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, 2000 ------------------------------------------- or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to --------------- --------------- Commission File Number: 0-6612 ----------------------------------------- RLI Corp. ----------------------------------------------------------------- (Exact name of registrant as specified in its charter) ILLINOIS 37-0889946 ----------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 9025 North Lindbergh Drive, Peoria, IL 61615 ----------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (309) 692-1000 ----------------------------------------------------------------- (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 10, 2000 the number of shares outstanding of the registrant's Common Stock was 9,803,962. Page 1 of 15 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) 2000 1999 ------------- ----------- Net premiums earned $61,250,871 $ 50,991,644 Net investment income 7,461,190 6,737,007 Net realized investment gains 603,801 2,264,925 ------------- ----------- 69,315,862 59,993,576 ------------- ----------- Losses and settlement expenses 34,660,846 27,104,767 Policy acquisition costs 19,339,611 15,304,061 Insurance operating expenses 4,304,520 4,097,696 Interest expense on debt 1,359,793 1,076,296 General corporate expenses 607,030 680,954 ------------- ----------- 60,271,800 48,263,774 ------------- ----------- Equity in earnings of uncons. investee 794,988 210,771 ------------- ----------- Earnings before income taxes 9,839,050 11,940,573 Income tax expense 2,459,829 3,469,082 ------------- ----------- Net earnings $ 7,379,221 $ 8,471,491 ============= ============ Other compre. earnings(loss), net of tax 9,399,962 (21,189,824) ------------- ----------- Comprehensive earnings (loss) $16,779,183 $(12,718,333) ============= =========== Earnings per share: Basic: Net earnings per share from operations $0.71 $0.70 Realized gains, net of tax $0.04 $0.15 ------------- ----------- Basic net earnings per share $0.75 $0.85 ============= =========== Basic compre. earnings(loss)per share $1.71 $(1.27) ============= =========== Diluted: Net earnings per share from operations $0.70 $0.69 Realized gains, net of tax $0.04 $0.15 ------------ ----------- Diluted net earnings per share $0.74 $0.84 ============ =========== Diluted compre. earnings(loss)per share $1.69 $(1.26) ============ =========== Weighted average number of common shares outstanding Basic 9,803,879 10,015,096 Diluted 9,951,406 10,129,261 Cash dividends declared per common share $0.15 $0.14 The accompanying notes are an integral part of the financial statements. 2 RLI Corp. & Subsidiaries Condensed Consolidated Statement of Earnings and Comprehensive Earnings For the Nine-Month Period Ended September 30, (Unaudited) 2000 1999 ------------- ------------ Net premiums earned $172,080,689 $144,453,076 Net investment income 21,482,936 19,165,187 Net realized investment gains 517,136 4,522,892 ------------- ------------ 194,080,761 168,141,155 ------------- ------------ Losses and settlement expenses 94,336,883 70,203,818 Policy acquisition costs 55,234,149 48,938,152 Insurance operating expenses 13,224,177 12,253,391 Interest expense on debt 3,893,753 2,905,051 General corporate expenses 2,036,118 2,383,848 ------------- ------------ 168,725,080 136,684,260 ------------- ------------ Equity in earnings of uncons. investee 2,761,672 1,428,151 ------------- ------------ Earnings before income taxes 28,117,353 32,885,046 Income tax expense 7,236,306 8,814,982 ------------- ------------ Net earnings $ 20,881,047 $ 24,070,064 ============= ============ Other compre. earnings (loss), net of tax 5,428,324 (13,577,938) ------------- ------------ Comprehensive earnings $ 26,309,371 $ 10,492,126 ============= ============ Earnings per share: Basic: Net earnings per share from operations $2.10 $2.07 Realized gains, net of tax $0.03 $0.29 ------------- ----------- Basic net earnings per share $2.13 $2.36 ============= =========== Basic compre. earnings per share $2.68 $1.03 ============= =========== Diluted: Net earnings per share from operations $2.07 $2.05 Realized gains, net of tax $0.03 $0.29 ------------ ----------- Diluted net earnings per share $2.10 $2.34 ============ =========== Diluted compre. earnings per share $2.65 $1.02 ============ =========== Weighted average number of common shares outstanding Basic 9,821,837 10,193,015 Diluted 9,933,191 10,290,735 Cash dividends declared per common share $0.44 $0.41 The accompanying notes are an integral part of the financial statements. 