the table below considering a termination date of December 31, 2007 and they represent only payments estimated in addition to the other compensation disclosed in this proxy statement.

 

 

 

 

 

 

 

 

In addition to the items disclosed in the table above, in the case of “Involuntary Without Cause” and “Voluntary With Good Reason” terminations, the employment agreements provide continuing coverage for all purposes for a period of three years after the date of termination of employment for the executive and his eligible dependents under all of our benefit plans in effect as of the date of termination of employment. The employment agreements also stipulate that for a period of three years after the date of the executive’s termination, we will provide such perquisites as were made available to the executive as of the date of termination.

The employment agreements also provide for certain additional payments by us. In the event that any payment or distribution by us to or for the benefit of the executive, whether paid or payable pursuant to the terms of the employment agreement or otherwise, is determined to be subject to the excise tax imposed by Section 4999 of the Code as an excess parachute payment, as that term is used and defined in Sections 4999 and 280G of the Code, the executive is entitled to receive an additional payment (a “gross-up payment”) in an amount equal to the then current rate of tax under Section 4999 multiplied by the total of the amounts so paid or payable, including the gross-up payment, which are deemed to be a part of an excess parachute payment.

 

Stock Ownership Guidelines

 

In 2005, our board of directors approved an executive stock ownership program that provides guidelines for ownership of our Class A common stock for each executive. The program is designed to further align the interests of executive management with those of our shareholders and drive long-term performance and profitability. Executive officers are required to reach prescribed stock ownership levels within three years from the program’s commencement date of January 1, 2006.

 

This program utilizes a fixed base-salary component, considering the executive’s salary as of January 1, 2006. The ownership guidelines require the chief executive officer to maintain ownership of Class A common stock in an amount equivalent in value to 3.0 times his base salary. All other executive officers are required to maintain ownership of Class A common stock in an amount equal to 1.5 times their respective base salaries. Shares owned outright and deferred and performance-based deferred shares (earned but not yet paid) count toward the ownership guideline. Restricted stock and shares held in tax-qualified retirement plans count toward satisfying the guidelines, as do shares beneficially owned through a spouse or dependent children.

 

The table below sets forth the ownership guidelines for each NEO and the value of shares owned as of February 15, 2008.

 

 

 

 

Our compensation committee annually reviews each covered executive’s progress toward, and continued compliance with, the approved guidelines. Our compensation committee will review market best practices regarding executive stock ownership guidelines at least every three years.

 

Tax Implications of Executive Compensation

 

Section 162(m) of the Code places a limit of $1.0 million on the amount of compensation that we may deduct in any one year with respect to each of our five most highly paid executive officers, subject to an exception to the $1.0 million limitation for performance-based compensation meeting certain requirements. Our AIP and LTIP awards are performance-based and have been approved by our shareholders. As such, payments made under these plans are not included in the $1.0 million limit on deductible compensation. All of our incentive awards and individual incentive awards are subject to federal income, FICA and other tax withholdings as required by applicable law.

 

We believe all compensation paid in 2007 and 2006 to our NEO’s is tax-deductible under Section 162(m) of the Code, except for certain amounts related to settlement of Mr. Brinling’s SERP benefit following his

retirement and prior to his re-employment. While our compensation committee intends to continue to provide compensation opportunities to our executives in as tax-efficient a manner as possible, it recognizes that from time to time it may be in the best interests of our shareholders to provide non-tax deductible compensation.

 

The following table sets forth the compensation during 2007 and 2006 for our NEOs. Compensation disclosed herein is for services rendered in all capacities to us, EFL, the Exchange and their subsidiaries and affiliates. Compensation is allocated among us, the Exchange, EFL and their subsidiaries and affiliates according to an estimated proportion of the executives’ time dedicated to the affairs of various entities. Our share of total compensation expense in 2007 and 2006 was 52.8% and 52.7%, respectively. Amounts indicated are pre-individual income taxes.

 

Summary Compensation Table

 

 

 

 

Salary

 

Salary includes all paid time off such as vacation and company holidays.

 

The salary disclosed for Mr. Ludrof includes payments made to him through December 19, 2007. His Post-Employment Agreement became effective December 27, 2007. See “Compensation Discussion and Analysis — Agreements with Executives Including Termination and Change in Control.”

