UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the period ended September 30, 1998
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or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
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Commission File Number: 0-6612
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RLI Corp.
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(Exact name of registrant as specified in its charter)
ILLINOIS 37-0889946
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
9025 North Lindbergh Drive, Peoria, IL 61615
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(Address of principal executive offices) (Zip Code)
(309) 692-1000
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of November 4, 1998 the number of shares outstanding of the registrant's
Common Stock was 10,389,034.
Page 1 of 18
PART I
Item 1. Financial Statements
RLI Corp. & Subsidiaries
Condensed Consolidated Statement of Earnings and Comprehensive Earnings
For the Three-Month Period Ended September 30,
(Unaudited) 1998 1997
------------- -----------
Net premiums earned $35,950,695 $35,895,116
Net investment income 6,179,146 6,246,661
Net realized investment gains 32,773 544,529
------------- -----------
42,162,614 42,686,306
------------- -----------
Losses and settlement expenses 20,242,656 15,224,756
Policy acquisition costs 10,513,079 11,318,719
Insurance operating expenses 3,501,110 4,522,323
Interest expense on debt 615,440 115,489
General corporate expenses 644,079 975,447
------------- -----------
35,516,364 32,156,734
------------- -----------
Equity in earnings of uncons. investee 490,968 319,148
------------- -----------
Earnings before income taxes 7,137,218 10,848,720
Income tax expense 1,558,720 2,952,000
------------- -----------
Net earnings $ 5,578,498 $ 7,896,720
============= ===========
Other compre. earnings (loss), net of tax ( 16,348,118) 8,738,640
------------- -----------
Comprehensive earnings (loss) ( $10,769,620) $16,635,360
============= ===========
Earnings per share:
Basic:
Net earnings per share from operations $0.53 $0.67
Realized gains, net of tax $0.00 $0.04
------------- -----------
Basic net earnings per share $0.53 $0.71
============= ===========
Basic compre. earnings (loss) per share ($1.03) $1.49
============= ===========
Diluted:
Net earnings per share from operations $0.53 $0.65
Realized gains, net of tax $0.00 $0.03
------------ -----------
Diluted net earnings per share $0.53 $0.68
============ ===========
Diluted compre. earnings (loss) per share ($1.02) $1.42
============ ===========
Weighted average number of common shares outstanding
Basic 10,477,837 11,179,783
Diluted 10,602,524 11,797,629
Cash dividends declared per common share $0.13 $0.12
The accompanying notes are an integral part of the financial statements.
2
RLI Corp. & Subsidiaries
Condensed Consolidated Statement of Earnings and Comprehensive Earnings
(Continued)
For the Nine-Month Period Ended September 30,
(Unaudited) 1998 1997
------------ ------------
Net premiums earned $105,951,174 $104,935,103
Net investment income 17,865,524 18,267,558
Net realized investment gains 671,319 2,839,013
------------ ------------
124,488,017 126,041,674
------------ ------------
Losses and settlement expenses 47,805,352 46,578,496
Policy acquisition costs 34,410,820 32,212,878
Insurance operating expenses 12,323,890 13,068,816
Interest expense on debt 1,659,625 1,496,573
General corporate expenses 2,764,314 2,820,156
------------ ------------
98,964,001 96,176,919
------------ ------------
Equity in earnings of uncons. investee 1,428,243 859,604
------------ ------------
Earnings before income taxes 26,952,259 30,724,359
Income tax expense 6,772,745 8,288,185
------------ ------------
Net earnings $ 20,179,514 $ 22,436,174
============ ============
Other comprehensive earnings, net of tax 1,240,108 27,149,676
------------ ------------
Comprehensive Earnings $ 21,419,622 $ 49,585,850
============ ============
Earnings per share:
Basic:
Net earnings per share from operations $1.87 $2.04
Realized gains, net of tax $0.04 $0.18
------------ ------------
Basic net earnings per share $1.91 $2.22
============ ============
Basic comprehensive earnings per share $2.03 $4.90
============ ============
Diluted:
Net earnings per share from operations $1.85 $1.83
Realized gains, net of tax $0.04 $0.15
------------ ------------
Diluted net earnings per share $1.89 $1.98
============ ============
Diluted comprehensive earnings per share $2.00 $4.28
============ ============
Weighted average number of common shares outstanding
Basic 10,562,051 10,117,366
Diluted 10,693,122 11,833,121
Cash dividends declared per common share $0.38 $0.35
The accompanying notes are an integral part of the financial statements.
