MANAGEMENT DISCUSSION & ANALYSIS
OVERVIEW>
RLI Corp. (the Company) is a holding company that underwrites selected property
and casualty insurance through its major subsidiaries collectively known as RLI
Insurance Group (the Group). The Group has accounted for approximately 87% of
consolidated revenue over the last three years by providing property and
casualty coverages primarily for commercial risks. As a niche insurer, the Group
offers products targeted to the needs of those insureds generally overlooked by
traditional insurance markets. Company management measures the results of its
insurance operations by monitoring certain critical measures across three
distinct business segments: property, casualty, and surety. Growth is measured
in terms of gross written premiums and profitability is analyzed through GAAP
combined ratios, which are further subdivided into their respective loss and
expense components.
The property and casualty insurance business is cyclical and influenced by
many factors, including price competition, economic conditions, natural
disasters, interest rates, state regulations, court decisions and changes in the
law. One of the unique and challenging features of the property and casualty
insurance business is that products must be priced before costs are fully known,
because premiums are charged before claims are incurred. In evaluating the
objective performance measures previously mentioned, it is important to consider
the following individual characteristics of each major insurance segment.
Property insurance results are subject to the variability introduced by
natural and man-made disasters such as earthquakes, fires and hurricanes. The
Company's major catastrophe exposure is to losses caused by earthquakes, since
approximately 46% of the Company's 2000 total property premiums were written in
California. The Company limits its net aggregate exposure to a catastrophic
event by purchasing reinsurance and through extensive use of computer-assisted
modeling techniques. These techniques provide estimates of the concentration of
risks exposed to catastrophic events.
The casualty portion of the Company's business consists largely of
commercial umbrella, general liability, transportation, personal umbrella and
programs coverages. In addition, the Group provides directors & officers
liability, employers indemnity and in-home business owners coverage. The
casualty book of business is subject to the risk of accurately estimating losses
and related loss reserves since the ultimate settlement of a casualty claim may
take several years to fully develop. The casualty line may also be affected by
evolving legislation and court decisions that define the extent of coverage and
the amount of compensation due for injuries or losses.
The surety segment of RLI specializes in writing small- and medium-sized
commercial and contract surety products, as well as those for the energy,
petrochemical and refining industries. The commercial surety products usually
involve a statutory requirement for bonds. This industry has historically
maintained a relatively low loss ratio. Losses may fluctuate, however, due to
adverse economic conditions that may affect the financial viability of an
insured.
18
The contract surety market guarantees the construction work of a
commercial contractor for a specific project. As such, this line has
historically produced marginally higher loss ratios than the miscellaneous
surety line. Generally, losses occur due to adverse economic conditions,
inclement weather conditions or the deterioration of a contractor's financial
condition.
The consolidated financial statements and related notes found on pages
28-50, and the "Forward Looking Statements" on page 27, should be read in
conjunction with the following discussion.
OPERATIONS>
Consolidated gross sales for 2000 totaled $469.8 million, a 26.9% increase from
1999, which followed a 16.8% gain over 1998. This two-year trend was largely due
to gross written premium growth of 28.9% and 16.7% for 2000 and 1999,
respectively. These premium increases -- the combined effect of new product
development, increased volume, and favorable market and price conditions in
selected product lines -- also generated greater cash flow that led to
investment income increases of 11.7% in 2000 and 8.7% in 1999. Consolidated
revenue for 2000 was $263.5 million, compared to $225.8 million in the prior
year. Net premiums earned, the main driver of this measurement, lagged behind
the 2000 gross writing trend, as 1999 results included $20.0 million in returned
ceded premiums from the implementation of a combined casualty reinsurance
treaty. Conversely, an increase in net retained premiums accounted for much of a
1999 increase in consolidated revenue of 34.3%.
Year Ended December 31,
GROSS SALES (in thousands) 2000 1999 1998
Gross premiums written $437,867 $339,575 $291,073
Net investment income 29,046 26,015 23,937
Realized investment gains 2,847 4,467 1,853
Total gross sales $469,760 $370,057 $316,863
Net earnings for the Company were $28.7 million ($2.89 per diluted share)
in 2000, compared to $31.5 million ($3.08 per share) in 1999 and $28.2 million
($2.65 per share) in 1998. Underwriting income is the most significant factor in
the Company's earnings. While 1999 did show some volume-related improvement over
1998, the combined ratio increased as the Company's mix of business shifted more
toward casualty lines. During 2000, underwriting profits were further pressured
by property losses in excess of expectations.
Comprehensive earnings more than doubled in 2000, reaching $42.0 million
from $20.9 million in 1999. For 1998, the Company posted comprehensive earnings
of $51.8 million. In 1999, rising interest rates on the financial and utility
sectors of the Company's equity investment portfolio, as well as a general
under-performance by value stocks, created unrealized investment losses. The
robust returns in both 1998 and 2000 reflect the Company's commitment to its
investment strategy, which management believes will maximize value for
shareholders in the future as it has done historically, according to the
following chart:
DILUTED EARNINGS PER SHARE Net Comprehensive
1996 $ 2.28 $ 3.62
1997 2.66 5.76
1998 2.65 4.87
1999 3.08 2.04
2000 2.89 4.23
Total $13.56 $20.52
As this chart indicates, comprehensive earnings per share for the last
five years exceeded reported net earnings by 51.3%.
RLI INSURANCE GROUP
As indicated earlier, gross written premiums grew substantially in each of the
last two years. While the 1999 increase was mostly attributable to the casualty
segment, all three segments grew significantly in 2000. Underwriting income
peaked at $17.1 million in 1999, up from $16.8 million in 1998, despite a rise
in the total combined ratio from 88.2 to 91.2. Higher-than-anticipated property
losses and increased reinsurance costs in 2000 dropped underwriting income to
$12.1 million on a 94.8 combined ratio. The expense ratio dropped each of the
last two years, as spending increases were leveraged against higher volume.
The Company's property segment contributed gross written premiums of
$160.5 million in 2000, a 28.6% improvement over 1999. By comparison, 1999
premium volume had only grown 9.8%, in part due to a 7.7% drop in difference in
conditions premiums from 1998. This line rebounded in 2000, with a 9.6%
increase. The segment's other major source of premiums in 2000 was the new
construction line, which produced $20.1 million in writings. Unfortunately, much
of this growth came during the seasonal height of loss activity, driving the
property segment combined ratio to 91.7, compared to 66.8 and 62.2 in 1999 and
1998, respectively. While management anticipated early construction loss
activity ahead of premium earnings, this segment's loss ratio of 139% far
19
exceeded these expectations. As a result, several courses of action were
pursued, including rate and deductible increases, commission restrictions,
reinsurance revisions and other types of exposure control. Management believes
these changes should result in improvements in the coming months.
Other property lines also experienced somewhat higher loss ratios. While
the causes in any given line vary considerably, in each case, management
evaluates the activity within the context of given time horizons, and takes
appropriate underwriting action where necessary. Such actions may include the
discontinuance of certain lines that do not give indications of long term
profitability.
While the property expense ratio declined to 36.1% in 1999 compared to
1998, a slight increase to 38.0% was seen in 2000. This was primarily the result
of higher reinsurance costs. Lines not affected by these increases actually saw
expense ratios decline as they posted premium increases without commensurate
growth in infrastructure.
Casualty gross written premiums continued to grow substantially; the
$233.9 million result in 2000 was a 27.2% increase over the $183.9 million
posting in 1999. This followed 1999 growth of 23.7% over 1998, achieved
primarily through the transportation and umbrella lines combining for $24.6
million of the total $35.2 million increase. This upward trend in casualty lines
continued in 2000, with the bulk of the increase coming from the program
business line. Bolstered with additional underwriting expertise, this line
generated $19.1 million more production than 1999; virtually none of this
business had been written in 1998. Transportation contributed $11.5 million to
2000 growth.
The GAAP combined ratio for the casualty segment fell to 101.9 in 1999,
compared to 103.2 in 1998. The new combined casualty reinsurance contract,
implemented at the start of 1999, resulted in an assumption of less exposure per
risk. It also increased the retention of premiums and eliminated reinsurance
commissions associated with this segment. In 2000, the casualty combined ratio
dropped below 100 to 97.4. This was the result of releasing reserve redundancies
on selected lines based on favorable loss experience. This action, in
conjunction with the conservative approach to a 100-plus combined ratio for this
segment, supports management's belief that casualty loss reserves will be
adequate and investment income derived from reserved funds will provide
significant future earnings potential.
Surety gross written premiums increased to $43.4 million in 2000, a 40.5%
improvement over 1999. This dramatic increase eclipsed 1999 growth of 7.4%,
which was hampered by a discontinued producer relationship late in 1998. The
growth in 2000 was due to the combined impact of both contract and oil and gas
operations, which experienced volume-related gains of 60.4% and 42.3%,
respectively. While the previous two years were vulnerable to rate instability,
this trend began to moderate during 2000, causing cautious optimism for the
coming months.
The increased volume was not achieved at the expense of profits. The
combined ratio for 2000 was a stellar 89.6 despite a slightly higher loss ratio
from unfavorable experience in the second quarter. This was more than offset by
the reduced expense ratio of 65.7, compared to 71.0 in 1999, as certain lines
transitioned from product start-up modes to a more efficient economy of scale.
The segment's combined ratio in 1999 was 90.5, compared to 103.9 in 1998. The
prior year included a charge of $2.6 million related to unfavorable loss
development from a discontinued contract surety book.
INVESTMENT INCOME
Net dividend and interest income increased by 11.7% during 2000 due to increased
cash flow allocated to fixed-income investments and higher reinvestment rates.
On an after-tax basis, investment income increased by 10.2%. The Company
realized $2.8 million in capital gains in 2000, compared to $4.5 million in
1999. Operating cash flows were $53.1 million in 2000. Cash flows in excess of
current needs were used to fund the stock repurchase program and purchase
fixed-income securities, which continue to be comprised primarily of high-grade,
tax-exempt or U.S. government/agency issues.
PRETAX YIELD 2000 1999 1998
Taxable (on book value) 6.75% 6.57% 6.58%
Tax-exempt (on book value) 4.92% 4.78% 4.95%
Equities (on market value) 2.30% 2.43% 2.49%
AFTER-TAX YIELD
Taxable (on book value) 4.39% 4.27% 4.27%
Tax-exempt (on book value) 4.66% 4.53% 4.69%
Equities (on market value) 1.96% 2.07% 2.14%
During 2000, the average tax-equivalent yield of the portfolio increased
23 basis points (7.06% vs. 6.83%), due to increases in both taxable and
tax-exempt yields on new purchases. During the year, the Company again focused
on purchasing high-quality investments, including intermediate-term agency
issues, and tax-exempt municipals in the 10-15 year part of the yield curve. The
majority of fixed income purchases occurred midyear, when yield levels were
relatively attractive.