 

The salary figure for Mr. Brinling includes his salary as executive vice president of EFL through his retirement date of January 31, 2007, and his salary for serving as our president and CEO.

 

Bonus

 

The bonus column includes retirement and special merit bonuses, as well as terminated vacation payouts.

Stock Awards: Long-Term Incentive Plans (LTIP)

 

In 1997, we adopted the Pre-2004 LTIP, which was designed to enhance our growth and profitability by providing the incentive of long-term rewards to key employees who are capable of having a significant impact on our performance, to attract and retain employees of outstanding competence and ability and to further align the interests of such employees with those of our shareholders. The holders of our voting common stock approved the Pre-2004 LTIP in 1997 as a performance-based plan under the Code, and our shareholders approved its continuation at our 2002 annual meeting in satisfaction of the requirements of the Code. We amended the Pre-2004 LTIP at our 2003 annual meeting to increase the maximum value of the phantom share units that could be earned by a participant in any performance award from $500,000 to $1,000,000. At the same time, our shareholders re-approved the Pre-2004 LTIP. Each participant is granted awards of phantom share units under the Pre-2004 LTIP based upon a target award calculated as a percentage of the participant’s base salary. The total value of any phantom share units is determined at the end of the performance period based upon the growth in our retained earnings. Each participant is then entitled to receive restricted shares of Class A common stock equal to the dollar value of the phantom share units at the end of the performance period. The vesting period for the restricted shares of Class A common stock issued to each executive is three years after the end of the performance period. If a participant ceases to be an employee prior to the end of the performance period for reasons other than retirement, death or disability, the participant forfeits all phantom share units awarded. If a participant ceases to be an employee after the end of the performance period but prior to the end of the vesting period for reasons other than retirement, death or disability, the participant forfeits all unvested restricted shares previously granted. Because our board of directors and the holders of our Class B common stock approved a new long-term incentive plan described below, no further awards will be made under the Pre-2004 LTIP and the last performance period under the Pre-2004 LTIP was 2003-2005.

 

In 2004, our compensation committee recommended the adoption of the Post-2004 LTIP and, in accordance with the Code and NASDAQ rules, the holders of our Class B common stock approved the Post-2004 LTIP at our 2004 annual meeting. The Post-2004 LTIP became effective March 2, 2004. Our compensation committee administers the Post-2004 LTIP. Our compensation committee is authorized to grant restricted performance shares to participants. Restricted performance shares represent a right to receive shares of Class A common stock based on the achievement, or the level of achievement, during a specified performance period of one or more performance goals established by our compensation committee at the time of the award. At the time restricted performance shares are granted, our compensation committee specifies in writing:

 

 

Following completion of the applicable performance period, our compensation committee will determine whether the applicable performance goals were achieved, or the level of such achievement, and the number of shares, if any, earned by the participant based upon such performance. We will then issue to the participant the number of restricted shares of Class A common stock earned pursuant to the award for the relevant performance period. If a participant ceases to be an employee prior to the end of a performance period by reason of death, disability or normal or early retirement (as defined in our qualified pension plan for employees), the participant may receive all or such portion of his or her award as may be determined by our compensation committee in its discretion; however, a participant will not receive less than the total number of restricted shares of Class A common stock earned pursuant to such participant’s award based upon performance during a performance period that is deemed to end on the last day of the year in which employment terminates. If a participant ceases to be an employee of us or our subsidiaries and affiliates prior to the end of a performance period for any reason other than death, disability or normal or early retirement, the participant may receive all or such portion of his or her award as may be determined by our compensation

committee in its discretion. A participant who is terminated for cause is not entitled to receive payment of any award for any performance period. The maximum number of shares of Class A common stock that may be earned under the Post-2004 LTIP by any single participant during any one calendar year is 250,000 shares.

 

The table below sets forth, with respect to the amounts shown in the “Stock Awards” column of the Summary Compensation Table above, the dollar amount of the change in our recorded estimates for open performance periods under the Post-2004 LTIP, as well as the change in market value for unvested shares under the Pre-2004 LTIP.