3
RLI Corp. and Subsidiaries Condensed Consolidated Balance Sheet
September 30, December 31,
ASSETS 1998 1997
(Unaudited)
Investments ------------ ------------
Fixed maturities
Held-to-maturity, at amortized cost $293,668,806 $290,034,309
Trading, at fair value 8,406,890 9,545,572
Available-for-sale, at fair value 34,197,609 34,120,202
Equity securities, at fair value 257,989,269 251,459,843
Short-term investments, at cost which
approximates fair value 28,940,760 18,696,896
------------ -------------
Total investments 623,203,334 603,856,822
Cash 0 0
Accrued investment income 6,079,034 6,348,257
Premiums and reinsurance balances receivable 42,643,346 30,719,768
Ceded unearned premiums 56,531,980 49,677,041
Reinsurance balances recoverable on unpaid losses 169,481,543 161,709,389
Deferred policy acquisition costs 22,473,137 21,984,585
Property and equipment 11,940,573 12,387,500
Investment in unconsolidated investee 13,548,570 13,615,577
Other assets 12,100,265 11,441,666
------------ ------------
TOTAL ASSETS $958,001,782 $911,740,605
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Unpaid losses and settlement expenses $418,367,663 $404,263,638
Unearned premiums 136,298,329 128,542,853
Reinsurance balances payable 35,891,338 24,390,338
Short-term debt:
LOC and notes payable 38,791,250 24,900,000
Income taxes-current 1,612,908 2,701,964
Income taxes-deferred 36,542,767 36,339,801
Other liabilities 22,827,675 24,049,571
------------ ------------
TOTAL LIABILITIES 690,331,930 645,188,165
------------ ------------
Shareholders' Equity:
Common stock ($1 par value, authorized
50,000,000 shares, issued 12,789,935 shares
at 9/30/98 and 10,229,673 at 12/31/97) 12,789,935 10,229,673
Accumulated other comprehensive earnings 88,092,771 86,852,663
Other shareholders' equity 228,083,382 215,019,386
Less: Unearned ESOP shares at cost
(70,400 shares at 9/30/98) ( 2,458,411) 0
Less: Treasury shares at cost
(2,318,916 shares at 9/30/98)
(1,994,272 shares at 12/31/97) (58,837,825) (45,549,282)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 267,669,852 266,552,440
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $958,001,782 $911,740,605
============ ============
The accompanying notes are an integral part of the financial statements.
4
RLI Corp. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the Nine-Month Period
Ended September 30,
--------------------------
1998 1997
------------ -------------
Net cash from operating activities $ 26,454,635 $ 7,704,628
------------ -------------
Cash Flows from Investing Activities
Investments purchased (37,826,525) (67,935,913)
Investments sold 3,885,579 12,572,571
Investments called or matured 24,616,600 28,066,592
Net (increase) decrease in
short-term investments (10,243,864) 36,239,946
Net property and equipment purchased ( 1,081,714) ( 1,736,419)
------------- --------------
Net cash from (used in) investing activities (20,649,924) 7,206,777
------------- --------------
Cash Flows from Financing Activities
Cash dividends paid ( 3,993,547) ( 3,604,004)
Proceeds from issuance of short-term debt 13,891,250 0
Fractional shares paid ( 16,099) ( 1,211)
Change in contributed capital 60,639 32,445
Treasury shares purchased (13,288,543) (11,338,635)
Unearned ESOP shares purchased ( 2,458,411) 0
------------- -------------
Net cash (used in) financing activities ( 5,804,711) (14,911,405)
------------- -------------
Net increase (decrease) in cash 0 0
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Cash at the beginning of the year 0 0
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Cash at September 30 $ 0 $ 0
============= =============
The accompanying notes are an integral part of the financial statements.
5
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 1997 annual report filed with the Securities and Exchange Commission.
The financial information included herein has been prepared by management
without audit by independent certified public accountants who do not
express an opinion thereon. The condensed consolidated balance sheet as
of December 31, 1997 has been derived from, and does not include all the
disclosures contained in the audited consolidated financial statements for
the year ended December 31, 1997.
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 nine month periods ended September 30, 1998 and 1997
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 1997 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 Nine-Month Period Ended September 30, 1998
Income Shares Per Share
(Numerator) (Denominator) Amount
- ------------------------------------------------------------------------------
Basic EPS
Income available to 20,179,514 10,562,051 1.91
common stockholders
Effect of Dilutive Securities
Incentive Stock Options -- 131,071
- ------------------------------------------------------------------------------
Diluted EPS
Income available to common 20,179,514 10,693,122 1.89
- ------------------------------------------------------------------------------
6
For the Nine-Month Period Ended September 30, 1997
Income Shares Per Share
(Numerator) (Denominator) Amount
- ------------------------------------------------------------------------------
Basic EPS
Income available to 22,436,174 10,117,366 2.22
common stockholders
Effect of Dilutive Securities
Convertible debentures 1,011,778 1,644,477
Incentive Stock Options -- 71,278
- ------------------------------------------------------------------------------
Diluted EPS
Income available to common 23,447,952 11,833,121 1.98
- ------------------------------------------------------------------------------
The comparison of Basic EPS between periods is impacted by the shares
associated with the Convertible debentures. In June 1997, the Company called
for redemption all of its outstanding convertible debentures. On July 24,
1997, the Company announced that all debentures had been converted. This
conversion resulted in an additional issuance of 2,211,538 shares of common
stock. Once converted, these shares became basic outstanding shares,
impacting both basic and diluted EPS. Prior to conversion, these potentially
dilutive shares were included in calculating dilutive EPS but were excluded
when computing basic EPS. For both periods presented, dilutive EPS includes
the impact of the shares associated with the convertible debentures and
provides a more accurate comparison of per share earnings.