20
The Company's investment results for the last five years are shown in the
following table:
(in thousands) Tax Equivalent
Annualized Annualized
Change in Return on Return on
Average Unrealized Average Average
Invested Investment Realized Appreciation Invested Invested
Year Assets(1) Income(2)(3) Gains(3) (3)(4) Assets Assets
1996 $504,773 $23,681 $1,017 $25,033 9.9% 10.7%
1997 570,901 24,558 2,982 55,760 14.6% 15.5%
1998 640,576 23,937 1,853 36,183 9.7% 10.6%
1999 684,269 26,015 4,467 (16,263) 2.1% 3.0%
2000 723,677 29,046 2,847 20,537 7.2% 8.1%
5-yr. avg. 624,839 25,447 2,633 24,250 8.4% 9.2%
(1)Average of amounts at beginning and end of year.
(2)Investment income, net of investment expenses, including non-debt interest
expense.
(3)Before income taxes.
(4)Relates to available-for-sale fixed maturity and equity securities.
INTEREST AND GENERAL CORPORATE EXPENSE
Interest expense on debt was $5.3 million in 2000, up from $4.1 million in 1999.
This increase was entirely attributable to rising rates, as the level of
outstanding debt between years was virtually unchanged. Interest expense of $2.3
million in 1998 had been lower due to less outstanding debt prior to the January
1999 acquisition of Underwriters Indemnity Holdings, Inc. (UIH). General
corporate expenses generally fluctuate relative to the Company's executive
compensation plan based on Market Value Potential. This model basically measures
comprehensive earnings against a minimum required return on company capital.
Accordingly, these general corporate expenses were $3.4 million, $2.1 million,
and $3.9 million for 2000, 1999 and 1998, respectively.
INCOME TAXES
The Company's effective tax rates for 2000, 1999 and 1998 were 25.1%, 26.9% and
25.1%, respectively. Effective rates are dependent upon components of pretax
earnings and the related tax effects. Much of the increase in 1999 was due to
the amortization of goodwill associated with the UIH acquisition, which is not
deductible for federal income tax purposes. This impact was offset in 2000, but
reduced the level of underwriting earnings relative to tax-preferential
investment earnings. The Company's pretax earnings in 2000 included $16.3
million of investment income that is wholly or partially exempt from federal
income tax, compared to $15.7 million in 1999 and $14.3 million in 1998.
INVESTEE EARNINGS
The Company maintains a 44% interest in the earnings of Maui Jim, Inc.,
primarily a manufacturer of high-quality polarized sunglasses. In 2000, the
Company recorded nearly $3.0 million in earnings compared to $1.6 million in
1999 and $1.3 million in 1998. Maui Jim sales revenue improved 35% in 2000, due
to improved gross sunglass margins. Improved performance by the dollar against
the yen, in addition to the opening of international distribution facilities,
contributed to the results. Total international revenues grew by 95% in 2000.
Sales for Maui Jim grew 35% in 1999 on the strength of expanded international
sunglass marketing efforts. Profit margins declined slightly in 1999 as the cost
of goods sold was unfavorably impacted by the dollar's performance against the
yen.
MARKET RISK DISCLOSURE>
Market risk is a general term describing the potential economic loss associated
with adverse changes in the fair market value of financial instruments.
Management of market risk is a critical component of the Company's investment
decisions and objectives. The Company manages its exposure to market risk by
using the following tools:
1. Monitoring the fair market value of all financial assets on a constant
basis;
2. Changing the character of future investment purchases as needed,
and;
3. Maintaining a balance between existing asset and liability portfolios.
The Company's primary risk exposures are to changes in interest rates
and equity prices, as it had no derivative or foreign exchange risk as of
December 31, 2000.
INTEREST RATE RISK
The Company's primary exposure to interest rate risk is with its fixed-income
investment portfolio and outstanding short-term debt instruments.
Modified duration analysis is used to measure the sensitivity of the
fixed-income portfolio to changes in interest rates, providing a measure of
price percentage volatility. The Company attempts to minimize interest rate risk
by matching the duration of its assets to that of its liabilities. The Company
limits the financial statement impact of changes in interest rates by
designating a majority of the fixed-income holdings as held-to-maturity. As of
December 31, 2000, the Company had classified 73.8% of its fixed-income
securities portfolio as held-to-maturity. The balance of the Company's
fixed-income portfolio is classified as either available-for-sale or trading
(see note 2). This
21
percentage of available-for-sale should increase somewhat in the future as the
Company positions the portfolio to be able to capitalize on changes in the
market.
Interest rate risk will also affect the Company's income statement due to
its impact on interest expense. The Company's debt obligations are short-term in
nature, as it has no long-term debt outstanding as of December 31, 2000. As a
result, the Company assumes interest rate risk in its ability to refinance these
short-term debt obligations. Any rise in interest rates will cause interest
expense to increase if debt levels are maintained at current levels. The Company
will continue to monitor this outstanding debt and may use operating cash flow
to pay it down -- all or in part -- as market conditions warrant.
EQUITY PRICE RISK
Equity price risk is the potential that the Company will incur economic loss due
to the decline of common stock prices. Beta analysis is used to measure the
sensitivity of the Company's equity portfolio to changes in the value of the S&P
500 index (an index representative of the broad equity market.) As measured from
December 31, 1981, to December 31, 2000, the Company's equity portfolio had a
beta of 0.66 in comparison to the S&P 500. This low beta statistic reflects the
Company's long-term emphasis on maintaining a conservative, value oriented,
dividend driven investment philosophy for its equity portfolio. Historically,
dividend paying common stocks have demonstrated superior down market performance
characteristics.
Additional risk management techniques include:
1. Restricting individual security weightings to no more than 5% of the
equity portfolio's market value, and
2. Reducing the exposure to sector risk by limiting the market value that
can be invested in any one particular industry sector to 25% of the
equity portfolio.
Equity securities are classified as available-for-sale, with unrealized
gains and losses excluded from net earnings but recorded as a component of
comprehensive earnings and shareholders' equity, net of deferred income taxes.
SENSITIVITY ANALYSIS
The following tables detail information on the market risk exposure for the
Company's financial investments as of December 31, 2000. Listed on each table is
the December 31, 2000, market value for the Company's assets and the expected
reduction in market value given the stated hypothetical events. This sensitivity
analysis assumes the composition of the Company's assets remains constant over
the period being measured and also assumes interest rate changes are reflected
uniformly across the yield curve. The analysis does not consider any action the
Company would undertake in response to the various changes in market conditions.
For purposes of this disclosure, market-risk-sensitive instruments are divided
into two categories: instruments held for trading purposes and those held for
nontrading purposes. The examples given are not predictions of future market
events, but rather illustrations of the effect such events may have on the
market value of the Company's investment portfolio.
As of December 31, 2000, the Company's fixed-income portfolio had a market
value of $400.8 million. The sensitivity analysis uses scenarios of interest
rates increasing 100 and 200 basis points from their December 31, 2000, levels
with all other variables held constant. Such scenarios would result in decreases
in the market value of the fixed-income portfolio of $15.7 million and $31.8
million, respectively. Due to the Company's use of the held-to-maturity
designation for a majority of the fixed-income portfolio, the balance sheet
impact of these scenarios would be much lower. The income statement will only be
affected by holdings designated as trading. As of December 31, 1999, the
Company's fixed-income portfolio had a market value of $338.5 million. Given the
same scenarios, the corresponding decreases in the market value of the
fixed-income portfolio as of the year-end 1999 were $14.2 million and $27.8
million, respectively. The potential decrease for 2000 is larger than for 1999,
due to the $63.3 million in fixed-income assets for the year.
As of December 31, 2000, the Company's equity portfolio had a market value
of $306.2 million. The base sensitivity analysis uses market scenarios of the
S&P 500 index declining both 10 percent and 20 percent. These scenarios would
result in approximate decreases in the equity market value of $20.2 million and
$40.4 million, respectively. As the Company designates all common stocks as
available-for-sale, these market value declines would impact the Company's
balance sheet. As of December 31, 1999, the Company's equity portfolio had a
market value of $284.6 million. Given the same scenarios, the market value
decreases as of year-end 1999 were $19.1 million and $38.1 million, respectively
- -- the change again attributable to growth in the equity portfolio during 2000.
Counter to the base scenarios shown in Tables 1 and 2, Tables 3 and 4
quantify the opposite impact. Under the assumptions of falling interest rates
and an increasing S&P 500 index, the market value of the Company's assets will
increase from their present levels by the indicated amounts.
The income statement will also be impacted by interest expense. As of
December 31, 2000, the Company had $78.8 million in short-term debt obligations.
Assuming this debt level remains constant, a hypothetical 100-basis-point
increase in interest rates would increase the Company's
22
annual interest expense by $0.8 million and a 200-basis-point increase would
increase annual interest expense by $1.6 million. Conversely, falling interest
rates would result in equivalent reductions in interest expense. These numbers
are not included in the following tables. As of December 31, 1999, the Company
had $78.4 million of short-term debt outstanding. Because the amount of debt
outstanding remained fairly constant through year-end 2000, there would be a
minimal change in the increases in interest expense over last year, given the
stated scenarios.
Table 1 (in thousands)
Effect of a 100-basis-point increase in interest rates and a 10% decline in the
S&P 500:
12/31/00 Interest Rate Equity
Market Value Risk Risk
Held for trading purposes
Fixed maturity securities $ 8,208 $ (288) --
Total trading 8,208 (288) --
Held for nontrading purposes
Fixed maturity securities 400,831 (15,406) --
Equity securities 306,194 -- $(20,209)
Total nontrading 707,025 (15,406) (20,209)
Total trading & nontrading $715,233 $(15,694) $(20,209)
Table 2 (in thousands)
Effect of a 200-basis-point increase in interest rates and a 20% decline in the
S&P 500:
12/31/00 Interest Rate Equity
Market Value Risk Risk
Held for trading purposes
Fixed maturity securities $ 8,208 $ (571) --
Total trading 8,208 (571) --
Held for nontrading purposes
Fixed maturity securities 400,831 (31,262) --
Equity securities 306,194 -- $(40,418)
Total nontrading 707,025 (31,262) (40,418)
Total trading & nontrading $715,233 $(31,833) $(40,418)
Table 3 (in thousands)
Effect of a 100-basis-point decrease in interest rates and a 10% increase in the
S&P 500:
12/31/00 Interest Rate Equity
Market Value Risk Risk
Held for trading purposes
Fixed maturity securities $ 8,208 $ 283 --
Total trading 8,208 283 --
Held for nontrading purposes
Fixed maturity securities 400,831 14,260 --
Equity securities 306,194 -- $20,209
Total nontrading 707,025 14,260 20,209
Total trading & nontrading $715,233 $14,543 $20,209
Table 4 (in thousands)
Effect of a 200-basis-point decrease in interest rates and a 20% increase in the
S&P 500:
12/31/00 Interest Rate Equity
Market Value Risk Risk
Held for trading purposes
Fixed maturity securities $ 8,208 $ 557 --
Total trading 8,208 557 --
Held for nontrading purposes
Fixed maturity securities 400,831 28,946 --
Equity securities 306,194 -- $40,418
Total nontrading 707,025 28,946 40,418
Total trading & nontrading $715,233 $29,503 $40,418
LIQUIDITY AND CAPITAL RESOURCES>
Historically, the primary sources of the Company's liquidity have been funds
generated from insurance premiums (operating activities) and investment income
and maturing investments (investment activities). In addition, the Company has
occasionally received funds from financing activities, such as short-term
borrowings and the issuance of common stock or convertible debentures.