 

Supplemental Stock Awards Table

 

 

 

 

(1) Under the Post-2004 LTIP, the accrual for an open performance period is calculated by first multiplying the number of target shares awarded to the executive by an LTIP performance factor to determine the estimated number of shares that will be earned for the three-year performance period. The LTIP performance factor is determined by the difference between our results under our estimated performance measures and the results of our peer group over the three-year performance period. The estimated performance measures are based on company projections of its own future results for 2008 and 2009, as well as projections of financial performance for seven of our property/casualty insurance peers. The minimum and maximum LTIP performance factors are 0 and 2.5 respectively. The estimated number of shares that will be earned for the performance period is then multiplied by the share price at the end of the current year. This total award is then pro-rated for the completed portion of the performance period.

(2) The 2004-2006 performance period ended December 31, 2006, and amounts were paid in May 2007. The 2007 reported amounts represent the true-up of amounts previously reported.

 

(3) A change in market value is recorded for the unvested shares under closed performance periods of the Pre-2004 LTIP; the Pre-2004 LTIP has a three-year performance period followed by a three-year vesting period. The closing share prices at December 31, 2007, 2006 and 2005 were $51.89, $57.98 and $53.20, respectively.

 

Non-Equity Incentive Plan Compensation: Annual Incentive Plan (AIP)

 

The AIP is a performance-based incentive plan that pays annual cash bonuses to our executive officers, senior vice presidents and regional vice presidents. The cost of the plan is charged to operations as the compensation is earned over the performance period of one year. Amounts reported in the Summary Compensation Table for the AIP represent the estimated amounts payable for the 2007 performance period. On February 22, 2007, our board of directors accepted and ratified the certification of the performance goals for the 2006 AIP awards and established the performance goals for the AIP for 2007 and for the Post-2004 LTIP for the 2007-2009 performance period.

 

Under our deferred compensation plan, executives can elect to defer 100% of their AIP amounts earned. Deferral elections must be made before the beginning of the calendar year for which each bonus is earned. Deferred amounts, if any, are also reported in the “Non-Equity Incentive Plan Compensation” column of the Summary Compensation Table.

 

Mr. Brinling did not officially participate in the 2007 AIP because his service began too late in the year to qualify. However, he will receive a payment outside the plan using the same measurements and criteria that would have been used for our former president and CEO. The amount disclosed for Mr. Brinling in the Summary Compensation Table is pro-rated from August 8, 2007 to December 31, 2007.

 

Pension Plan

 

Change in Pension Value and Non-Qualified Deferred Compensation Earnings

 

The Summary Compensation Table above includes the net change in the present value of accrued benefits from December 31, 2006 to December 31, 2007 under our retirement plan, a tax-qualified defined benefit pension plan, and our SERP, a non-qualified defined benefit arrangement.

 

We calculated the present values using assumptions consistent with those disclosures under FAS 87, “Employers’ Accounting for Pensions,” including for December 31, 2005, 2006 and 2007 discount rates of 5.75%, 6.25% and 6.62%, respectively, (5% post-retirement discount rate for our SERP).

 

There are no above-market or preferential non-qualified deferred compensation earnings to disclose in this column. See the discussion related to the Nonqualified Deferred Compensation Table for a description of the investment funds and earnings.

The Pension Benefits Table below includes the present value of accrued benefits under our defined benefit pension plan and our SERP as of December 31, 2007. Each NEO is 100% vested in our retirement plan.

 

Pension Benefits Table

 

 

 

 

Because the value of Mr. Brinling’s pension decreased by $676,242 in 2007, no change in pension value is shown for that year in the Summary Compensation Table. The negative value resulted from an increase in value in his retirement plan of $206,182 offset by a decrease in SERP value of $882,427 which represents the total of the payments made to him in 2007. The increase in value for Mr. Brinling’s retirement plan is primarily attributable to the 2007 present value calculation using his current age because he is in a pay status, whereas the 2006 present value was calculated assuming payment at the normal retirement age of 65.

 

The present value information presented in the Pension Benefits Table utilizes assumptions consistent with those used for fiscal year 2007 disclosure under FAS 87, including a 6.62% discount rate as of December 31, 2007 (5% post-retirement discount rate for our SERP) and assumes retirement at age 65 for our retirement plan and our SERP and no pre-retirement decrements.

Normal retirement age under both our retirement plan and our SERP is age 65 because that is the earliest time that an executive could retire and commence benefit payments under the plans without any benefit reduction due to age, unless the executive is covered by an employment agreement that provides for unreduced benefits.

