RLI Corp. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
The accompanying notes are an integral part of the financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - - The financial information is prepared in conformity with generally accepted accounting principles and such principles are applied on a basis consistent with those reflected in the 2000 annual report filed with the Securities and Exchange Commission. Management has prepared the financial information included herein without audit by independent certified public accountants that do not express an opinion thereon. The condensed consolidated balance sheet as of December 31, 2000 has been derived from, and does not include all the disclosures contained in the audited consolidated financial statements for the year ended December 31, 2000.
The information furnished includes all adjustments and normal recurring accrual adjustments, which are, in the opinion of management, necessary for a fair statement of results for the interim periods. Results of operations for the three-month periods ended March 31, 2001 and 2000 are not necessarily indicative of the results of a full year.
The accompanying financial data should be read in conjunction with the notes to the financial statements contained in the 2000 10-K Annual Report.
Earnings Per Share: Basic earnings per share (EPS) excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the dilution that could occur if securities or other contracts to issue common stock (common stock equivalents) were exercised or converted into common stock. When inclusion of common stock equivalents increases the earnings per share or reduces the loss per share, the effect on earnings is antidilutive. Under these circumstances, the diluted net earnings or net loss per share is computed excluding the common stock equivalents.
Pursuant to disclosure requirements contained in Statement 128, the following represents a reconciliation of the numerator and denominator of the basic and diluted EPS computations contained in the financial statements.
| | For the Three-Month Period Ended March 31, 2001 |
| | Income | Shares | Per Share |
| | (Numerator)
| (Denominator)
| Amount
|
| Basic EPS | | | |
| Income available to common stockholders | $7,133,372 | 9,811,252 | $0.73 |
| Effect of Dilutive Securities | | | |
| Incentive Stock Options | —
| 195,467
|
|
| | | | |
| Diluted EPS | | | |
| Income available to common | $7,133,372
| 10,006,719
| $0.71
|
| | |
| | For the Three-Month Period Ended March 31, 2000 |
| | Income | Shares | Per Share |
| | (Numerator)
| (Denominator)
| Amount
|
| Basic EPS | | | |
| Income available to common stockholders | $6,539,849 | 9,859,149 | $0.66 |
| Effect of Dilutive Securities | | | |
| Incentive Stock Options | —
| 79,349
|
|
| | | | |
| Diluted EPS | | | |
| Income available to common | $6,539,849
| 9,938,498
| $0.66
|
Other Accounting Standards: In June 1998, the Financial Accounting Standards Board (FASB) issued Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities”(Statement 133). Statement 133 addresses the accounting for and disclosure of derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. Statement 133 standardizes the accounting for derivative instruments by requiring that an entity recognize those items as assets or liabilities in the statement of financial position and measure them at fair value. Statement 133, as amended by FASB Statement No. 137, was effective for all fiscal quarters of fiscal years beginning after June 15, 2000.
In March 2001, the FASB adopted the guidance set forth in Derivatives Implementation Group (DIG) Issue A17, “ Contracts That Provide for Net Share Settlement.” Based on this newly approved guidance, the Company has determined that stock warrants received in conjunction with the purchase of a note receivable qualify as derivatives under Statement 133. Therefore, in accordance with the transition provisions of Statement 133, the Company will account for these warrants as derivatives effective April 1, 2001.
As no hedging relationship exists with respect to these instruments, they will be marked to fair value as a cumulative-effect-type adjustment of net income as of April 1, 2001, with subsequent changes in fair value recorded through the statement of earnings in the periods in which they arise. The warrants held represent a 20% interest in the underlying equity of the issuer. The Company is currently in the process of determining the fair value of the warrants, and estimates the initial impact of recording these instruments in accordance with Statement 133 will be in excess of 20% of the issuer’s underlying equity value ($1.8 million at February 28, 2001).