The Company maintains a $30.0 million revolving line of credit with one
financial institution. The facility has a three-year term that expires on
December 31, 2001. At December 31, 2000, the Company had $19.6 million in
outstanding debt from this facility. Additionally, the Company was party to five
reverse repurchase transactions totaling $59.1 million. Management believes that
cash generated from operations, investments, and cash available from financing
activities will provide sufficient liquidity to meet the Company's anticipated
needs over the next 12 to 24 months.
23
The Company continues an innovative catastrophe reinsurance and loss
financing program with Zurich Reinsurance NA (Zurich Re). The program, called
Catastrophe Equity Puts (CatEPuts-SM-), augments the Company's traditional
reinsurance by integrating its loss financing needs with a prenegotiated sale of
securities linked to exchange-traded shares. For a more detailed description of
CatEPuts, see note 5.
During 2000, the Company generated net operating cash flow of $53.1
million, which was added to the Company's investment portfolio.
The Company's fixed-income portfolio continues to be biased toward U.S.
government and agency securities and highly rated tax-exempt securities due to
their high liquidity. As part of its investment strategy, the Company attempts
to avoid exposure to default risk by holding, almost exclusively, securities
ranked in the top two grades of investment quality by Standard & Poor's and
Moody's (i.e., AAA or AA). Virtually all of the Company's fixed-income portfolio
consists of securities rated A or better, with 98% rated AA or better. Most of
the Company's fixed-income portfolio is noncallable.
The Company follows a program of matching held-to-maturity assets to
anticipated liabilities to ensure its ability to hold securities until maturity.
Anticipated liabilities are factored against ultimate payout patterns and the
resulting payout streams are funded with the purchase of fixed-income securities
of like maturity. Management believes that both liquidity and interest rate risk
can be minimized by such asset/liability matching.
The Company currently classifies 73.8% of the securities in its
fixed-income portfolio as held-to-maturity, meaning they are carried at
amortized cost and are intended to be held until their contractual maturity.
Smaller portions of the fixed-income portfolio are classified as
available-for-sale (24.2%) or trading (2%) and are carried at fair market value.
As of December 31, 2000, the Company maintained $105.4 million in fixed-income
securities within the available-for-sale and trading classifications. Although
it is likely that the majority of these securities will be held by the Company
to maturity, they provide an additional source of liquidity and can be used to
address potential future changes in the Company's asset/liability structure.
The Company's equity portfolio increased by $21.6 million during 2000, to
$306.2 million. The Company had a pretax portfolio appreciation of $17.1
million. Capital gains of $2.9 million on this portfolio were realized during
the year. The securities within the equity portfolio remain invested in
large-cap issues with strong dividend performance. The strategy remains one of
value investing, with security selection taking precedence over market timing. A
buy-and-hold strategy is used, minimizing both transactional costs and taxes.
OUTLOOK FOR 2001>
In 2001, the Company intends to capitalize on what industry pundits see as
positive indications for the insurance marketplace. Rate improvements in many
lines, recent economic growth, better expense management, and an improved
investment environment all bode well for the industry in coming years. These
trends, coupled with the Company's own continuing commitment to growth without
compromise on profitable underwriting, set the stage for continued exceptional
performance. As always, the Company will continue its pursuit of growth through
such avenues as the addition of underwriting talent in certain product lines,
strategic alliances with producers on existing products or through acquisition.
The materiality or viability of future ventures or products is not known at this
time. Specific details regarding events in the Group's various business segments
follow.
PROPERTY
Despite the expectation for only modest growth in this segment, there is
optimism for increased profitability related to improved rate activity and
better underwriting results. The growing pains associated with the new
construction line are not expected to continue, which should allow for an
improvement in 2001. While gross writings for the difference in conditions line
are anticipated to be level, the Company expects to secure reinsurance terms
superior to those of the overall market.
CASUALTY
Continued growth is expected for this segment under favorable rate conditions,
expansion of Internet-based business, and the expansion and maturation of newer
product lines. Sizeable contributions are expected specifically from the program
business, professional liability, general liability and transportation lines.
Combined ratios are expected to be slightly above 100 while contributing
appreciably to the growth of investment income.
Surety
Gross written premium increases are anticipated across all existing lines in the
surety segment. Additionally, late in 2000, the Company formed a new middle
market commercial surety unit expected to contribute to premium growth during
2001. Profit expectations for this segment include a combined ratio well below
100, reflecting a stable loss ratio and acceptable expense ratio, despite the
investment in production.
24
CAPITAL MANAGEMENT
In July 1997, the Company implemented a 2.25 million share common stock
repurchase program. In 2000, the Company repurchased 71,272 shares at a total
cost of $2.1 million. Including 1999 and 1998, 1,008,210 shares were purchased
at a total cost of $35.8 million. Approximately 283,000 shares remain authorized
for repurchase at year-end 2000. It is anticipated that the program will
continue only as the Company's capital requirements and market conditions
warrant.
The repurchase program has been funded by the use of the Company's
operating cash flow, line of credit facility and reverse repurchase agreements.
It is anticipated that future repurchases will be funded in a similar fashion.
Depending upon the Company's capital needs and prevailing market conditions, the
Company may issue a longer-term debt instrument or use operating cash flow to
repay the outstanding short-term debt.
In the fourth quarter of 2000, RLI declared a cash dividend to be paid in
January 2001 of $0.15 per share, representing the 98th consecutive dividend
payment for the Company. Since the inception of cash dividends in 1976, the
Company has increased its annual dividend every year. In its annual "Handbook of
Dividend Achievers," Mergent FIS (formerly a division of Moody's) ranks RLI
190th out of 28,000 U.S. public companies in dividend growth over the last
decade. No changes in the Company's dividend policy are anticipated in 2001.
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. 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 has reviewed the investment portfolio and various risk
management techniques used to hedge all exposures. The Company has determined
that none of the instruments held at December 31, 2000, currently meets the
definition of a derivative as defined in Statement 133 or have only nominal
value; therefore, implementation of this Statement will not have any significant
impact on the Company's financial statements as of January 1, 2001. The Company
will continue to evaluate all current and future instruments and apply the
requirements of Statement 133 as necessary.
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 supersedes 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 receivables, 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 has
applied the standards set forth in this statement as detailed in notes 2 and 4.
LEGISLATION>
STATE REGULATION
As an insurance holding company, RLI Corp., as well as its insurance
subsidiaries, is subject to regulation by the states in which the insurance
subsidiaries are domiciled or transact business. Holding company registration in
each insurer's state of domicile requires reporting to the state regulatory
authority the financial, operational and management data of the insurers within
the holding company system. All transactions within a holding company system
affecting insurers must be fair, and the insurers' policyholder surplus
following any transaction must be both reasonable in relation to its outstanding
liabilities and adequate for its needs. Notice to regulators is required prior
to the consummation of certain transactions affecting insurance subsidiaries of
the holding company system.
Other regulations limit the amount of dividends and other distributions
the subsidiaries can pay without prior approval of the insurance department in
the states in which they are physically and/or commercially domiciled, and
impose restrictions on the amount and type of investments they may have.
Regulations designed to ensure financial solvency of insurers and to require
fair and adequate treatment and service for policyholders are enforced by
filing, reporting and examination requirements. Market oversight is conducted by
monitoring trade practices, approving policy forms, licensing of agents and
brokers, and requiring fair and equitable premiums and commission rates.
Financial solvency is monitored by minimum reserve and capital requirements,
periodic reporting procedures (annually, quarterly, or more frequently if
necessary) and periodic examinations.
25
The quarterly and annual financial reports to the states utilize
accounting principles which are different from the generally accepted accounting
principles that show the business as a going concern. The statutory accounting
principles used by regulators, in keeping with the intent to assure policyholder
protection, are generally based on a liquidation concept. The National
Association of Insurance Commissioners (NAIC) has recently developed a codified
version of these statutory accounting principles, and its deployment in 2001
will foster more consistency among the states for accounting guidelines and
reporting. As of year-end 2000, the potential impact of codification was
estimated to be a $27 million reduction in statutory surplus. These statutory
accounting principles will have no effect on the Company's net earnings or
shareholders' equity.
State regulatory authorities have relatively broad discretion with respect
to granting, renewing and revoking brokers' and agents' licenses to transact
business in the state. The manner of operating in particular states may vary
according to the licensing requirements of the particular state, which may,
among other things, require a firm to operate in the state through a
corporation. In a few states, licenses are issued only to individual residents.
COMMERCIAL LINES DEREGULATION -- The NAIC and several state legislatures
have taken up the issue of commercial lines deregulation in an attempt to
streamline specific areas of insurance regulation. A growing contingent in the
regulatory community has acknowledged that some regulatory procedures and
practices may be cumbersome and inappropriate for commercial buyers of
insurance. Specifically, the large, sophisticated, multi-state or multinational
businesses that employ their own teams of risk managers to evaluate, reduce and
finance their loss exposures are less likely to need the form and rate
protections that regulators provide consumers and small to medium business
endeavors. And, while these large businesses may receive some benefit from the
state financial regulation of licensed insurers, it has long been acknowledged
that they do not need the protections addressed by the barriers to the surplus
lines market and other nontraditional markets. Indisputably, deregulation of the
licensed market will have an impact on the surplus lines insurance carriers,
which have been free from form and rate requirements.
USE OF CREDIT REPORTS IN UNDERWRITING -- Gains in access to electronic
commerce, and the means to gather information more rapidly, have spurred
regulators to take a second look at the use of consumer credit reports in
underwriting and rate making. In some states, regulators charged with protecting
insurance consumers from unfair trade practices are concerned that some
consumers' risks may be underwritten based solely on their credit standing, and
have sought to strengthen their laws and regulations to address this. This trend
comes on the heels of Congress' retooling of the Fair Credit Reporting Act in
1997, which specifically addresses this issue, and permits the use of consumer
credit reports in underwriting. The issue of federal preemption of state action
in this arena has not been judicially addressed.