Note additionally, that 1997 share and per share data has been restated to
reflect the 5/4 stock split that occurred on June 19, 1998.
Comprehensive Earnings: Financial Accounting Standards Board (FASB) Statement
No. 130, "Reporting Comprehensive Income," was issued in June 1997 and became
effective for interim and annual periods beginning after December 15, 1997.
The primary difference between reporting the Company's net and comprehensive
earnings is that comprehensive earnings include unrealized gains/losses net of
tax. Traditional reporting of net earnings directly credits or charges
shareholders' equity with unrealized gains/losses, rather than including them
in earnings.
Other Accounting Standards: In June 1997, the FASB issued Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information"
(Statement 131). Statement 131 establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. This Statement
is effective for fiscal periods beginning after December 15, 1997. In the
initial year of application, this Statement need not be applied to interim
financial statements. The Company is currently evaluating its segment
disclosures with respect to this Statement.
7
In February 1998, the FASB issued Statement No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits" (Statement 132). Statement
132 revises employers' disclosures about pension and other postretirement
benefit plans. It does not change the measurement or recognition of those
plans. Statement 132 standardizes the disclosure requirements for pensions
and other postretirement benefits to the extent practicable, requires
additional information on changes in the benefit obligations and fair values
of plan assets that will facilitate financial analysis, and eliminates certain
other disclosures that are no longer useful. This Statement is effective for
fiscal years beginning after December 15, 1997. The Company is currently
evaluating this recently issued Statement.
In June 1998, the 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.
This Statement 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. This
Statement is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999. Although the Company does not currently invest in derivative
instruments, this recently issued Statement is under evaluation.
2. INDUSTRY SEGMENT INFORMATION - Selected information by industry segment
for the nine months ended September 30, 1998 and 1997 is presented below.
SEGMENT DATA - (in thousands) EARNINGS
(LOSS)
BEFORE
REV. TAXES ASSETS*
1998 -------- --------- --------
RLI Insurance Group--Property $ 40,196 $ 14,540 $923,174
RLI Insurance Group--Casualty 52,629 ( 2,068)
RLI Insurance Group--Surety 13,126 ( 1,061)
Net investment income 17,866 17,866
Net realized investment gains 671 671
General corporate & interest expense -- (4,424) 21,279
Equity in Earnings of unconsolidated
investee -- 1,428 13,549
--------- ---------- ---------
Consolidated $124,488 $ 26,952 $958,002
========= ========== =========
1997
RLI Insurance Group--Property $ 44,994 $ 14,580 $857,497
RLI Insurance Group--Casualty 51,927 ( 1,936)
RLI Insurance Group--Surety 8,014 431
Net investment income 18,268 18,268
Net realized investment gains 2,839 2,839
General corporate & interest expense -- ( 4,317) 27,475
Equity in Earnings of unconsolidated
investee -- 860 13,524
--------- ---------- ---------
Consolidated $126,042 $ 30,725 $898,496
========= ========== =========
*The Company does not evaluate assets on the basis of individual Insurance
Group segments. Insurance Group assets presented in the tables represent
total assets of RLI Insurance Group and are inclusive of all segments
contained therein. 8
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,
1997.
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 85% of the Company's total revenue for the
nine months ended September 30, 1998.
NINE MONTHS ENDED SEPTEMBER 30, 1998, COMPARED TO NINE MONTHS
ENDED SEPTEMBER 30, 1997
Consolidated gross sales, which consist of gross premiums written, net
investment income and realized investment gains totaled $233.1 million for the
first nine months of 1998, equal to that reported for the same period in 1997.
Gross writings of the Insurance Group improved 1.2% over 1997 levels, in spite
of $10.7 million in non-recurring premiums booked during the first nine months
of 1997. As detailed in the discussion of RLI Insurance Group that follows,
1997 results included $10.7 million of non-recurring premiums associated with
the Company's purchase of the Hawaii Residential Insurance program.