2. INDUSTRY SEGMENT INFORMATION - Selected information by industry segment for the three months ended March 31, 2001 and 2000 is presented below.
| SEGMENT DATA— (in thousands) | EARNINGS | REVENUES |
| | 2001
| 2000
| 2001
| 2000
|
| Property | 1,583 | 3,240 | 17,270 | 13,215 |
| Casualty | (614) | (620) | 36,019 | 32,757 |
| Surety | 1,155 | 1,095 | 9,998 | 7,215 |
| Net investment income | 7,452 | 6,937 | 7,452 | 6,937 |
| Realized gains (loss) | 1,432 | (121) | 1,432 | (121) |
| General corporate expense and interest on debt | (2,004) | (2,097) | | |
| Equity in earnings of unconsolidated investee | 533
| 562
| | |
| Total segment earnings before income taxes | 9,537
| 8,996
| | |
| Income taxes | 2,404
| 2,456
|
|
|
| Total | 7,133
| 6,540
| 72,171
| 60,003
|
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995: This discussion and analysis may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 which are not historical facts, and involve risks and uncertainties that could cause actual results to differ materially from those expected and projected. Various risk factors that could affect future results are listed in the Company's filings with the Securities Exchange Commission, including the Form 10-K for the year ended December 31, 2000.
OVERVIEW
RLI Corp. (the Company) is a holding company that, through its subsidiaries, underwrites selected property and casualty insurance products.
The most significant operation is RLI Insurance Group (the Group), which provides specialty property and casualty coverages for primarily commercial risks. The Group accounted for 88% of the Company's total revenue for the three months ended March 31, 2001.
THREE MONTHS ENDED MARCH 31, 2001, COMPARED TO THREE MONTHS
ENDED MARCH 31, 2000
Consolidated gross sales, which consist of gross premiums written, net investment income and realized investment gains totaled $129.0 million for the first three months of 2001 compared to $109.2 million for the same period in 2000. Gross writings of the Insurance Group improved 17.3% over 2000 levels fueled by increases in the casualty and surety segments. Consolidated revenue for the first three months of 2001 increased $12.2 million or 20.3% from the same period in 2000. Net premiums earned alone increased 19.0%. Net investment income improved 7.4% to $7.5 million. Additionally, the sale of certain securities during the first quarter of 2001 resulted in $1.4 million in realized gains, compared to $121,000 in realized losses for the same period last year.
The net after-tax earnings for the first three months of 2001 totaled $7.1 million, $.71 per diluted share, compared to $6.5 million, $.66 per share, for the same period in 2000. Net operating earnings, which consist of the Company's net earnings reduced by after-tax realized investment gains/losses, totaled $6.2 million, $.62 per share, compared to $6.6 million, $.67 per share, for the same period in 2000. The small decline in operating earnings was the result of the Company’s Seattle earthquake loss experience, which totaled just under $1.0 million ($.06 per share).
Comprehensive earnings, which include net earnings plus unrealized gains/losses net of tax, were subject to the quarter’s volatility in the equity markets. Comprehensive loss for the quarter totaled $7.1 million, $.71 per share, compared to comprehensive earnings of $1.6 million, $.16 per share, for the same period in 2000. Unrealized losses, net of tax, for the first three months of 2001 were $14.3 million, $1.42 per share compared to losses of $4.9 million, $.50 per share, for the same period in 2000.
RLI INSURANCE GROUP
Gross written premium for the Group increased to $120.1 million for the first quarter of 2001 compared to $102.4 million for the same period in 2000. Much of this improvement came from the casualty segment where improved pricing and various growth initiatives have positively impacted the top-line. Underwriting income declined to a pre-tax profit of $2.1 million for the first quarter of 2001 compared to $3.7 million for the same period in 2000. The GAAP combined ratio increased to 96.7 for the first quarter of 2001 compared to 93.0 for the first quarter of 2000. Loss experience from the Seattle earthquake contributed to the quarter’s higher combined ratio.