FEDERAL REGULATION
Although the federal government generally does not directly regulate the
insurance business, federal initiatives often have an impact on the business in
a variety of ways. Current and proposed federal measures which may significantly
affect the insurance business include federal preemption of state auto liability
laws, tax reform measures, product liability and electronic commerce. The
Company is also monitoring the following federal proposals:
NATURAL DISASTER ACT -- Recent natural disasters, including Atlantic Coast
hurricanes, continue to fuel concern regarding the best way to provide
affordable insurance coverage for such events. Congress has yet to pass
legislation, but proposals to set up a system for federal relief to the industry
continue to be discussed. Two Initiatives, "The Natural Disaster Protection and
Insurance Act of 1997" (S.1361) and "The Homeowners Insurance Availability Act
of 1997" (H.R. 21), focus on excess federal reinsurance. In 1999, both the House
and Senate introduced versions of the "Policyholder Disaster Protection Act,"
which would permit insurers to build tax-deferred catastrophe reserves. The
Company will continue to monitor the progress of these issues.
FINANCIAL SERVICES MODERNIZATION -- The Gramm-Leach-Bliley Act was signed
into law by President Clinton on November 12, 1999. The principal focus of the
Act is to facilitate affiliations among banks, securities firms and insurance
companies. The Act amends the Federal Bank Holding Company Act by creating a new
category of bank holding company known as a "financial holding company" to
engage in activities that are "financial in nature," such as securities and
insurance. The Act repealed the Glass-Steagall Act, which prohibited a Federal
Reserve System member bank from being affiliated with a securities firm;
repealed the Garn-St. Germain Act, which prohibited a bank holding company and
its subsidiaries from selling or underwriting insurance; and repealed the
Federal Bank Holding Company Act provisions that prohibited a director, officer
or employee of a securities firm from serving as a director, officer or employee
of a bank.
NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS
The National Association of Insurance Commissioners (NAIC) facilitates the
regulation of multi-state companies through uniform reporting requirements,
standardized procedures for financial examina-
26
tions and uniform regulatory procedures embodied in model acts and
regulations. Current developments address the reporting and regulation of the
adequacy of capital and surplus.
The NAIC has developed the Privacy Consumer Financial and Health
Implementation regulation in response to the section of the Gramm-Leach-Bliley
Act that requires financial institutions to protect private information of
consumers. The Company is establishing procedures for compliance in accordance
with individual state statutes that incorporate elements of the NAIC regulation.
The NAIC has developed Property-Casualty Risk-Based Capital (RBC)
standards that relate an insurer's reported statutory surplus to the risks
inherent in its overall operations. The RBC formula uses the statutory annual
statement to calculate the minimum indicated capital level to support asset
(investment and credit) risk and underwriting (loss reserves, premiums written
and unearned premium) risk. The NAIC model law calls for various levels of
regulatory action based on the magnitude of an indicated RBC capital deficiency,
if any. The Company continues to monitor its subsidiaries' internal capital
requirements and the NAIC's RBC developments. The Company has determined that
its subsidiaries' capital levels are well in excess of the minimum capital
requirements for all RBC action levels. Management believes that its capital
levels are sufficient to support the level of risk inherent in its operations.
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.
From an underwriting perspective, 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.
A comprehensive Year 2000 Disclosure is clearly posted on the Company's
Internet site (www.rlicorp.com) to provide status information for insureds,
producers, shareholders and prospective investors. In addition, regular reports
will continue to be prepared for SEC reporting, insurance regulators, internal
management and the board of directors pertaining to Y2K efforts.
FORWARD LOOKING STATEMENTS>
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 appear
throughout this report. These statements relate to the Company's expectations,
hopes, beliefs, intentions, goals or strategies regarding the future and are
based on certain underlying assumptions by the Company. Such assumptions are, in
turn, based on information available and internal estimates and analyses of
general economic conditions, competitive factors, conditions specific to the
property and casualty insurance industry, claims development and the impact
thereof on the Company's loss reserves, the adequacy of the Company's
reinsurance programs, developments in the securities market and the impact on
the Company's investment portfolio, regulatory changes and conditions, and other
factors. Actual results could differ materially from those in forward looking
statements. The Company assumes no obligation to update any such statements. You
should review the various risks, uncertainties and other factors listed from
time to time in the Company's Securities and Exchange Commission filings.
27
CONSOLIDATED BALANCE SHEETS
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
December 31,
(in thousands, except share data) 2000 1999
Assets
Investments:
Fixed maturities:
Held-to-maturity, at amortized cost
(fair value - $303,684 in 2000 and $290,219 in 1999) $ 296,467 $ 294,199
Trading, at fair value
(amortized cost - $8,076 in 2000 and $7,887 in 1999) 8,208 7,651
Available-for-sale, at fair value
(amortized cost - $94,335 in 2000 and $41,277 in 1999) 97,147 40,663
Equity securities available-for-sale, at fair value
(cost - $135,248 in 2000 and $130,808 in 1999) 306,194 284,639
Short-term investments, at cost which approximates fair value 48,095 64,092
Total investments 756,111 691,244
Cash - -
Accrued investment income 7,767 6,999
Premiums and reinsurance balances receivable, net of allowances for
insolvent reinsurers of $9,687 in 2000 and $9,825 in 1999 94,761 65,477
Ceded unearned premiums 64,184 48,676
Reinsurance balances recoverable on unpaid losses and settlement expenses, net
of allowances for insolvent reinsurers of $2,161 in 2000 and $2,092 in 1999 239,696 245,580
Federal income tax receivable 353 2,062
Deferred policy acquisition costs, net 43,287 34,358
Property and equipment, at cost, net of accumulated depreciation
of $26,582 in 2000 and $24,004 in 1999 13,808 15,441
Investment in unconsolidated investee 18,048 15,070
Goodwill, net of accumulated amortization of $4,822 in 2000 and $2,727 in 1999 32,716 34,140
Other assets 10,592 11,316
Total assets $1,281,323 $1,170,363
28
CONSOLIDATED BALANCE SHEETS
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
December 31,
(continued) 2000 1999
Liabilities and shareholders' equity
Liabilities:
Unpaid losses and settlement expenses $ 539,750 $ 520,494
Unearned premiums 211,802 167,044
Reinsurance balances payable 51,167 44,279
Income taxes - deferred 50,702 41,662
Notes payable, short-term 78,763 78,397
Other liabilities 22,485 25,418
Total liabilities 954,669 877,294
Shareholders' equity:
Common stock ($1 par value, authorized 50,000,000 shares,
issued 12,806,446 shares in 2000 and 12,804,558 shares in 1999) 12,806 12,804
Paid-in capital 69,942 70,531
Accumulated other comprehensive earnings net of tax 113,150 99,801
Retained earnings 212,159 189,250
Deferred compensation 5,389 4,705
Treasury stock, at cost (3,002,484 shares in 2000 and 2,931,212 shares in 1999) (86,792) (84,022)
Total shareholders' equity 326,654 293,069
Total liabilities and shareholders' equity $1,281,323 $1,170,363
29
CONSOLIDATED STATEMENTS OF EARNINGS
AND COMPREHENSIVE EARNINGS
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
Years ended December 31,
(in thousands, except per share data) 2000 1999 1998
Net premiums earned $231,603 $195,274 $142,324
Net investment income 29,046 26,015 23,937
Net realized investment gains 2,847 4,467 1,853
Consolidated revenue 263,496 225,756 168,114
Losses and settlement expenses 124,586 96,457 64,728
Policy acquisition costs 76,454 66,552 44,281
Insurance operating expenses 18,479 15,130 16,526
Interest expense on debt 5,275 4,104 2,280
General corporate expenses 3,388 2,091 3,915
Total expenses 228,182 184,334 131,730
Equity in earnings of unconsolidated investee 2,979 1,613 1,337
Earnings before income taxes 38,293 43,035 37,721
Income tax expense (benefit):
Current 7,748 13,659 10,065
Deferred 1,852 (2,075) (583)
Income tax expense 9,600 11,584 9,482
Net earnings $ 28,693 $ 31,451 $ 28,239
Other comprehensive earnings (loss), net of tax
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)
arising during the period $ 15,283 $ (7,689) $ 24,259
Less: Reclassification adjustment for gains
included in net earnings (1,934) (2,882) (740)
Other comprehensive earnings (loss) 13,349 (10,571) 23,519
Comprehensive earnings $ 42,042 $ 20,880 $ 51,758
30
Years ended December 31,
(continued) 2000 1999 1998
Earnings per share:
Basic
Net earnings per share from operations $2.73 $2.82 $2.58
Realized gains, net of tax 0.19 0.29 0.11
Net earnings per share $2.92 $3.11 $2.69
Comprehensive earnings per share $4.28 $2.06 $4.92
Diluted
Net earnings per share from operations $2.70 $2.79 $2.54
Realized gains, net of tax 0.19 0.29 0.11
Net earnings per share $2.89 $3.08 $2.65
Comprehensive earnings per share $4.23 $2.04 $4.87
Weighted average number of common shares outstanding:
Basic 9,817 10,124 10,514
Diluted 9,945 10,222 10,638
31
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
THE CONSOLIDATED FINANCIAL STATEMENTS.
Accumulated
Total Other
Share- Compre- Deferred Unearned Treasury
(in thousands, holders' Common Paid-in hensive Retained Compen- ESOP Stock
except per share data) Equity Stock Capital Earnings Earnings sation shares at Cost
Balance, January 1, 1998 $266,552 $10,230 $74,586 $86,853 $140,432 $(45,549)
Net earnings 28,239 28,239
Other comprehensive earnings, net of tax 23,519 23,519
Treasury shares purchased
(390,464 shares) (15,570) (15,570)
5-for-4 stock split (16) 2,558 (2,574)
Adjustment to accounting for
deferred compensation plans 0 3,461 (3,461)
Shares issued from exercise
of stock options 62 2 60
Other capital items, including
CatEPuts amortization (979) (979)
Unearned ESOP shares purchased (2,501) (2,501)
Dividends declared ($.51 per share) (5,347) (5,347)
Balance, December 31, 1998 $293,959 $12,790 $71,093 $110,372 $163,324 $3,461 $(2,501) $(64,580)
Net earnings 31,451 31,451
Other comprehensive earnings, net of tax (10,571) (10,571)
Treasury shares purchased
(546,476 shares) (18,198) (18,198)
Adjustment to accounting for
deferred compensation plans 0 1,244 (1,244)
Shares issued from exercise
of stock options 302 14 288
Other capital items, including
CatEPuts amortization (850) (850)
Unearned ESOP shares purchased 2,501 2,501
Dividends declared ($.55 per share) (5,525) (5,525)
Balance, December 31, 1999 $293,069 $12,804 $70,531 $99,801 $189,250 $4,705 $ 0 $(84,022)
32
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
THE CONSOLIDATED FINANCIAL STATEMENTS.