3 RLI Corp. and Subsidiaries Condensed Consolidated Balance Sheet September 30, 2000 December 31, 1999 (Unaudited) ------------------ ----------------- ASSETS Investments Fixed maturities Held-to-maturity, at amortized cost $ 309,443,955 $ 294,198,626 Trading, at market value 7,920,053 7,650,901 Available-for-sale, at market value 86,680,018 40,662,978 Equity securities, at fair value 294,647,667 284,639,044 Short-term investments, at cost 45,569,617 64,092,009 -------------- -------------- Total investments 744,261,310 691,243,558 Accrued investment income 6,902,135 6,999,134 Premiums and reinsurance balances receivable 98,358,607 65,476,876 Ceded unearned premium 61,635,431 48,676,411 Reinsurance balances recoverable on unpaid losses 231,140,599 245,580,145 Federal income tax receivable 1,363,665 2,061,958 Deferred policy acquisition costs 45,321,492 34,357,631 Property and equipment 14,077,463 15,440,784 Investment in unconsolidated investee 17,833,608 15,070,277 Goodwill 32,805,763 34,140,327 Other assets 11,942,074 11,315,728 -------------- -------------- TOTAL ASSETS $1,265,642,147 $1,170,362,828 ============== ============== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Unpaid losses and settlement expenses $ 533,857,479 $ 520,494,454 Unearned premiums 211,592,281 167,044,325 Reinsurance balances payable 55,745,839 44,278,883 Short-term debt, LOC and notes payable 78,539,318 78,396,568 Income taxes-deferred 44,786,285 41,662,396 Other liabilities 28,518,463 25,416,744 -------------- -------------- TOTAL LIABILITIES 953,039,665 877,293,370 -------------- -------------- Shareholders' Equity: Common stock ($1 par value, authorized) (12,806,446 shares issued at 9/30/00) (12,804,558 shares issued at 12/31/99) 12,806,446 12,804,558 Paid-In Capital 70,153,160 70,531,201 Accumulated other comprehensive earnings 105,228,433 99,800,109 Retained Earnings 205,818,003 189,250,195 Deferred compensation 5,182,822 4,705,536 Less: Treasury shares at cost (3,002,484 shares at 9/30/00) (2,931,212 shares at 12/31/99) (86,586,382) (84,022,141) -------------- -------------- TOTAL SHAREHOLDERS' EQUITY 312,602,482 293,069,458 -------------- -------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,265,642,147 $1,170,362,828 ============== ============== 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, --------------------------- 2000 1999 ------------ ------------- Net cash provided by operating activities $ 55,414,044 $ 34,627,063 ------------ ------------- Cash Flows from Investing Activities Investments purchased (106,887,481) (54,251,597) Investments sold 22,147,519 18,629,145 Investments called or matured 21,856,700 23,650,563 Net decrease in short-term investments 14,533,268 2,858,716 Net property and equipment purchased (931,209) (4,154,528) Investment in Underwriters Indemnity Holdings 0 (40,700,000) ------------ ------------- Net cash used in investing activities (49,281,203) (53,967,701) ------------ ------------- Cash Flows from Financing Activities Cash dividends paid (4,225,557) (4,172,608) Proceeds from issuance of notes payable 1,029,250 36,330,603 Payments on debt (886,500) 0 Change in contributed capital 36,921 302,696 Treasury shares purchased (2,086,955) (15,621,052) Unearned ESOP shares purchased - 2,500,999 ------------ ------------- Net cash provided by (used in) financing activities (6,132,841) 19,340,638 ------------ ------------- Net increase in cash 0 0 ------------ ------------- Cash at the beginning of the year 0 0 ------------ ------------- 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 1999 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, 1999 has been derived from, and does not include all the disclosures contained in the audited consolidated financial statements for the year ended December 31, 1999. 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, 2000 and 1999 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 1999 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 the FASB issued Statement No. 128, "Earnings per Share," 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, 2000 Income Shares Per Share (Numerator) (Denominator) Amount - ------------------------------------------------------------------------------ BASIC EPS Income available to $20,881,047 9,821,837 2.13 common stockholders EFFECT OF DILUTIVE SECURITIES Incentive Stock Options -- 111,354 - ------------------------------------------------------------------------------ DILUTED EPS Income available to common $20,881,047 9,933,191 2.10 - ------------------------------------------------------------------------------ 6 For the Nine-Month Period Ended September 30, 1999 Income Shares Per Share (Numerator) (Denominator) Amount - ------------------------------------------------------------------------------ BASIC EPS Income available to $24,070,064 10,193,015 2.36 common stockholders EFFECT OF DILUTIVE SECURITIES Incentive Stock Options -- 97,720 - ------------------------------------------------------------------------------ DILUTED EPS Income available to common $24,070,064 10,290,735 2.34 - ------------------------------------------------------------------------------ OTHER ACCOUNTING STANDARDS: 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, as amended by FASB Statement No. 137, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company is currently evaluating its investment portfolio under the guidelines set forth in this recently issued Statement. In October 1998, the AICPA issued Statement of Position (SOP) 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." SOP 98-7 provides guidance on how to account for insurance and reinsurance contracts that do not transfer insurance risk. The method used for these contracts is referred to as deposit accounting. This SOP specifies that at inception, a deposit asset or liability should be recognized for insurance and reinsurance contracts accounted for under deposit accounting and should be measured based on the consideration paid or received, less any explicitly identified premiums or fees to be retained by the insurer effective for financial statements for fiscal years beginning after June 15, 1999. The Company does not have any insurance or reinsurance contracts that are required to be accounted for under the deposit method as of September 30, 2000. In September 2000, the FASB issued Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"(Statement 140). Statement 140 supercedes and replaces the guidance in FASB issued Statement 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". Statement 140 provides guidance on securitization transactions involving financial assets, sales of financial assets such as receivable, loans and securities, collateralized borrowing arrangements, securities lending transactions, and repurchase agreements. Disclosure requirements under this Statement become effective for financial statements for fiscal years ending after December 15, 2000. The Company is currently evaluating this recently issued Statement. 7 2. INDUSTRY SEGMENT INFORMATION - Selected information by industry segment for the nine months ended September 30, 2000 and 1999 is presented below. SEGMENT DATA-- (in thousands) EARNINGS REVENUES 2000 1999 2000 1999 -------- -------- -------- ------- Property 7,152 12,963 44,229 37,902 Casualty (778) (1,711) 102,910 87,473 Surety 2,912 1,806 24,942 19,078 Net investment income 21,483 19,165 21,483 19,165 Realized gains 517 4,523 517 4,523 General corporate expense and interest on debt (5,931) (5,289) Equity in earnings of unconsolidated investee 2,762 1,428 -------- ------- Total segment earnings before income taxes 28,117 32,885 -------- ------- Income taxes 7,236 8,815 -------- -------- -------- ------- Total 20,881 24,070 194,081 168,141 -------- -------- -------- ------- 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, 1999. 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 89% of the Company's total revenue for the nine months ended September 30, 2000. 8 NINE MONTHS ENDED SEPTEMBER 30, 2000, COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1999 Consolidated gross sales, which consist of gross premiums written, net investment income and realized investment gains totaled $355.6 million for the first nine months of 2000 compared to $278.4 million for the same period in 1999. Gross premium writings of the Group improved 31.0% over 1999 levels, fueled by growth in virtually every product line. Consolidated revenue for the first nine months of 2000 increased $25.9 million or 15.4% from the same period in 1999. Net premiums earned alone increased 19.1%. Net investment income improved 12.1% to $21.5 million. Realized investment gains declined to $517,000, compared to $4.5 million reported in 1999. The strategic sale of certain equity securities, during the second and third quarters of 1999, accounted for this difference. The net after-tax earnings for the first nine months of 2000 totaled $20.9 million, $2.10 per diluted share, compared to $24.1 million, $2.34 per share, for the same period in 1999. Net operating earnings, which consist of the Company's net earnings reduced by after-tax realized investment gains, totaled $20.5 million, $2.07 per share, compared to $21.1 million, $2.05 per share, for the same period in 1999. Comprehensive earnings, which include net earnings plus unrealized gains/losses net of tax, totaled $26.3 million, $2.65 per share, compared to $10.5 million, $1.02 per share, for the same period in 1999. Unrealized gains, net of tax, for the first nine months of 2000 were $5.4 million, $0.55 per share compared to net unrealized losses of $13.6 million, $1.32 per share, for the same period in 1999. The decline in the stock market in the third quarter of 1999 compared to the stock market rally experienced in third quarter of 2000 account for this difference. RLI INSURANCE GROUP Gross written premium for the Group increased to $333.6 million for the first nine months of 2000 compared to $254.7 million for the same period in 1999. All segments have contributed to this improvement as growth initiatives and firming prices in select product lines have combined to advance the Company's top line. Profitability declined with $9.3 million in pretax underwriting profit compared to $13.1 million last year, as the Company's GAAP combined ratio increased to 94.6 for the first nine months of 2000 from 91.0 reported for the same period last year. The Group's property segment increased premium writings by $28.5 million, or 30.2%, in the first nine months of 2000. The driving force behind this improvement was $15.6 million in premium from the new construction product, which was launched in the fourth quarter of 1999, as well as $6.7 million in increased fire premiums. Difference-in-conditions premiums also increased by 7.2% along with increases in other product lines. The property segment generated underwriting profits of $7.2 million for the first nine months of the year compared to $13.0 million last year. The GAAP combined ratio increased to 83.8 compared to 65.8 a year ago due to a shift in the mix of product volume away from difference-in-conditions, a lower loss frequency product, to construction and fire. Additionally, certain construction and commercial fire losses experienced during the first nine months of 2000 impacted the combined ratio. 9 Casualty segment gross written premiums were $176.4 million for the first nine months of 2000, up $39.4 million, or 28.7% from the same period in 1999. The driving forces behind this improvement were increases in the program business of $14.3 million, the transportation product of $9.7 million, the general liability product of $4.9 million, executive products group of $4.7 million, and personal umbrella of $2.4 million. The GAAP combined ratio fell slightly to 100.8 for the first nine months compared to 102.0 last year, as the segment's expense ratio has shown improvement. At a combined ratio slightly above break-even, the management of the Company believes this segment creates value for the Company as investments supporting reserves and the resulting cash flows generate significant investment income. Surety segment gross written premiums increased to $34.6 million for the first nine months of 2000, up $11.0 million, or 46.9%, from the same period in 1999. Increased premium production in contract and oil and gas bonding has accounted for this improvement. The GAAP combined ratio for the surety segment fell to 88.3 in the first nine months of 2000 from 90.5 a year ago, due to an improvement in the segment's expense ratio. The surety book continues to mature and provide profitable growth opportunities. INVESTMENT INCOME The Company's investment portfolio generated net dividends and interest income of $21.5 million during the first nine months of 2000, an increase of 12.1% over that reported for the same period in 1999. Both a higher interest rate environment and continued positive operating cash flow have resulted in the rise in investment income. The Company experienced a net realized gain from investments of $517,000 in the first nine months of 2000, compared to a net realized gain of $4.5 million for the same period in 1999, which was impacted by the sale of certain equity securities. For the nine months ended September 30, 2000, the Company experienced $8.4 million pre-tax unrealized gains on its investment portfolio. 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, 2000 and 1999 are as follows: 2000 1999 ----- ----- Taxable 6.66% 6.55% Non-taxable 4.91% 4.76% For the first nine months of 2000, yields on taxable and non-taxable securities increased from the same period last year, reflecting an increasing interest rate environment and the subsequent investment of new cash flow. Yields on non-taxable securities reflect a greater increase than taxable securities due to wider spreads in the maturities targeted for these investments and a greater proportion of new cash flow being directed to the non-taxable portfolios. 10 The Company's available-for-sale portfolio of debt and equity securities had net unrealized gains before tax of $8.4 million for the first nine months of 2000, compared with a $20.9 million loss for the same period in 1999. The 2000 year-to-date gain reflects the continuing improvement in the total return generated by the equity portfolio. During the third quarter of 1999, the decline experienced in the stock market negatively impacted the equity portfolio's performance. The Company's net cumulative unrealized gain before tax was $161.6 million up from $153.2 million at December 31, 1999. 