 

Under our retirement plan, the executive’s final average earnings are the average of the executive’s highest 36 consecutive months of compensation during his final 120 months of employment. Under our SERP, the executive’s final average earnings are the average of the executive’s highest 24 consecutive months of compensation during the executive’s final 120 months of employment. For this purpose, compensation includes base salary and a lump sum paid in lieu of a merit increase but excludes bonuses, deferred compensation plan payments and severance pay under any severance benefit plan. An executive’s compensation that exceeds annual limits imposed by the Code is excluded in computing benefits derived under our retirement plan but included in computing benefits due under our SERP.

 

Each executive’s “credited service” is generally defined as the executive’s years of continuous employment with us as a covered employee, up to a maximum of 30 years. For purposes of determining the number of years of credited service that will be used to calculate the amount of the executive’s benefit, the executive, as well as all other employees, earns a full year of credited service for a partial year of employment as a covered employee. The Pension Benefits Table reflects the recognition of a full year of credited service for a partial year of employment as of December 31, 2007.

 

Executive service in our SERP means employment with the Company as both a covered employee and a senior vice president or higher-ranking executive.

 

Our retirement plan’s benefit formula at normal retirement age is 1.0% of the executive’s final average earnings up to the social security-covered compensation level (an amount published each year by the Social Security Administration) plus 1.5% of the final average earnings in excess of the social security covered compensation level with the resulting sum multiplied by the executive’s years of credited service, up to a maximum of 30 years. Our retirement plan’s benefit is accrued in the form of a single life annuity with optional actuarially-equivalent forms of payment available.

 

The SERP’s benefit formula at normal retirement age is equal to 60% of SERP final average earnings, reduced proportionately for less than 30 years of credited service. This benefit is accrued in the form of a 10-year certain and life annuity. The executive’s benefit that is payable under our retirement plan is subtracted from our SERP benefit. For purposes of this offset, such monthly benefits which are payable in a form other than a 10-year certain and life thereafter annuity are converted to a monthly benefit which is the actuarial equivalent of a 10-year certain and life thereafter annuity. Optional actuarially-equivalent forms of payment are available under our SERP. The SERP has been amended to provide that, effective January 1, 2009, a lump sum is the only available form of payment.

 

Each executive may become eligible for a SERP benefit only in the event that:

 

 

 

 

Executives in our retirement plan and our SERP are eligible for early retirement after attaining age 55 and completing at least 15 full years of service as a covered employee. The executive’s early retirement benefit under these plans is reduced by 0.25% for each complete calendar month up to 60 months and 0.375% for each complete calendar month in excess of 60 months by which the executive’s early retirement benefit commencement date precedes such executive’s normal retirement date. Mr. Ziegler has satisfied the plans’ eligibility requirements for early retirement.

 

The NEO’s listed in the Pension Benefits Table have entered into employment agreements with us. See “Agreements with Executive Officers” below. In certain termination situations, the terms of those employment agreements, as amended in 2007, provide for the payment of SERP benefits that are not reduced for early retirement. The effect of those provisions for each NEO is disclosed in the “Agreements with Executives Including Termination and Change in Control” section of Compensation Discussion and Analysis.

 

See also “Postretirement Benefit Plans,” in the notes to consolidated financial statements included in our 2007 annual report that describes plan assumptions in more detail.

 

All Other Compensation

 

Supplemental Table for All Other Compensation

 

 

 

 

Agreements with Executive Officers

 

On October 11, 2007, we entered into an arrangement with our president and CEO, John J. Brinling, Jr., regarding his compensation and benefits. Mr. Brinling assumed this position on August 8, 2007, upon the resignation of our former president and CEO, Jeffrey A. Ludrof. The material terms of Mr. Brinling’s compensation arrangement were substantially the same as the Company had with Mr. Ludrof, including an annual salary of $815,626 and bonus payments calculated using the criteria of the Company’s Annual and Long-term Incentive Plans on a pro-rated basis for the portion of the year that Mr. Brinling serves as president and CEO. In addition, and in lieu of Mr. Brinling’s participation in the Company’s pension plans, we will credit an amount equal to a certain percentage of his salary to a hypothetical account to be paid to him after conclusion of his service as president and CEO. For more information about the material terms of Mr. Brinling’s compensation arrangement see “Compensation Discussion and Analysis — Agreements with Executives Including Termination and Change in Control.”