(continued) Accumulated
Total Other
Share- Compre- Deferred Unearned Treasury
(in thousands, holders' Common Paid-in hensive Retained Compen- ESOP Stock
except per share data) Equity Stock Capital Earnings Earnings sation shares at Cost
Balance, December 31, 1999 $293,069 $12,804 $70,531 $99,801 $189,250 $4,705 $0 $(84,022)
Net earnings 28,693 28,693
Other comprehensive earnings, net of tax 13,349 13,349
Treasury shares purchased
(71,272 shares) (2,086) (2,086)
Adjustment to accounting for
deferred compensation plans 0 684 (684)
Shares issued from exercise
of stock options 37 2 35
Other capital items, including
CatEPuts amortization (624) (624)
Dividends declared ($.59 per share) (5,784) (5,784)
Balance, December 31, 2000 $326,654 $12,806 $69,942 $113,150 $212,159 $5,389 $0 $(86,792)
33
CONSOLIDATED STATEMENTS OF CASH FLOWS
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
THE CONSOLIDATED FINANCIAL STATEMENTS.
Years ended December 31,
(in thousands) 2000 1999 1998
Cash Flows from Operating Activities
Net earnings $28,693 $31,451 $28,239
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Net realized investment gains (2,847) (4,467) (1,853)
Depreciation 3,092 2,663 2,070
Other items, net 1,530 (4,643) (4,525)
Change in:
Accrued investment income (768) (340) (109)
Premiums and reinsurance balances receivable
(net of direct write-offs and commutations) (29,284) (5,789) (9,949)
Reinsurance balances payable 6,888 5,678 7,771
Ceded unearned premium (15,507) 17,935 (10,103)
Reinsurance balances recoverable
on unpaid losses 5,884 8,704 (12,550)
Deferred policy acquisition costs (8,929) (10,243) (526)
Unpaid losses and settlement expenses 19,255 6,134 11,260
Unearned premiums 44,758 14,414 13,480
Income taxes:
Current 1,708 313 (578)
Deferred 1,852 (2,075) (583)
Changes in investment in unconsolidated investee:
Undistributed earnings (2,979) (1,613) (1,337)
Dividends received - - 1,495
Net proceeds from trading portfolio activity (228) 239 1,376
Net cash provided by operating activities $53,118 $58,361 $23,578
34
CONSOLIDATED STATEMENTS OF CASH FLOWS
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
THE CONSOLIDATED FINANCIAL STATEMENTS.
Years ended December 31,
(continued) 2000 1999 1998
Cash Flows from Investing Activities
Purchase of:
Fixed maturities, held-to-maturity $(41,173) $(49,750) $(29,793)
Fixed maturities, available-for-sale (61,642) (15,651) (8,898)
Equity securities, available-for-sale (36,797) (15,873) (15,790)
Short-term investments, net - (13,359) (7,799)
Property and equipment (2,642) (5,710) (2,529)
Interest in Underwriters Indemnity Holdings - (40,700) -
Note receivable - (10,000) -
Proceeds from sale of:
Fixed maturities, available-for-sale - 11,111 772
Equity securities, available-for-sale 35,145 18,671 8,207
Short-term investments, net 13,315 - -
Property and equipment 1,183 276 646
Proceeds from call or maturity of:
Fixed maturities, held-to-maturity 38,250 38,560 34,596
Fixed maturities, available-for-sale 8,622 9,836 5,511
Net cash used in investing activities (45,739) (72,589) (15,077)
Cash Flows from Financing Activities
Proceeds from issuance of debt 366 35,189 14,744
Fractional shares paid - - (16)
Shares issued under stock option plan 37 302 62
Unearned ESOP shares - 2,501 (2,501)
Treasury shares purchased (2,086) (18,198) (15,570)
Cash dividends paid (5,696) (5,566) (5,220)
Net cash provided by (used in) financing activities (7,379) 14,228 (8,501)
Net decrease in cash 0 0 0
Cash at beginning of year 0 0 0
Cash at end of year $ 0 $ 0 $ 0
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.>SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. DESCRIPTION OF BUSINESS: RLI Corp. is a holding company that, through its
subsidiaries, underwrites selected property and casualty insurance products.
The property and casualty insurance segment, RLI Insurance Group (the
Group), is principally composed of four insurance companies. RLI Insurance
Company, the principal subsidiary, writes multiple lines of insurance on an
admitted basis in all 50 states, the District of Columbia and Puerto Rico. Mt.
Hawley Insurance Company, a subsidiary of RLI Insurance Company, writes surplus
lines insurance in all 50 states, the District of Columbia, Puerto Rico, the
Virgin Islands and Guam. Underwriters Indemnity Company (UIC), a subsidiary of
RLI Insurance Company, writes multiple lines of insurance on an admitted basis
in 33 states and the District of Columbia and surplus lines insurance in Ohio.
Planet Indemnity Company (PIC), a subsidiary of Mt. Hawley Insurance Company,
writes multiple lines of insurance on an admitted basis in 23 states and the
District of Columbia. PIC writes surplus lines insurance in an additional five
states.
B. PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION: The accompanying
consolidated financial statements were prepared in conformity with generally
accepted accounting principles (GAAP), which differ in some respects from those
followed in reports to insurance regulatory authorities. The consolidated
financial statements include the accounts of RLI Corp. and its subsidiaries (the
Company). All significant intercompany balances and transactions have been
eliminated. Certain reclassifications were made to the prior years' financial
statements to conform with the classifications used in 2000.
In January 1999, RLI Insurance Company acquired Underwriters Indemnity
Holdings, Inc. (UIH), located in Houston, Texas. UIH specializes in the
marketing and underwriting of surety products for oil, gas, mining and other
energy-related exposures.
RLI paid $40.7 million in cash in exchange for all outstanding shares of
UIH. Included in the transaction were both of UIH's insurance operating
subsidiaries, Underwriters Indemnity Company and Planet Indemnity Company. The
transaction was financed through short-term borrowings and has been accounted
for under the purchase method of accounting. See note 11 for further discussion
and related disclosures.
C. INVESTMENTS: In compliance with FASB Statement No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," the Company classifies its
investments in all debt securities and those equity securities with readily
determinable fair values into one of three categories: held-to-maturity, trading
or available-for-sale.
36
HELD-TO-MATURITY SECURITIES
Debt securities that the Company has the positive intent and ability to hold to
maturity are classified as held-to-maturity and carried at amortized cost.
Except for declines that are other than temporary, changes in the fair value of
these securities are not reflected in the financial statements. The Company has
classified approximately 74% of its portfolio of debt securities as
held-to-maturity.
TRADING SECURITIES
Debt and equity securities purchased for short-term resale are classified as
trading securities. These securities are reported at fair value with unrealized
gains and losses included in earnings. The Company has classified approximately
2% of its portfolio of debt securities as trading.
AVAILABLE-FOR-SALE SECURITIES
All other debt and equity securities not included in the above categories are
classified as available-for-sale and reported at fair value. Unrealized gains
and losses on these securities are excluded from net earnings but are recorded
as a separate component of comprehensive earnings and shareholders' equity, net
of deferred income taxes. All of the Company's equity securities and
approximately 24% of debt securities are classified as available-for-sale.
Short-term investments are carried at cost, which approximates fair value.
The Company continuously monitors the values of its investments in fixed
maturities and equity securities. If this review shows that a decline in fair
value is other than temporary, the Company's carrying value in the investment is
reduced to its fair market value through an adjustment to earnings. Realized
gains and losses on disposition of investments are based on specific
identification of the investments sold.
Interest on fixed maturities and short-term investments is credited to
earnings as it accrues. Dividends on equity securities are credited to earnings
on the ex-dividend date.
D. REINSURANCE: Ceded unearned premiums and reinsurance balances
recoverable on unpaid losses and settlement expenses are reported separately as
assets, instead of being netted with the appropriate liabilities, since
reinsurance does not relieve the Company of its legal liability to its
policyholders.
The Company continuously monitors the financial condition of its
reinsurers. The Company's policy is to periodically charge to earnings an
estimate of unrecoverable amounts from troubled or insolvent reinsurers. No
charges occurred in 2000, 1999 or 1998. The Company believes that current
reserve levels for uncollectible reinsurance are sufficient to cover the related
exposure.
E. UNPAID LOSSES AND SETTLEMENT EXPENSES: The liability for unpaid losses
and settlement expenses represents estimates of amounts needed to pay reported
and unreported claims and related expenses. The estimates are based on certain
actuarial and other assumptions related to the ultimate cost to settle such
claims. Such assumptions are subject to occasional changes due to evolving
economic, social and political conditions. All estimates are periodically
reviewed and, as experience develops and new information becomes known, the
reserves are adjusted as necessary. Such adjustments are reflected in the
results of operations in the period in which they are determined. Due to the
inherent uncertainty in estimating reserves for losses and settlement expenses,
there can be no assurance that the ultimate liability will not exceed recorded
amounts, with a resulting adverse effect on the Company. Based on the current
assumptions used in calculating reserves, management believes that the Company's
overall reserve levels at December 31, 2000, are adequate to meet its future
obligations.
F. REVENUE RECOGNITION: Insurance premiums are recognized ratably over the
term of the contracts, net of ceded reinsurance. Unearned premiums are
calculated on the monthly pro rata basis.
G. POLICY ACQUISITION COSTS: The costs of acquiring insurance premiums --
principally commissions and brokerage, sales compensation, premium taxes and
other direct underwriting expenses -- net of reinsurance commissions received,
are amortized over the life of the policies in order to properly match policy
acquisition costs to the related premium revenue. The method followed in
computing deferred policy acquisition costs limits the amount of such deferred
costs to their estimated realizable value, which gives effect to the premium to
be earned, related investment income, losses and settlement expenses and certain
other costs expected to be incurred as the premium is earned.
H. PROPERTY AND EQUIPMENT: Property and equipment are depreciated on a
straight-line basis for financial statement purposes over periods ranging from
three to 10 years for equipment and up to 40 years for buildings and
improvements.
I. INTANGIBLE ASSETS: Goodwill, which represents the excess of purchase
price over fair value of assets acquired, is amortized on a straight-line basis
for financial statement purposes over periods ranging from 10 to 20 years. The
Company will periodi-
37
cally review the recoverability of goodwill based on an assessment of
undiscounted cash flows of future operations to ensure it is appropriately
valued.
J. INCOME TAXES: The Company files a consolidated income tax return. Tax
provisions are computed and apportioned to the subsidiaries on the basis of
their taxable income.
K. EARNINGS PER SHARE: Pursuant to disclosure requirements contained in
FASB Statement No. 128, the following represents a reconciliation of the
numerator and denominator of the basic and diluted EPS computations contained in
the financial statements.