Consolidated revenue for the first nine months of 1998 decreased $1.5 million
from the same period in 1997 to $124.5 million. Net premiums earned in the
first nine months of 1998 were up $1.0 million, or 1.0%, compared to the same
period in 1997, as casualty and surety revenue showed improvement. Net
investment income declined $400,000 to $17.9 million for the first nine months
of 1998. Additionally, realized investment gains are tracking $2.2 million
below 1997 levels. The sale of certain equity securities and real estate
during the first nine months of 1997 accounted for this decrease between
periods.
The net after-tax earnings for the first nine months of 1998 totaled $20.2
million, $1.89 per diluted share, compared to $22.4 million, $1.98 per share,
for the same period in 1997. Net operating earnings, which consist of the
Company's net earnings reduced by after-tax realized investment gains, totaled
to $19.7 million, $1.85 per share, compared to $20.6 million, $1.83 per share,
for the same period in 1997. During September of 1998, two significant
charges have impacted the Company's earnings. Damage estimates from Hurricane
Georges, which occurred in late September, eroded the Company's earnings by
$700,000 after tax, or $0.07 per share. Additionally, as detailed in the
discussion of RLI Insurance Group that follows, reserve strengthening on the
surety line reduced earnings by $1.7 million after tax, or $0.16 per share.
9
Comprehensive earnings, which includes net earnings plus unrealized
gains/losses net of tax, totaled $21.4 million, $2.00 per share, compared to
$49.6 million, $4.20 per share, for the same period in 1997. Unrealized
gains, net of tax, for the first nine months of 1998 were $1.2 million, $0.11
per share compared to $27.2 million, $2.30 per share, for the same period in
1997. The tremendous rise in the stock market during 1997 accounted for this
difference.
RLI INSURANCE GROUP
Gross premiums written for the first nine months of 1998 totaled $214.6
million, compared to $212.0 million reported for the same period in 1997.
Property premiums decreased $26.6 million to $84.2 million for the first nine
months of 1998. Non-recurring premiums associated with the acquisition of the
Hawaiian Homeowners business in March of 1997 account for $10.7 million of
this decline. As part of the purchase agreement with the Hawaii Property
Insurance Association, RLI Insurance Group assumed, on a one-time basis, $10.7
million in unearned premium. Additionally, rate reductions experienced on
property's Difference-In-Condition product have resulted in a decline of $14.2
million compared to 1997 levels. The Company's surety book, on the other
hand, grew its top line by 22.1% during the first nine months of 1998. Direct
writings for surety improved $4.2 million to $23.4 million versus $19.2
million for the same period in 1997. This increase is primarily the result of
the continued growth of the Universal Bonding and Surety America programs.
Gross writings on the casualty book improved, as well, up $24.9 million over
the first nine months of 1997 to $107.0 million. Commercial Umbrella improved
$15.9 million to $37.3 million for the first nine months of 1998. The
Company's expansion into the West Coast market, through its relationship with
the general agency ALCO, accounted for $9.8 million of this growth, while an
additional $7.6 million in production came from the Company's newly opened
office in Dallas, Texas. Additionally, the Transportation program launched in
November of 1997 added $12.0 million in writings during its first nine months
of production. It is anticipated that this program will add $17.0 million in
annual written premiums during 1998. Partially offsetting the growth in the
Commercial Umbrella and Transportation programs, Employer's Excess Indemnity
experienced a decline of $6.0 million, as the Company discontinued its
relationship with its primary brokerage firm for this program.
Net premiums written for the first nine months of 1998 decreased $4.0 million
or 3.6% from the same period in 1997. Net property writings decreased $18.9
million from 1997 levels, due to the non-recurring premiums associated with
the assumption of the Hawaiian Homeowners business and difference-in-condition
pricing, as mentioned previously. The surety book posted net premium written
of $14.9 million, a $4.2 million improvement over the same period in 1997,
while net casualty writings improved $10.7 million to $58.3 million.
Net premiums earned of $106.0 million in the first nine months of 1998
represents a $1.0 million improvement from the same period in 1997. Earned
premiums on the property book declined $4.8 million to $40.2 million.
Offsetting this decline, both the surety and casualty books have posted
improvements. With the continued growth of Universal Bonding and Surety
America, as mentioned previously, the surety book improved to $13.1 million, a
$5.1 million increase over 1997 levels. Additionally, earned premiums on the
casualty book improved by $700,000 to $52.6 million. Growth initiatives in
10
the Commercial Umbrella and Transportation lines, which have served to improve
casualty's gross and net writings, have begun to translate into improvements
in premium earned. Earned premium on Commercial Umbrella improved $3.9
million to $9.9 million compared to last year, while Transportation posted
$2.6 million in earned premium during its first nine months of operation.
Partially offsetting these improvements were declines of $2.9 and $2.6 million
in General Liability and Employer's Excess Indemnity.