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 $3.9 million for the first nine months of 2000, a $989,000 increase from the same period in 1999. This change is related to increased debt costs resulting from rising interest rates on the short-term floating rate outstanding debt, as well as a net increase of $4.7 million in the average outstanding debt balances over the same period last year. The increase in average debt balances for the year-to-date is, in part, attributable to the January 29, 1999, acquisition of Underwriters' Indemnity Holdings, Inc., which was funded through $42.8 million in reverse repurchase agreements from RLI Insurance Company. Also contributing to the increase was a temporary pay-down on the line of credit in 1999 reflected in last year's average debt balance. At September 30, 2000, outstanding short-term balances totaled $78.5 million, compared to $79.5 million at September 30, 1999. INCOME TAXES The Company's effective tax rate for the first nine months of 2000 was 26% compared to 27% for the same period in 1999. The change in the effective rate is reflective of a decline in underwriting profits, which are taxed at the 35% rate, coupled with an increase tax-exempt interest income. 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 2000 and 1999 as a result of the following: 2000 1999 Amount % Amount % ----------- --- ----------- ---- Provision for income taxes at the statutory rate of 35% $ 9,841,073 35% $11,509,766 35% Increase (reduction) in taxes resulting from: Tax exempt interest income (2,019,010) (7%) (1,916,438) (6%) Dividends received deduction (1,151,347) (4%) (1,120,546) (3%) Dividends paid deduction (195,509) (1%) (183,071) (1%) Goodwill amortization 422,409 2% 280,707 1% Other items, net 338,690 1% 244,564 1% ----------- ---- ----------- --- Total tax expense $ 7,236,306 26% $ 8,814,982 27% =========== ==== =========== === 11 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 nine months of 2000, the Company repurchased 71,272 of its outstanding shares at a cost of nearly $2.1 million. All repurchase activity for the year, thus far, occurred in the first quarter and was funded through operating cash flow. At September 30, 2000 the Company had short-term investments, cash and other investments maturing within one year, of approximately $73.3 million and additional investments of $150.6 million maturing within five years. The Company maintains one source of bank credit, a $30.0 million line of credit that cannot be canceled during its annual term. As of September 30, 2000, the Company had $19.6 million in outstanding short-term borrowings on this facility. Additionally, the Company was party to five reverse repurchase transactions totaling $58.9 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. OTHER MATTERS The Company completed its year 2000 (Y2K) project in 1999 with subsequent monitoring of mission critical systems during the calendar rollover. Since this project's beginning in 1997, the Company has incurred approximately $1.5 million of direct expense to complete changes and modifications to the business and systems environment for Y2K compliance. Of this amount, approximately $420,000 was incurred in 1999 and $20,000 was incurred in the first quarter of 2000. Throughout the initiative, actual Y2K expenses were within acceptable ranges of those forecasted. To date, the Company has not experienced production issues related to Y2K in any of the primary or supporting computer systems. The Company has received a minimal number of Y2K-related claims and believes that, ultimately, no indemnity payments will be made, only related adjustment expenses. 12 THREE MONTHS ENDED SEPTEMBER 30, 2000, COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1999 Consolidated gross sales totaled $121.2 million for the third quarter of 2000 compared to $100.1 million for the same period in 1999. As detailed in the discussion of RLI Insurance Group that follows, third quarter 2000 gross premiums improved $22.1 million, or 24.2%, over third quarter 1999 levels. Consolidated revenue for the third quarter of 2000 increased $9.3 million, or 15.5%, from the same period in 1999. Net premiums earned in the third quarter of 2000 improved $10.3 million compared to 1999, and investment income advanced $724,000 over third quarter 1999 levels. Realized investment gains declined $1.7 million from third quarter 1999 levels due to the strategic sale of certain equity positions during the third quarter of 1999. The net after-tax earnings for the third quarter of 2000 totaled $7.4 million, $0.74 per diluted share, compared to $8.5 million, $0.84 per share, for the same period in 1999. Net operating earnings, which consist of the Company's net earnings reduced by after-tax realized investment gains, was $7.0 million, $0.70 per share, compared to $7.0 million, $0.69 per share, for the same period in 1999. Comprehensive earnings, which includes net earnings plus unrealized gains/losses net of tax, totaled $16.8 million, $1.69 per share, compared to a comprehensive loss of $12.7 million, $1.26 