Income Shares Per Share
(in thousands, except per share data) (Numerator) (Denominator) Amount
FOR THE YEAR ENDED DECEMBER 31, 2000
BASIC EPS
Income available to
common shareholders $28,693 9,817 $2.92
Incentive stock options -- 128
DILUTED EPS
Income available to common share-
holders and assumed conversions 28,693 9,945 2.89
For the year ended December 31, 1999
BASIC EPS
Income available to
common shareholders $31,451 10,124 $3.11
Incentive stock options -- 98
DILUTED EPS
Income available to common share-
holders and assumed conversions 31,451 10,222 3.08
For the year ended December 31, 1998
BASIC EPS
Income available to
common shareholders $28,239 10,514 $2.69
Incentive stock options -- 124
DILUTED EPS
Income available to common share-
holders and assumed conversions 28,239 10,638 2.65
L. COMPREHENSIVE EARNINGS: FASB Statement No. 130, "Reporting
Comprehensive Income," was adopted by the Company in 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. In
reporting the components of comprehensive earnings on a net basis in the income
statement, the Company has used a 35% tax rate. Other comprehensive income
(loss), as shown, is net of tax expense (benefit) of $7.2 million, ($5.7
million) and $12.7 million, respectively, for 2000, 1999 and 1998.
M. FAIR VALUE DISCLOSURES: The following methods were used to estimate the
fair value of each class of financial instruments for which it was practicable
to estimate that value. Fixed maturities and equity securities are valued using
quoted market prices, if available. If a quoted market price is not available,
fair value is estimated using independent pricing services or quoted market
prices of similar securities. Fair value disclosures for investments are
included in note 2. Due to the relatively short-term nature of cash, short-term
investments, accounts receivable, accounts payable and short-term debt, their
carrying amounts are reasonable estimates of fair value. Fair value of long-term
debt is based on quoted market prices if available or quoted market prices of
similar issues.
N. STOCK BASED COMPENSATION: The Company grants to officers and directors
stock options for shares with an exercise price equal to the fair market value
of the shares at the date of grant. The Company accounts for stock option grants
in accordance with APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and accordingly recognizes no compensation expense for the stock
option grants. See note 8 for further discussion and related disclosures.
O. RISKS AND UNCERTAINTIES: Certain risks and uncertainties are inherent
to the Company's day-to-day operations and to the process of preparing its
financial statements. The more significant risks and uncertainties, as well as
the Company's methods for mitigating, quantifying and minimizing such, are
presented below and throughout the notes to the consolidated financial
statements.
CATASTROPHE EXPOSURES
The Company's past and present insurance coverages include exposure to
catastrophic events. Catastrophic events such as earthquakes, floods and
windstorms are covered by certain of the Company's property policies. The
Company has a concentration of such coverages in California (46% of gross
property premiums written during 2000). Using computer-assisted modeling
techniques, the Company quantifies and monitors its exposure to catastrophic
events. Additionally, the Company further limits its risk to such catastrophes
through the purchase of reinsurance.
ENVIRONMENTAL EXPOSURES
The Company is subject to environmental claims and exposures through its
commercial umbrella, general liability and discontinued assumed
38
reinsurance lines of business. Although exposure to environmental claims exists
in these lines of business, management has sought to mitigate or control the
extent of this exposure through the following methods: 1) the Company's policies
include pollution exclusions that have been continually updated to further
strengthen the exclusion; 2) the Company's policies primarily cover moderate
hazard risks; and 3) the Company began writing this business after the industry
became aware of the potential pollution liability exposure.
The Company has made loss and settlement expense payments on environmental
liability claims and has loss and settlement expense reserves for others. The
Company includes this historical environmental loss experience with the
remaining loss experience in the applicable line of business to project ultimate
incurred losses and settlement expenses and related "incurred but not reported"
loss and settlement expense reserves.
Although historical experience on environmental claims may not accurately
reflect future environmental exposures, the Company has used this experience to
record loss and settlement expense reserves in the exposed lines of business.
See further discussion of environmental exposures in note 6.
REINSURANCE
Reinsurance does not discharge the Company from its primary liability to
policyholders, and to the extent that a reinsurer is unable to meet its
obligations, the Company would be liable. The Company continuously monitors the
financial condition of prospective and existing reinsurers. As a result, the
Company currently purchases reinsurance from a limited number of financially
strong reinsurers. The Company provides a reserve for reinsurance balances
deemed uncollectible.
FINANCIAL STATEMENTS
The preparation of the consolidated financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the reported
financial statement balances as well as the disclosure of contingent assets and
liabilities. Actual results could differ from those estimates. The most
significant of these amounts is the liability for unpaid losses and settlement
expenses. Management continually updates its estimates as additional data
becomes available and adjusts the financial statements as deemed necessary.
Other estimates such as the recoverability of reinsurance balances, deferred tax
assets and deferred policy acquisition costs are regularly monitored, evaluated
and adjusted. Although recorded estimates are supported by actuarial
computations and other supportive data, the estimates are ultimately based on
management's expectations of future events.
EXTERNAL FACTORS
The Company's insurance subsidiaries are highly regulated by the states in which
they are incorporated and by the states in which they do business. Such
regulations, among other things, limit the amount of dividends, impose
restrictions on the amount and types of investments and regulate rates insurers
may charge for various products. The Company is also subject to insolvency and
guarantee fund assessments for various programs designed to ensure policyholder
indemnification. The Company generally accrues the full amount of the assessment
upon notification.
The National Association of Insurance Commissioners (NAIC) has developed
Property-Casualty Risk-Based Capital (RBC) standards that relate an insurer's
reported statutory surplus to the risks inherent in its overall operations. The
RBC formula uses the statutory annual statement to calculate the minimum
indicated capital level to support asset (investment and credit) risk and
underwriting (loss reserves, premiums written, and unearned premium) risk. The
NAIC model law calls for various levels of regulatory action based on the
magnitude of an indicated RBC capital deficiency, if any. The Company regularly
monitors its subsidiaries' internal capital requirements and the NAIC's RBC
developments. The Company has determined that its capital levels are well in
excess of the minimum capital requirements for all RBC action levels and that
its capital levels are sufficient to support the level of risk inherent in its
operations.
2.>INVESTMENTS
A summary of net investment income is as follows:
INVESTMENT INCOME (in thousands) 2000 1999 1998
Interest on fixed maturities $22,992 $19,837 $19,479
Dividends on equity securities 7,241 7,120 6,718
Interest on short-term investments 2,488 2,318 1,296
Gross investment income 32,721 29,275 27,493
Less investment expenses 3,675 3,260 3,556
Net investment income $29,046 $26,015 $23,937
39
Pretax net realized investment gains (losses) and net changes in
unrealized gains (losses) on investments for the years ended December 31 are
summarized as follows:
REALIZED/UNREALIZED GAINS (in thousands) 2000 1999 1998
Net realized investment gains (losses)
Fixed maturities
Held-to-maturity $ (17) $ 7 $ 34
Trading 331 (446) 179
Available-for-sale (2) (494) (9)
Equity securities 2,978 4,928 1,148
Other (443) 472 501
2,847 4,467 1,853
Net changes in unrealized gains
(losses) on investments
Fixed maturities
Held-to-maturity 11,197 (14,533) 3,779
Available-for-sale 3,425 (945) (147)
Equity securities 17,112 (15,318) 36,330
31,734 (30,796) 39,962
Net realized investment gains and
changes in unrealized gains
(losses) on investments $34,581 $ (26,329) $ 41,815
Following is a summary of the disposition of fixed maturities for the
years ended December 31, with separate presentations for sales and
calls/maturities.
Proceeds Gross Realized Net Realized
SALES (in thousands) From Sales Gains Losses Gain (Loss)
2000 --Trading $ 2,771 $ 8 $ (45) $ (37)
1999 --Available-for-sale 10,210 188 (829) (641)
Trading 4,222 15 (34) (19)
1998 --Available-for-sale 772 -- -- --
Trading 9,358 131 (17) 114
Proceeds Gross Realized Net Realized
CALLS/MATURITIES (in thousands) From Sales Gains Losses Gain (Loss)
2000 --Held-to-maturity $38,250 $ -- $(17) $(17)
Available-for-sale 8,622 -- (2) (2)
Trading 668 -- -- --
1999 --Held-to-maturity 38,560 7 -- 7
Available-for-sale 12,537 151 (4) 147
Trading 257 -- -- -
1998 --Held-to-maturity 34,596 46 (12) 34
Available-for-sale 5,511 1 (10) (9)
Trading 70 -- -- --
The following is a schedule of amortized costs and estimated fair values
of investments in fixed maturities and equity securities as of December 31, 2000
and 1999.
Amortized Estimated Gross Unrealized
(in thousands) Cost Fair Value Gains Losses
2000
Held-to-maturity
U.S. government $118,049 $120,636 $ 2,703 $ (116)
States, political subdi-
visions & revenues 178,418 183,048 4,688 (58)
Total held-to-maturity $296,467 $303,684 $ 7,391 $ (174)
Trading
U.S. government $ 4,164 $ 4,241 $ 86 $ (9)
Corporate 3,912 3,967 66 (11)
Total trading $ 8,076 $ 8,208 $ 152 $ (20)
Available-for-sale
U.S. government $ 76,333 $ 78,822 $ 2,497 $ (8)
States, political subdi-
visions & revenues 18,002 18,325 361 (38)
Fixed maturities 94,335 97,147 2,858 (46)
Equity securities 135,248 306,194 175,117 (4,171)
Total available-for-sale $229,583 $403,341 $177,975 $(4,217)
Total $534,126 $715,233 $185,518 $(4,411)
1999
Held-to-maturity
U.S. government $121,788 $120,074 $ 115 $(1,829)
States, political subdi-
visions & revenues 172,411 170,145 511 (2,777)
Total held-to-maturity $294,199 $290,219 $ 626 $(4,606)
Trading
U.S. government $ 4,240 $ 4,081 $ 2 $ (161)
Corporate 3,447 3,370 -- (77)
States, political subdi-
visions & revenues 200 200 -- --
Total trading $ 7,887 $ 7,651 $ 2 $ (238)
Available-for-sale
U.S. government $ 25,472 $ 25,153 $ 8 $ (327)
States, political subdi-
visions & revenues 15,805 15,510 24 (319)
Fixed maturities 41,277 40,663 32 (646)
Equity securities 130,808 284,639 157,761 (3,930)
Total available-for-sale $172,085 $325,302 $157,793 $(4,576)
Total $474,171 $623,172 $158,421 $(9,420)
40
The amortized cost and estimated fair value of fixed-maturity securities
at December 31, 2000, by contractual maturity, are shown as follows.
Amortized Estimated
(in thousands) Cost Fair Value
Held-to-maturity
Due in one year or less $ 17,452 $ 17,523
Due after one year through five years 103,882 105,573
Due after five years through ten years 130,507 134,700
Due after ten years 44,626 45,888
$296,467 $303,684
Trading
Due in one year or less $ -- --
Due after one year through five years 3,558 3,631
Due after five years through ten years 3,135 3,176
Due after ten years 1,383 1,401
$ 8,076 $ 8,208
Available-for-sale
Due in one year or less $ 3,907 $ 3,905
Due after one year through five years 50,170 51,371
Due after five years through ten years 34,166 35,586
Due after ten years 6,092 6,285
$ 94,335 $ 97,147
Expected maturities may differ from contractual maturities due to call
provisions present on some existing securities. Management believes the impact
of any calls should be slight and intends to follow its policy of matching
assets against anticipated liabilities.