The Group’s property segment experienced a decline in gross writings of $1.6 million, or 4.2%, compared to first quarter 2000. For the first quarter of 2001, property premiums totaled $37.0 million. The decline in writings was due primarily to the fire book. Fire premium was down by $6.2 million, as the Company has nonrenewed or exited from writing certain unprofitable products and accounts. The decline in the fire premium was partially offset by a $4.6 million increase in construction premium. Underwriting profits for the property segment were $1.6 million for first quarter of 2001, compared to $3.2 million in 2000. The GAAP combined ratio increased to 90.9 compared to 75.5 for the same period last year. The Seattle earthquake, which registered 6.8 magnitude, resulted in just under $1.0 million in losses. Disciplined underwriting, coupled with the deep location of the quake’s epicenter, resulted in few claims reported from this event. In addition to the impact of the earthquake, the construction book experienced higher than expected losses for the quarter on builder’s risk business. Changes to underwriting standards and policy terms for this product were made late in 2000. Management will continue to carefully monitor the results of this product.
Gross written premiums for the casualty segment were $71.8 million for 2001, up $18.4 million, or 34.4%, from 2000. Increases in the following products contributed to this growth: transportation up $6.3 million, program business up $5.0 million, general liability up $3.9 million, employer’s indemnity up $1.9 million, and executive products up $1.0 million. Underwriting loss on the casualty book was $600,000, in line with first quarter 2000. These results translate into a combined ratio of 101.8 in 2001 versus 101.9 for the same period in 2000. The segment’s expense ratio at 35.9 has continued to show improvement, as premium volume has continued to increase, while the loss ratio at 65.9 remains in check.
Gross written premiums for the surety segment increased to $11.3 million for 2001, up $900,000, or 9.1%, from the same period in 2000. The recent expansion of the commercial surety product, with a focus on small- to middle-market accounts, resulted in $1.2 million of premium written during the first quarter of 2001. The surety book reported underwriting income of $1.2 million, compared to $1.1 million for the first quarter of 2000. The combined ratio for the surety segment totaled 88.4 in 2001 compared to 84.8 in 2000. The loss ratio component increased over last year due to several contract losses experienced during the first quarter of 2001. Partially offsetting this increase, the expense ratio has shown improvement, as increased premium volume has driven a reduction in the expense ratio.
INVESTMENT INCOME
The Company's investment portfolio generated net dividends and interest income of $7.5 million during the first three months of 2001, an increase of 7.4% over that reported for the same period in 2000. This is the result of the continued growth in the operating cash flow and incrementally higher yields on new investments.
Virtually all the Company's fixed income portfolio consists of securities rated A or better and 95% were rated AA or better. The year-to-date yields on the Company's fixed income investments for the three month periods ended March 31, 2001 and 2000 are as follows:
| | 2001
| 2000
|
| Taxable | 6.66% | 6.58% |
| Non-taxable | 4.96% | 4.89% |
For the first three months of 2001, yields on taxable and non-taxable securities remained at an equivalent level to that reported last year.
The Company's available-for-sale portfolio of debt and equity securities had a net unrealized loss before tax of $22.0 million for the first three months of 2001, compared to an unrealized loss of $7.6 million for the same period in 2000. The 2001 year-to-date loss reflects largely stock market fluctuations experienced during the first three months of the year. The Company's net unrealized gains before tax were $151.8 million and $173.8 million at March 31, 2001 and December 31, 2000, respectively. Unrealized appreciation on securities, net of tax, is reflected in accumulated other comprehensive earnings, a component of shareholders' equity.
Interest expense on debt obligations totaled $1.2 million for the first three months of 2001, unchanged from the same period in 2000. Average debt outstanding decreased by $3.7 million with debt payments in late February and March. The average interest rate on debt outstanding was, however, slightly higher in 2001 compared to 2000. Interest expense is expected to decrease as the weighted average interest rate for debt outstanding at March 31, 2001 was only 5.33%. At March 31, 2001, outstanding short-term balances totaled $66.0 million, compared to $77.8 million at March 31, 2000.