The Group's pretax earnings totaled $11.4 million for the first nine months of
1998 compared to $13.1 million for the same period in 1997. Despite $1.1
million in Hurricane Georges losses, the property book remained strong,
posting $14.5 million in pretax earnings compared to $14.6 million for the
same period in 1997. Surety declined to a loss of $1.1 million, down $1.5
million from the pretax profit of $430,000 reported for the same period in
1997. Reserve strengthening on the surety book reduced this segment's pre-tax
earnings by $2.6 million. Loss development from one specific contract surety
producer, whose production represents only 8% of the total surety book,
brought the need for this action in late September. With this action, the
Company believes it has sufficiently reserved for these particular losses and
implemented changes to improve the program's results going forward. The
casualty book remained flat, posting a pretax loss of $2.1 million for the
first nine months of 1998 compared to a pretax loss of $1.9 million for the
same period in 1997.
The GAAP combined ratio through the first nine months of 1998 was 89.2
compared to 87.6 for the same period in 1997. The loss ratio increased from
44.4 for the first nine months of 1997 to 45.1 for the same period in 1998.
This increase was the result of an increase in property's loss ratio from 20.0
in 1997 to 22.8 in 1998, as a result of losses incurred from Hurricane
Georges. Additionally, reserve strengthening on the surety book increased the
surety book's loss ratio from 21.9 in 1997 to 40.8 thus far in 1998.
Partially offsetting these increases, the casualty book posted a decline in
its loss ratio from 69.0 in 1997 to 63.3 in 1998. Based on loss experience-
to-date, first quarter 1998 casualty results contained a $3.0 million reclass
between losses incurred and operating expenses (decreasing losses incurred and
increasing contingent commissions) on the Company's deductible buy-back
program, an experience-based program. This reclass has no impact on bottom
line net earnings, but does affect the comparison of loss and expense ratios
between periods. Net of this reclass, casualty's loss ratio is 69.0, in line
with 1997. The Company's expense ratio increased from 43.2 for the first nine
months of 1997 to 44.1 for the same period in 1998. This increase was
primarily related to increases experienced on the casualty book. The casualty
book's expense ratio increased from 34.7 in 1997 to 40.7 in 1998. The
aforementioned reclass on the Company's deductible buy-back program accounted
for 5.7 of the 6.0 point increase. Net of this reclass, the casualty book's
expense ratio was 35.0, up 0.3 points from 1997's 34.7. Start-up costs
associated with the Company's Transportation program, as well as the expansion
of casualty operations in Dallas, San Francisco, and Los Angeles, have caused
expenses to trend upward. Partially offsetting this increase, the Company's
property and surety books have shown declines in their expense ratios for the
first nine months of 1998. Property's expense ratio decreased from 47.6 in
1997 to 41.0 in 1998. Commissions associated with the Hawaiian Homeowner's
acquisition caused 1997's expense ratio to be higher. Additionally, the
surety book posted an improvement in expense ratio, decreasing from 72.7 in
1997 to 67.3 in 1998.
11
INVESTMENT INCOME
The Company's investment portfolio generated net dividends and interest income
of $17.9 million during the first nine months of 1998, a decrease of 2.2% over
that reported for the same period in 1997. This decrease is the result of a
drop in fixed income yields, an increase in tax exempt securities, and
increasing asset management fees on the appreciated common stock portfolio.
Invested assets at September 30, 1998 increased by $19.3 million, or 3.2%,
from December 31, 1997. For the nine months ended September 30, 1998, the
Company experienced $1.9 million in pre-tax unrealized gains on its investment
portfolio. Additionally, short-term investments increased to $28.9 million,
up $10.2 million from December 31, 1997.
Virtually all the Company's fixed income portfolio consists of securities
rated A or better and 98% were rated AA or better. The year-to-date yields
on the Company's fixed income investments for the nine month periods ended
September 30, 1998 and 1997 are as follows:
1998 1997
----- -----
Taxable 6.54% 6.91%
Non-taxable 4.96% 4.99%
Yields on taxable and non-taxable securities declined through the first nine
months of 1998 due to the maturity of higher yielding securities from the
portfolio. In a period of declining interest rates, these securities were
replaced with lower yielding securities. Additionally, during the second
quarter of 1998, a one-time adjustment to the premium amortization on callable
bonds has negatively impacted yields on the taxable bond portfolio.