At December 31, 2000, the net unrealized appreciation of
available-for-sale fixed maturities and equity securities totaled $113.1
million. This amount was net of deferred taxes of $60.6 million. At December 31,
1999, the net unrealized appreciation of available-for-sale fixed maturities and
equity securities totaled $99.8 million. This amount is net of deferred taxes of
$53.4 million.
The Company is party to a securities lending program whereby fixed-income
securities are loaned to third parties, primarily major brokerage firms. As of
December 31, 2000 and 1999, fixed maturities with a fair value of $10.8 million
and $13.1 million, respectively, were loaned. Agreements with custodian banks
facilitating such lending generally require 102% of the value of the loaned
securities to be separately maintained as collateral for each loan. Pursuant to
FASB Statements 125, 127 and 140, an invested asset and a corresponding
liability have been recognized for the cash collateral amount. This gross-up is
not required for non-cash collateral. To further minimize the credit risks
related to this lending program, the Company monitors the financial condition of
other parties to these agreements.
As required by law, certain fixed maturities and short-term investments
amounting to $22.6 million at December 31, 2000, were on deposit with either
regulatory authorities or banks. Additionally, the Company has certain fixed
maturities held in trust amounting to $8.2 million at December 31, 2000. These
funds cover net premiums, losses and expenses related to a property and casualty
insurance program.
3.>POLICY ACQUISITION COSTS
Policy acquisition costs deferred and amortized to income for the years ended
December 31 are summarized as follows:
(in thousands) 2000 1999 1998
Deferred policy acquisition costs,
beginning of year $34,358 $22,510 $21,985
Deferred policy acquisition costs,
UIH, Inc.-Acquisition Date 1,604
Deferred:
Direct commissions 80,837 64,312 55,035
Premium taxes 7,738 5,982 4,489
Other direct underwriting expenses 31,121 26,340 20,335
Ceding commissions (32,718) (20,450) (33,644)
Net deferred 86,978 76,184 46,215
Amortized 78,049 65,940 45,690
Deferred policy acquisition costs,
end of year $43,287 $34,358 $22,510
Policy acquisition costs:
Amortized to expense 78,049 65,940 45,690
Period costs:
Ceding commission-contingent (4,392) (3,159) (6,604)
Other 2,797 3,771 5,195
Total policy acquisition costs $76,454 $66,552 $44,281
4.>DEBT
The Company continued the use of short-term credit facilities through reverse
repurchase transactions. During 1999, the Company borrowed $42.8 million in
reverse repurchase agreements, in part, to finance the January acquisition of
Underwriters Indemnity Holdings. These repurchase agreements have been renewed
continuously during 2000 and remain outstanding at December 31, 2000.
Additionally, proceeds from reverse repurchase agreements have been used to
partially fund the Company's
41
stock repurchase program. At December 31, 2000, the Company was party to five
reverse repurchase transactions which represent $59.1 million in outstanding
debt. The carrying value of fixed maturities pledged as collateral in these
transactions totaled $56.4 million of held-to-maturity and $3.0 million of
available-for-sale securities.
Interest paid on outstanding debt for 2000, 1999, and 1998, amounted to
$5.2 million, $3.5 million and $2.3 million, respectively.
The Company maintains a $30.0 million revolving line of credit from one
financial institution. The facility has a three-year term that expires on
December 31, 2001. As of December 31, 2000, the Company had $19.6 million in
outstanding debt from this facility. The weighted-average interest rate on this
line of credit was 7.21% for 2000 versus 5.98% in 1999.
5.>REINSURANCE
In the ordinary course of business, the insurance subsidiaries assume and cede
premiums with other insurance companies. A large portion of the reinsurance is
put into effect under contracts known as treaties and, in some instances, by
negotiation on each individual risk. In addition, there are excess of loss and
catastrophe reinsurance contracts that protect against losses over stipulated
amounts arising from any one occurrence or event. The arrangements provide
greater diversification of business and serve to limit the maximum net loss on
catastrophes and large and unusually hazardous risks.
Through the purchase of reinsurance, the Company generally limits the loss
on any individual risk to $1.0 million. Additionally, through extensive use of
computer-assisted modeling techniques, the Company monitors the concentration of
risks exposed to catastrophic events (predominantly earthquakes).
In 1996, the Company entered into an innovative catastrophe reinsurance
and loss financing program with Zurich Reinsurance NA (Zurich Re). The program,
called Catastrophe Equity Puts (CatEPuts), augments the Company's traditional
reinsurance by integrating its loss financing needs with a pre-negotiated sale
of securities linked to exchange-traded shares. CatEPuts allows the Company to
put up to $50.0 million of its convertible preferred shares to Zurich Re at a
pre-negotiated rate in the event of a catastrophic loss, provided the loss does
not reduce GAAP equity to less than $55.0 million. CatEPuts began as a
multi-year program and is designed to enable the Company to continue operating
after a loss of such magnitude that its reinsurance capacity is exhausted. If
the Company exercises its option to put preferred shares to Zurich Re, then
Zurich Re, in turn, has the option to reinsure certain business written by the
Company on a prospective basis. In November 2000, this agreement was renewed for
an additional three-year period.
Premiums written and earned along with losses and settlement expenses
incurred for the years ended December 31 are summarized as follows:
(in thousands) 2000 1999 1998
WRITTEN
Direct $429,986 $332,275 $288,135
Reinsurance assumed 7,880 7,300 2,938
Reinsurance ceded (177,013) (111,951) (145,372)
Net $260,853 $227,624 $145,701
EARNED
Direct $384,139 $314,111 $274,996
Reinsurance assumed 8,952 11,049 2,597
Reinsurance ceded (161,488) (129,886) (135,269)
Net $231,603 $195,274 $142,324
LOSSES AND SETTLEMENT
EXPENSES INCURRED
Direct $217,006 $189,394 $112,325
Reinsurance assumed 7,402 3,299 6,887
Reinsurance ceded (99,822) (96,236) (54,484)
Net $124,586 $ 96,457 $ 64,728
At December 31, 2000, the Company had prepaid reinsurance premiums and
reinsurance recoverables on paid and unpaid losses and settlement expenses with
American Re-Insurance Company and with General Cologne Re (both rated A++
"Superior" by A.M. Best Company) that amounted to $69.2 million and $33.3
million, respectively. All other reinsurance balances recoverable, when
considered by individual reinsurer, are less than 10% of shareholders' equity.
6.>UNPAID LOSSES AND SETTLEMENT EXPENSES
The following table reconciles the Company's liability for unpaid losses and
settlement expenses (LAE) for the three years ended December 31, 2000. Since
reserves are based on estimates, the ultimate net cost may vary from the
original estimate. As adjustments to these estimates become necessary, they are
reflected in current operations. As part of the reserving process, historical
data is reviewed and consideration is given to the anticipated impact of various
factors such as legal developments and economic conditions, including the
effects of inflation. Changes in reserves from the prior years' estimates are
calculated based on experience as of the end of each succeeding year (loss and
LAE development).
42
(in thousands) 2000 1999 1998
Unpaid losses and LAE
at beginning of year:
Gross $520,494 $415,523 $404,263
Ceded (245,580) (168,261) (155,711)
Net 274,914 247,262 248,552
Unpaid losses and LAE
UIH, Inc.-Acquisition Date:
Gross 74,979
Ceded (67,642)
Net 7,337
Increase (decrease) in incurred
losses and LAE:
Current accident year 126,270 101,053 68,131
Prior accident years (1,684) (4,596) (3,403)
Total incurred 124,586 96,457 64,728
Loss and LAE payments for
claims incurred:
Current accident year (34,373) (21,675) (14,762)
Prior accident years (65,216) (53,892) (54,927)
Total paid (99,589) (75,567) (69,689)
Insolvent reinsurer charge off 143 (1,000) 7,911
Loss reserves commuted 425 (4,240)
Net unpaid losses and LAE
at end of year $300,054 $274,914 $247,262
Unpaid losses and LAE
at end of year:
Gross 539,750 520,494 415,523
Ceded (239,696) (245,580) (168,261)
Net $300,054 $274,914 $247,262
During the three years, overall development on prior accident-year loss
and settlement expense reserves was insignificant to recorded loss and
settlement expense reserves.
The Company is subject to environmental claims and exposures through its
commercial umbrella, general liability and discontinued assumed reinsurance
lines of business. Within these lines, the Company's environmental exposures
include environmental site cleanup, asbestos removal and mass tort liability.
The majority of the exposure is in the excess layers of the Company's commercial
umbrella and assumed reinsurance books of business.
The following table represents inception-to-date paid and unpaid
environmental claims data (including incurred but not reported losses) as of
December 31, 2000, 1999 and 1998:
Inception-to-date December 31,
(in thousands) 2000 1999 1998
Loss and LAE payments for
claims incurred
Gross $ 23,720 $22,565 $15,269
Ceded (14,070) (13,671) (9,354)
Net $ 9,650 8,894 $ 5,915
Unpaid losses and LAE at end of year
Gross $ 17,110 $16,125 $18,226
Ceded (9,220) (8,566) (9,391)
Net $ 7,890 $ 7,559 $ 8,835
Although the Company's environmental exposure is limited as a result of
entering liability lines after the industry had already recognized it as a
problem, management cannot determine the Company's ultimate liability with any
reasonable degree of certainty. This ultimate liability is difficult to assess
due to evolving legislation on such issues as joint and several liability,
retroactive liability and standards of cleanup. Additionally, the Company
participates primarily in the excess layers, making it even more difficult to
assess the ultimate impact.
7.>INCOME TAXES
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are summarized in the
following table.
(in thousands) 2000 1999 1998
Deferred tax assets:
Tax discounting of claim reserves $ 18,354 $ 16,989 $ 15,388
Unearned premium offset 10,333 8,285 5,757
Other, net 337 1,772 2,551
29,024 27,046 23,696
Less valuation allowance (300) (300) (300)
Total deferred tax assets $ 28,724 $ 26,746 $ 23,396
Deferred tax liabilities:
Net unrealized appreciation
of securities $60,608 $ 53,421 $ 59,113
Deferred policy acquisition costs 15,153 12,025 7,879
Book/tax depreciation 1,179 1,298 1,328
Other, net 2,486 1,664 3,497
Total deferred tax liabilities 79,426 68,408 71,817
Net deferred tax asset (liability) $(50,702) $(41,662) $(48,421)
Management feels it is more likely than not that a portion of the
Company's deferred tax assets will not be realized. Therefore, an
43
allowance has been established for certain deferred tax assets that have an
indefinite reversal pattern. Management also believes the Company's remaining
deferred tax assets will be fully realized through deductions against future
taxable income.