per share, for the same period in 1999. Unrealized gains, net of tax, for the third quarter of 2000 were $9.4 million, $0.95 per share compared to unrealized losses of $21.2 million, $2.10 per share, for the same period in 1999. The loss incurred in 1999 is attributable to the stock market declines in August and September, 1999. RLI INSURANCE GROUP Gross written premium for the third quarter of 2000 totaled $113.2 million, compared to $91.1 million reported for the same period in 1999. All segments have contributed to this improvement, as mentioned previously. Pretax underwriting profit declined to $2.9 million in the third quarter of 2000 compared to $4.5 million for the same period last year. This equates to GAAP combined ratios of 95.2 for the third quarter of 2000 compared to 91.2 for the third quarter of 1999. The decline in profitability is attributed to certain property losses experienced during the third quarter of 2000. Property segment gross written premiums increased by $9.0 million to $42.2 million in the third quarter of 2000. Fueling this growth, premiums from the new construction product added $6.5 million for the third quarter of 2000. Difference-in-conditions premium advanced, as well, posting a $2.0 million, or 11.2%, increase to $20.1 million. Property segment underwriting profits were $1.6 million for the third quarter of the year compared to $4.0 million last year. The GAAP combined ratio for the property segment increased to 90.3 for the third quarter of 2000 compared to 69.3 for the same period last year. This increase is partially attributable to a shift in the mix of product volume away from the lower loss frequency, difference-in-condition product to construction and fire business. Additionally, certain construction and commercial fire losses experienced during the third quarter of 2000 impacted the combined ratio. 13 Gross written premiums for the casualty segment were $59.2 million for the third quarter of 2000 compared to $48.1 million for the prior year. This is primarily due to the increases in program business, transportation, general liability, and executive products, mentioned previously. Program business and transportation improved gross writings by $6.1 million and $1.8 million, respectively for the quarter, while general liability advanced $1.2 million, and executive products $1.6 million. The GAAP combined ratio fell slightly to 100.3 for the third quarter compared to 101.6 last year, as the segment's expense ratio has shown improvement. The Group's surety segment gross written premiums increased by 18.7% to $11.8 million for the third quarter of 2000 compared to $9.9 million for the same period in 1999. This improvement was primarily the result of growth in contract bonding, as mentioned previously. The GAAP combined ratio for the surety segment fell to 84.1 for the third quarter of 2000 from 85.6 a year ago, due to an improvement in the segment's expense ratio. INVESTMENT INCOME The Company's investment portfolio generated net dividends and interest income of $7.5 million during the third quarter of 2000, an increase of 10.7% over the same period in 1999. Both a higher interest rate environment and continued positive operating cash flow have allowed for increased bond and short-term investments, resulting in the rise in investment income. The Company experienced a net realized gain from investments of $604,000 in the third quarter of 2000 compared to $2.3 million for the same period in 1999. The majority of gains realized in the third quarter of 1999 were the result of the sale of certain equity securities. INCOME TAXES The Company's effective tax rate for the third quarter of 2000 was 25% compared to 29% reported for the same period in 1999. The change in the effective rate is reflective of a decline in underwriting profits, which are taxed at the 35% rate, coupled with an increase tax-exempt interest income. 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 2000 and 1999 as a result of the following: 2000 1999 Amount % Amount % ------ --- ------ --- Provision for income taxes at the statutory rate of 35% $ 3,443,667 35% $ 4,179,201 35% Increase (reduction) in taxes resulting from: Tax exempt interest income (682,585) (7%) (652,423) (5%) Dividends received deduction (374,929) (4%) (368,891) (3%) Dividends paid deduction (68,504) (1%) ( 62,533) (1%) Goodwill amortization 102,206 1% 280,707 2% Other items, net 39,974 1% 93,021 1% ----------- ---- ----------- --- Total tax expense $ 2,459,829 25% $ 3,469,082 29% =========== ==== =========== === 14 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 September 30, 2000, have not materially changed from those identified at December 31, 1999. 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 nine months ended September 30, 2000. 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 10, 2000 15