The Company's available-for-sale portfolio of debt and equity securities had
net unrealized gains before tax of $1.9 million for the first nine months of
1998 compared to net unrealized gains before tax of $41.8 million for the same
period in 1997. The tremendous rise in the stock market during 1997 accounted
for this difference. The Company's net unrealized gain before tax was $135.2
million and $133.3 million at September 30, 1998 and December 31, 1997,
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 increased to $1.7 million for the first
nine months of 1998, a $200,000 increase from the same period in 1997. This
change is related to an increase in outstanding debt balances. Conversion of
the $46.0 million convertible debt into common equity occurred in July 1997,
resulting in no outstanding debt at September 30, 1997. In conjunction with
the Company's stock repurchase program, the Company accumulated $24.9 million
in short-term debt during the last three months of 1997. Through the first
nine months of 1998, an additional $13.9 million in short-term debt has
accumulated as this repurchase program has continued. At September 30, 1998,
outstanding short-term debt totaled $38.8 million.
12
INCOME TAXES
The Company's effective tax rate for the first nine months of 1998 was 25%
compared to 27% for the same period in 1997. This decrease is primarily
attributable to reduced underwriting income, which is taxable at 35%. 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 nine months of 1998 and 1997 as a result of the following:
1998 1997
Amount % Amount %
------ --- ------ ---
Provision for income taxes at
the statutory rate of 35% $ 9,433,291 35% $10,753,526 35%
Increase (reduction) in taxes
resulting from:
Tax exempt interest income (1,661,771) ( 6%) (1,367,868) ( 4%)
Dividends received deduction (1,048,852) ( 4%) ( 990,358) ( 3%)
Dividends paid deduction ( 172,078) ( 1%) ( 178,512) ( 1%)
Other items, net 222,155 1% 71,397 --
----------- ---- ----------- ---
Total tax expense $ 6,772,745 25% $ 8,288,185 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, sale of convertible
debentures, and short-term borrowings.
During the first nine months of 1998, the Company repurchased 324,644 of its
outstanding shares at a cost of $13.3 million. This repurchase program has
been funded through the issuance of short-term debt. These treasury shares
are reflected as a separate component of shareholders' equity. Additionally,
in the third quarter of 1998, the Company established a leveraged ESOP.
During the quarter, the Company contributed $2.5 million, the expected 1998
plan year funding, to leverage the ESOP. Funds received were used by the ESOP
to purchase 70,400 shares. These shares are reflected as unearned ESOP
shares, a separate component of shareholder's equity.
At September 30, 1998 the Company had short-term investments, cash and other
investments maturing within one year, of approximately $55.1 million and
additional investments of $131.8 million maturing within five years. The
Company maintains one source of credit, a $30.0 million unsecured line of
credit that cannot be canceled during its annual term. As of September 30,
1998, the Company had $17.7 million in outstanding short-term borrowings.
Additionally, the Company was party to three reverse repurchase transactions
totaling $21.1 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.
13
OTHER MATTERS
The Year 2000 ("Y2K") issue is a result of computerized systems, including
both hardware and software systems, using a two-digit format, as opposed to
four digits, to indicate the year in the date field. Such computer systems
may be unable to interpret dates beyond the year 1999, which could cause a
system failure or other computer errors, leading to disruptions in operations.
In 1997, the Company began work on a five phase program for Y2K compliance.
Phase I was to identify those primary and mission critical business systems,
those essential to continuing operations, which presented Y2K issues. This
phase was a four month process beginning in August of 1997. Phase II was to
form a committee by business unit to identify all secondary and general
infrastructure issues which would need to be addressed for Y2K compliance.
This phase began in December of 1997 and was completed in April of 1998 with
the evaluation and initial identification of secondary Y2K exposures which
needed attention. Phase III was the modification and testing of mission
critical systems identified in Phase I. Phase III included changes to the
Company's property and casualty systems, accounts receivable, custom business
processing, general ledger, accounts payable, external business interfaces,
digital image processing and accounting interface systems. The status of
completion of Phase III are discussed below. Phase IV which began in May of
1998, included the development of plans to address secondary infrastructure
issues, line of business of strategies to address exposures associated with
the Company's insurance products and a process to survey key vendors and
business partners. This phase is scheduled to be complete within the first
quarter of 1999. Phase V is designed to refine operational and contingency
plans for Y2K cut-over. This phase is scheduled to begin in the first quarter
of 1999 and carry through the first quarter of the year 2000. Items carried
through the first quarter of the year 2000 are considered non-critical and
incidental to the Company's operations.
The Company has identified three major areas determined to be critical for
successful Y2K compliance: (1) accounting and premium processing systems, (2)
terms and conditions of existing insurance contracts and (3) third-party
relationships. Y2K compliance and progress is regularly reviewed by the
Company's MIS Steering Committee, Audit Committee and the Board of Directors.
In accordance with Phase I of the program, the Company completed an internal
review of all primary and mission critical systems and contacted related
software suppliers to determine major areas of exposure by December of 1997.
In November of 1998, the Company successfully completed the modification,
testing and implementation of Y2K compliant core property and casualty
systems, accounts receivable, custom business processing, general ledger,
accounts payable and accounting interfaces. The Company's new reinsurance
system implemented in early 1998 was already identified as Y2K complaint.