 

On December 27, 2007, the Company entered into a Post-Employment Agreement with Mr. Ludrof which provided for the resolution of all matters relating to Mr. Ludrof’s employment including all obligations of the Company to Mr. Ludrof under his employment agreement. See “Compensation Discussion and Analysis — Agreements with Executives Including Termination and Change in Control” for additional information about Mr. Ludrof’s Post-Employment Agreement.

 

The Company has substantially identical Officer Employment Agreements with three of its senior officers (Philip A. Garcia, Executive Vice President and Chief Financial Officer; Michael J. Krahe, Executive Vice President of Human Development and Leadership; and Douglas F. Ziegler, Senior Vice President, Treasurer and Chief Investment Officer). Each of these agreements was amended in December of 2005, as more fully described in our proxy statement dated March 16, 2007, and further amended in December of 2007, as more fully described in a current Report on Form 8-K filed by us on January 3, 2008. Each of the Officer Employment Agreements provides that its term will expire on December 11, 2008, unless earlier terminated in accordance with its terms.

 

In connection with its review of the Officer Employment Agreements for purposes of determining what changes were needed to comply with recently adopted changes to the federal tax laws regarding deferred compensation, and in the context of structuring the former president and CEO’s post-employment arrangement, our board of directors decided that it will not renew or extend the term of the Officer Employment Agreements for these three senior officers nor replace them with new agreements. Accordingly, the Company and each of the three senior officers named above have entered into an Amendment and Payment Designation Agreement dated December 31, 2007, which (a) confirms that each of the Officer Employment Agreements will expire on December 11, 2008, unless sooner terminated, (b) confirms the continuation of certain provisions that provide post-expiration protection to each senior officer, and (c) sets a specific date and method of payment of SERP benefits, as required by the new tax rules on deferred compensation. Each of these provisions is discussed below.

 

In 2008 the Officer Employment Agreements, as amended by the Amendment and Payment Designation Agreements, have the following principal terms:

 

 

 

 

 

In addition, each agreement provides that if the executive’s employment terminates, other than as a result of a termination by the Company for cause, or if the agreement expires, the executive is entitled to the following with respect to our SERP:

 

 

Additional Executive Compensation Policies

 

Nonqualified Deferred Compensation

 

We maintain a deferred compensation plan in which executives are eligible to participate. This plan is an unfunded, non-qualified, deferred compensation arrangement created for a select group of our management and highly compensated employees. Four of our NEO’s participated in this plan during 2007.

 

The deferred compensation plan is an arrangement whereby the participants can elect to defer receipt of a portion of their compensation until a later date. Executives may elect to defer up to 100% of their annual

salary and up to 100% of any cash award under our AIP. Those participating in the plan select hypothetical investment funds for their deferrals and are credited with the hypothetical returns generated.

 

Executives identify:

 

 

The following table summarizes NEO contributions, our contributions, credited earnings, withdrawals and the aggregate balance as of December 31, 2007.

 

Nonqualified Deferred Compensation Table for 2007

 

 

 

 

With the exception of the T. Rowe Price Science and Technology Fund, the plan’s hypothetical investment funds mirror investment options that are offered to the executives in our tax-qualified 401(k) plan. As in our 401(k) plan, executives participating in our deferred compensation plan may exchange investment funds daily. The return credited to their deferred compensation plan accounts is determined by the investment results of the hypothetical investment funds selected.

Grants of Plan-Based Awards Table for 2007

 

 

 

 

An executive’s target award is established by our compensation committee. The target number of performance shares for each executive is based on a competitive total direct compensation target opportunity and an agreed-upon target pay mix. The target number of LTIP shares for a performance period is determined by dividing the dollar target by the average share price for the month of December that precedes the beginning of the performance period. When our compensation committee approves target awards, it also approves the performance measures, performance goals and the calibration of shares earned at different performance levels above and below the performance goals.

Under the Post-2004 LTIP, the actual number and value of the restricted shares of Class A common stock paid to an executive at the end of a performance period may be more or less than the executive’s target. However, the number of restricted shares of Class A common stock issued to an executive may not exceed 250,000 shares at the end of a performance period. See also “Incentive Plans and Deferred Compensation,” in the notes to consolidated financial statements contained in our 2007 annual report.

 

Outstanding Equity Awards at December 31, 2007