INCOME TAXES
The Company's effective tax rate for the first three months of 2001 was 25% compared to 27% for the same period in 2000. Income tax expense attributable to income from operations differed from the amounts computed by applying the U.S. federal tax rate of 35% to pretax income for the first three months of 2001 and 2000 as a result of the following:
| | 2001 | 2000 |
| | Amount
| %
| Amount
| %
|
| Provision for income taxes at the statutory rate of 35% | $3,338,006 | 35% | $3,148,483 | 35% |
| Increase (reduction) in taxes resulting from: | | | | |
| Tax exempt interest income | (707,618) | (7%) | (670,647) | (7%) |
| Dividends received deduction | (375,894) | (4%) | (401,219) | (4%) |
| Dividends paid deduction | (66,444) | (1%) | (61,528) | (1%) |
| Goodwill amortization | 138,811 | 1% | 139,865 | 2% |
| Other items, net | 76,928
| 1%
| 300,862
| 2%
|
| Total tax expense | $2,403,789
| 25%
| $2,455,816
| 27%
|
LIQUIDITY AND CAPITAL RESOURCES
Historically, the primary sources of the Company's liquidity have been funds generated from insurance premiums and investment income (operating activities) and maturing investments (investing activities). In addition, the Company has occasionally received proceeds from financing activities such as the sale of common stock to the employee stock ownership plan, the sale of convertible debentures, and short-term borrowings.
During the first three months of 2001, the Company retired 1,272 outstanding shares at a cost of $57,000. During the same period in 2000, the Company repurchased 71,272 of its outstanding shares at a cost of nearly $2.1 million. This repurchase program was funded through operating cash flow.
Invested assets at March 31, 2001 decreased by $30.1 million, or 4.0%, from December 31, 2000. Contributing to this decline, unrealized losses on the equity portfolio totaled $22.9 million. Additionally, proceeds from the sales and maturities of certain debt securities were used to pay down short-term debt. During the first quarter of 2001, $12.8 million in short-term debt was extinguished.
At March 31, 2001 the Company had short-term investments, cash and other investments maturing within one year, of approximately $70.0 million and additional investments of $149.0 million maturing within five years. The Company maintains one source of credit, a $30.0 million line of credit that cannot be canceled during its annual term. As of March 31, 2001, the Company had $19.6 million in outstanding short-term borrowings. Additionally, the Company was party to four reverse repurchase transactions totaling $46.4 million.
Management believes that cash generated by operations, cash generated by investments and cash available from financing activities will provide sufficient sources of liquidity to meet its anticipated needs over the next twelve to twenty-four months.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of economic losses due to adverse changes in the estimated fair value of a financial instrument as the result of changes in equity prices, interest rates, foreign exchange rates and commodity prices. The Company's consolidated balance sheets include assets and liabilities whose estimated fair values are subject to market risk. The primary market risks to the Company are equity price risk associated with investments in equity securities and interest rate risk associated with investments in fixed maturities. From time to time, equity prices and interest rates fluctuate causing an effect on the Company's investment portfolio. The Company has no direct commodity or foreign exchange risk.
The Company's market risk exposures at March 31, 2001, have not materially changed from those identified at December 31, 2000.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings - Not Applicable
Item 2. Change in Securities - Not Applicable
Item 3. Defaults Upon Senior Securities - - Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders - Not Applicable
Item 5. Other Information - Not Applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Not Applicable
(b) On January 18, 2001, the Company disseminated its fourth quarter 2000 earnings announcement and supporting schedules on Form 8-K. Information contained therein is available in SEC file number 0001-09463.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | RLI Corp. |
| |
/s/ Joseph E. Dondanville
|
| Joseph E. Dondanville |
| Vice President, Chief Financial Officer |
| (Duly authorized and Principal |
| Financial and Accounting Officer) |
Date: May 11, 2001