Business transactions are presently being processed and premium earned on
inforce policies with Y2K expiration dates. Testing of the digital image
processing upgrades are in process with expected completion in the fourth
quarter of 1998. External business interfaces have been addressed within core
systems efforts, but may require additional modification for any subsequent
changes implemented by external parties.
As a component of Phase IV, the Company completed the development of
strategies by line of business which it feels will effectively manage Y2K
related exposures and coverages. This exposure is divided into two distinct
14
areas, business partners and insurance coverage issues for our
policyholders/customers.
In August of 1998, all significant vendors and business partners were surveyed
for compliance efforts and responses are being evaluated by the Company's
internal audit and compliance unit for further steps and action, prior to the
end of the first quarter of 1999. Of the responses received from vendors and
business partners a significant number state that they are Y2K compliant or
intend to be Y2K compliant by December 31, 1999. The Company will continue to
make efforts to ensure its business partners and vendors are Y2K compliant,
however, the ultimate state of compliance of these providers is beyond the
Company's control and could impact the Company's operations and financial
results in future periods.
The types of insurance which may be the subject of claims arising from Y2K
losses include property, Directors & Officers liability, Miscellaneous
Professional liability, and other casualty. Although uncertainty exists with
respect to legal interpretations of Y2K liability, it is anticipated that if
Y2K claims are received, the majority will stem from Director & Officers and
Miscellaneous Professional liability policies, in terms of both frequency and
severity. The Company has formulated a Y2K questionnaire to be completed at
the time of initial policy application and renewal. Each application is
individually underwritten, and responses on the Y2K questionnaire are a
component of the underwriter's determination whether to offer coverage, and if
so, to what extent. A Y2K exclusion has been drafted and is available for
underwriters' use if needed. Additionally, a Y2K team of underwriters and
claims personnel has been assembled to prepare for the proper handling of Y2K
claims. All claims are handled on an individual basis in accordance with
policy terms and conditions.
As an element of Phase V, the Company has system contingency services
contracted through a major third party provider and is presently refining
support related specifically to potential Y2K issues. In addition, the
Company plans to develop a Y2K operational support plan for the millennium
weekend, including on site staff and on call support by the third quarter of
1999. Exposure and risk management of new or developing Y2K exposures will
continue through the first quarter of 2000.
The Company has incurred $1.2 million in expenses to complete the core system
modifications for Y2K. It required over 26,000 hours of technical staff
effort and changes to systems representing 12.5 million lines of program code.
It is estimated that the Company will incur an additional $300,000 of expense
in 1999 to upgrade telephone systems, corporate e-mail solutions and to assure
the necessary services are in place for contingency efforts.
THREE MONTHS ENDED SEPTEMBER 30, 1998, COMPARED TO
THREE MONTHS ENDED SEPTEMBER 30, 1997
Consolidated gross sales totaled $80.0 million for the third quarter of 1998,
up $7.7 million, or 10.7%, from that reported for the same period in 1997. As
detailed in the discussion of RLI Insurance Group that follows, third quarter
1998 gross premiums improved $8.3 million, or 12.7%, over third quarter 1997.
Consolidated revenue for the third quarter of 1998 decreased $600,000, or
1.2%, from the same period in 1997. Net premiums earned in the third quarter
of 1998 remained flat at $36.0 million, compared to $35.9 million, while
investment income and investment gains declined $600,000 over third quarter
1997 levels. 15
The net after-tax earnings for the third quarter of 1998 totaled $5.6 million,
$0.53 per diluted share, compared to $7.9 million, $0.68 per share, for the
same period in 1997. Net earnings for the third quarter of 1997 include
$400,000, $0.03 per share, in after-tax realized investment gains. Net
operating earnings, which consist of the Company's net earnings reduced by
after-tax realized investment gains, declined to $5.6 million, $0.53 per
share, compared to $7.5 million, $0.65 per share, for the same period in 1997.
This decrease is primarily attributable to two significant charges impacting
third quarter 1998 earnings. First, damage estimates from Hurricane Georges
impacted the quarter's earnings by $700,000 after tax, or $0.07 per share.
Secondly, reserve strengthening on the surety line reduced third quarter
earning's by $1.7 million after tax, or $0.16 per share.
Comprehensive earnings, which includes net earnings plus unrealized
gains/losses net of tax, totaled a loss of $10.8 million, $1.02 loss per
share, compared to a profit of $16.6 million, $1.42 earnings per share for the
same period in 1997. Unrealized losses, net of tax, for the third quarter of
1998 were $16.3 million, $1.55 loss per share, compared to unrealized gains of
$8.7, $0.74 earnings per share, for the same period in 1997.
RLI INSURANCE GROUP
Gross premiums written for the third quarter of 1998 totaled $73.8 million,
compared to $65.5 million reported for the same period in 1997. Property
premiums decreased $4.4 million to $27.6 million for the third quarter of
1998, primarily due to a decline in Difference-In-Conditions writings as
mentioned previously. The Company's surety book, on the other hand, grew its
top line by 5.1% during the third quarter of 1998. Direct writings for surety
improved $300,000 to $7.1 million versus $6.8 million for the same period in
1997. This increase is primarily the result of the continued growth of the
Universal Bonding and Surety America programs. Gross writings on the casualty
book improved, as well, up to $12.4 million over third quarter 1997 to $39.1
million. Commercial Umbrella improved $6.1 million to $14.7 million for the
third quarter of 1998. General Liability grew its top-line, as well, totaling
$8.4 million in gross writings, up $2.3 million from that reported for the
third quarter of 1997. As mentioned previously, the Company's expansion into
the West Coast market, coupled with the newly opened office in Dallas, Texas
accounted for these improvements. Additionally, the Transportation program
launched in November of 1997 added $4.2 million in writings during its third
quarter of production. Partially offsetting the growth in the Commercial
Umbrella and Transportation programs, Employer's Excess Indemnity experienced
a decline of $1.1 million, as the Company discontinued its relationship with
its primary brokerage firm for this program.
Net premiums written for the third quarter of 1998 increased $3.2 million, or
15.8%, from the same period in 1997. Net property writings decreased $3.0
million over third quarter 1997, primarily due to the decline in Difference-
In-Condition writings mentioned previously. The surety book posted net
premium written of $4.9 million, a $1.1 million improvement over the same
period in 1997. On the strength of Commercial Umbrella, Transportation, and
General Liability production, net casualty writings improved $7.2 million to
$21.8 million.
Net premiums earned of $36.0 million in the third quarter of 1998 represents a
$100,000 increase over the same period in 1997. Earned premiums on the
property book declined $4.1 million, due to the reduction in writings as
16
previously detailed. Surety, however, posted growth, improving $1.7 million,
or 51.2%, over the same period in 1997. Continued growth in the Universal
Bonding and Surety America programs fueled this improvement. Additionally,
top-line growth initiatives on the casualty book have begun to translate into
earned premium. Commercial Umbrella and Transportation improved $1.9 and $1.3
million, respectively, and served to offset declines experienced on Employer's
Excess Indemnity.
The Group's pretax earnings totaled $1.7 million for the third quarter of 1998
compared to $4.8 million for the same period in 1997, as property and profits
declined. As mentioned previously, during September of 1998, two one-time
charges have impacted the Company's underwriting results. Property earnings
were suppressed by $1.1 million in pre-tax losses associated with Hurricane
Georges, which occurred during the third quarter of 1998. Additionally,
surety's results were impacted by $2.6 million in one-time reserve
strengthening on contract surety business. The GAAP combined ratio for the
third quarter of 1998 was 95.3 compared to 86.5 for the same period in 1997.
The third quarter loss ratio increased from 42.4 for the third quarter of 1997
to 56.3 in the third quarter of 1998, due to property and surety losses
discussed previously. The Company's expense ratio decreased from 44.1 for the
third quarter of 1997 to 39.0 for the third quarter of 1998, as property,
surety and casualty have shown improvement.
INVESTMENT INCOME
The Company's investment portfolio generated net dividends and interest income
of $6.2 million during the third quarter of 1998, a decrease of 1.1% over that
reported for the same period in 1997. This decrease is the result of a drop
in fixed income yields and an increase in tax exempt securities. In addition,
the Company recognized realized investment gains of $32,000 in the third
quarter of 1998 compared to $500,000 in the third quarter of 1997.
INCOME TAXES
The Company's effective tax rate for the third quarter of 1998 was 22%
compared to 27% reported for the same period in 1997. This decrease is
primarily attributable to a decline in third quarter 1998 underwriting income
which is taxable at 35%. 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 second quarter of 1998 and 1997 as a
result of the following:
1998 1997
Amount % Amount %
------ --- ------ ---
Provision for income taxes at
the statutory rate of 35% $ 2,498,026 35% $ 3,797,052 35%
Increase (reduction) in taxes
resulting from:
Tax exempt interest income ( 578,181) ( 8%) ( 476,853) ( 4%)
Dividends received deduction ( 349,255) ( 5%) ( 328,787) ( 3%)
Dividends paid deduction ( 59,927) ( 1%) ( 59,015) ( 1%)
Other items, net 48,057 1% 19,603 --
------------ --- ----------- ---
Total tax expense $ 1,558,720 22% $ 2,952,000 27%
17
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) The Company did not file any reports on Form 8-K during the three
months ended September 30, 1998.
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: November 9, 1998
18