Income tax expense attributable to income from operations for the years
ended December 31, 2000, 1999 and 1998, differed from the amounts computed by
applying the U.S. federal tax rate of 35% to pretax income from continuing
operations as demonstrated in the following table.
(in thousands) 2000 1999 1998
Provision for income taxes at
the statutory federal tax rates $13,402 $15,062 $13,202
Increase (reduction) in taxes
resulting from:
Dividends received deduction (1,525) (1,492) (1,409)
ESOP dividends paid deduction (265) (245) (231)
Tax-exempt interest income (2,721) (2,576) (2,271)
Goodwill 561 513 --
State income tax provision 162 164 170
Other items, net (14) 158 21
$ 9,600 $11,584 $ 9,482
The Company has recorded its deferred tax assets and liabilities using the
statutory federal tax rate of 35%. Management believes when these deferred items
reverse in future years, the Company's taxable income will be taxed at an
effective rate of 35%.
Net federal and state income taxes paid in 2000, 1999 and 1998 amounted to
$6.3 million, $13.3 million, and $10.6 million, respectively.
The Internal Revenue Service (IRS) has examined the Company's income tax
returns through the tax year ended December 31, 1994. The IRS is not currently
examining any of the Company's income tax returns.
8.>EMPLOYEE BENEFITS
PENSION PLAN
The Company maintains a noncontributory defined benefit pension plan
covering substantially all employees meeting age and service requirements. The
plan provides a benefit based on a participant's service and the highest five
consecutive years' average compensation out of the last 10 years. The Company
funds pension costs as accrued, except that in no case will the Company
contribute amounts less than the minimum contribution required under the
Employee Retirement Income Security Act of 1974 or more than the maximum tax
deductible contribution for the year. The plan reached the full funding
limitation in 1986 and remained fully funded through 1993. During 1999 and 1998,
the Company made the maximum tax deductible contribution allowed, totaling
$448,695 and $422,489, respectively. During 2000, the Company made
tax-deductible contributions totaling $2.5 million, to adequately meet the
funding requirements of the plan.
The Company has made various amendments to the plan in order to comply
with certain Internal Revenue Code changes.
The financial status of the plan for each of the three years ended
December 31 is illustrated in the following tables:
For the year ended December 31,
2000 1999 1998
Components of pension cost
Service cost $ 636,094 $ 672,939 $ 530,886
Interest cost 449,194 373,514 336,573
Expected return on plan assets (478,270) (489,319) (427,320)
Recognized prior service cost 17,681 3,051 3,051
Recognized net loss 13,425 -- --
Amortization of transition
(asset) obligation (32,566) (32,566) (32,566)
Pension cost $ 605,558 $ 527,619 $ 410,624
Accumulated benefit obligation $4,801,878 $3,593,215 $3,854,111
For the year ended December 31,
2000 1999 1998
Change in plan assets
Fair value of plan assets
at January 1 $4,529,865 $4,716,875 $4,157,321
Actual return on plan assets 443,778 (147,904) 600,966
Employer contribution 2,485,549 448,695 422,489
Benefit payments (249,069) (487,801) (463,901)
Fair value of plan assets
at December 31 $7,210,123 $4,529,865 $4,716,875
Change in projected
benefit obligation
Projected benefit obligation
at January 1 $4,901,818 $5,337,974 $4,416,028
Service cost 636,094 672,939 530,886
Interest cost 449,194 373,514 336,573
Actuarial (gains) losses 852,271 (994,808) 518,388
Benefit payments (249,069) (487,801) (463,901)
Plan amendment 148,802 -- --
Projected benefit obligation
at December 31 $6,739,110 $4,901,818 $5,337,974
44
For the year ended December 31,
(continued) 2000 1999 1998
Funded status $ 471,013 $ (371,953) $ (621,099)
Unrecognized net loss 974,144 100,806 458,391
Unamortized prior service cost 131,284 163 3,214
Unrecognized transition
(asset) obligation (104,215) (136,781) (169,347)
(Accrued) prepaid at
December 31 $1,472,226 $ (407,765) $ (328,841)
Amounts recognized in the
statement of financial
position consist of:
(Accrued benefit liability)
prepaid benefit cost $1,472,226 $ (407,765) $ (328,841)
Net amount recognized $1,472,226 $ (407,765) $ (328,841)
Rates
Discount rate 7.75% 8.00% 7.00%
Compensation increase 6.00% 6.00% 6.00%
Expected return on
plan assets 10.00% 10.00% 10.00%
At December 31, 2000, plan assets at fair value are comprised of
approximately 74% equity securities and 26% invested cash.
EMPLOYEE STOCK OWNERSHIP AND BONUS AND INCENTIVE PLANS
The Company maintains an Employee Stock Ownership Plan (ESOP) and bonus and
incentive plans covering executives, managers and associates. Funding of these
plans is primarily dependent upon reaching predetermined levels of operating
earnings and Market Value Potential (MVP). While some management incentive plans
may be affected somewhat by other performance factors, the larger influence of
corporate performance ensures that the interests of the Company's executives,
managers and associates correspond with those of our shareholders.
MVP requires that the Company generate a return in excess of its cost of
capital before the payment of bonuses. Under MVP, funds in excess of the cost of
capital are first designated to fund the Company's ESOP, up to the maximum
allowable contribution of 15% of eligible wages. A portion of both MVP in excess
of the ESOP funding, as well as operating earnings, is then shared by
executives, managers and associates. All remaining funds are reinvested in the
Company for the benefit of the shareholders. Annual expenses for all of these
plans totaled $3.1 million, $255,000, and $3.9 million for 2000, 1999 and 1998,
respectively.
The Company's ESOP covers substantially all employees meeting eligibility
requirements. ESOP contributions are determined annually by the Company's board
of directors and are expensed in the year earned. ESOP-related expenses were
$3.6 million, $2.9 million and $2.6 million, respectively, for 2000, 1999 and
1998.
During 2000, the ESOP purchased 98,375 shares of the Company's common
stock on the open market at an average price of $30.69 ($3.0 million). During
the third quarter of 1998, the Company leveraged the ESOP and purchased a total
of 70,400 shares at an average price of $35.58 per share ($2.5 million) in
advance of the actual contribution to the plan in January 1999. There were no
additional shares purchased in 1999. As a result of the 1997 ESOP contribution
made in January 1998, the ESOP purchased 61,802 shares on the open market at an
average price of $38.54 ($2.4 million). Shares held by the ESOP are treated as
outstanding in computing the Company's earnings per share. At December 31, 1998,
unearned leveraged shares were not considered outstanding for calculating
earnings per share. Dividends on earned ESOP shares are passed through to the
participants.
DEFERRED COMPENSATION
The Company maintains a Rabbi Trust for deferred compensation plans for
directors, key employees and executive officers through which company shares are
purchased. During 1998, the Emerging Issues Task Force reached its consensus on
Issue 97-14 relative to Rabbi Trusts. This prescribed an accounting treatment
whereby the employer stock in the plan is classified and accounted for as
equity, in a manner consistent with the accounting for treasury stock. This
increased the Company's treasury stock by $3.5 million in 1998. The deferred
compensation obligation is classified as an equity instrument. This treatment
was applied prospectively by the Company in 1998.
The expense associated with funding these plans is recognized through
salary, bonus, and ESOP expenses for key employees and executive officers as
disclosed in prior notes. The expense recognized from the directors' deferred
plan was $154,544, $162,700 and $175,900 in 2000, 1999 and 1998,
respectively. In 2000, the Rabbi Trusts purchased 23,3 c16 shares of the
Company's common stock on the open market at an average price of $34.51
($804,657). In 1999, the Rabbi Trusts purchased 38,837 shares of the
Company's common stock on the open market at an average price of $32.97
($1,280,347). In 1998, the Rabbi Trusts purchased 15,521 shares of the
Company's common stock on the open market at an average price of $37.20
($577,409). At December 31, 2000, the Trusts' assets were valued at $10.5
million.
STOCK OPTION PLANS
During 1995, the Company adopted and the shareholders approved a tax-favored
incentive stock option plan (the Incentive Plan). During 1997, the
45
shareholders approved the Outside Directors' Stock Option Plan (the Directors'
Plan). The Company accounts for these plans in accordance with APB Opinion No.
25, under which no compensation cost is recognized.
Had compensation cost for the plan been determined consistent with FASB
Statement No. 123, "Accounting for Stock-Based Compensation," the Company's net
income and earnings per share would have been reduced to the following pro forma
amounts:
(in thousands, except per share data) 2000 1999 1998
Net income: As reported $28,693 $31,451 $28,239
Pro forma 27,781 30,608 27,592
Diluted EPS: As reported $2.89 $3.08 $2.65
Pro forma $2.79 $2.99 $2.59
These pro forma amounts may not be representative of the effects of FASB
Statement No. 123 on pro forma net income for future years because options vest
over several years and additional awards may be granted in the future.
Under the Incentive Plan, an officer may be granted an option to purchase
shares at 100% of the grant date fair market value (110% if the optionee and
affiliates own 10% or more of the shares), payable as determined by the
Company's board of directors. An option may be granted only during the 10-year
period ending in May 2005. An optionee must exercise an option within 10 years
(five years if the optionee and affiliates own 10% or more of the shares) from
the grant date. With few exceptions, full vesting of options granted occurs at
the end of five years.
Under the Directors' Plan, shares granted do not qualify as tax-favored
incentive stock options. Directors may be granted non-qualified options to
purchase shares at 100% of the grant date fair market value. An optionee must
exercise an option within 10 years from the grant date. With few exceptions,
full vesting occurs at the end of three years.
The Company may grant options for up to 1,562,500 shares under the
Incentive Plan and 250,000 shares under the Directors' Plan. Through December
31, 2000, the Company had granted 735,851 options under these plans. Under both
plans, the option exercise price equals the stock's fair market value on the
date of grant.
A summary of the status of the plans at December 31, 2000, 1999 and 1998,
and changes during the years then ended are presented in the following table and
narrative:
2000 1999 1998
Weighted- Weighted- Weighted-
Average Average Average
Number Exercise Number Exercise Number Exercise
of Shares Price of Shares Price of Shares Price
Outstanding
at beginning
of year 526,731 $29.25 385,074 $27.78 277,347 $21.15
Granted 148,300 $31.90 162,200 32.02 134,252 42.06
Exercised 1,888 $19.56 14,623 20.70 3,231 18.77
Forfeited 22,095 $32.14 5,920 30.88 23,294 32.22
Outstanding at
end of year 651,048 $29.78 526,731 29.25 385,074 27.78
Exercisable at
end of year 280,387 $25.62 180,174 23.16 112,652 19.46
Weighted-avg
fair value of
options granted
during year $10.97 $ 9.87 $12.49
The fair market value of each option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 2000, 1999 and 1998,
respectively: risk-free interest rates of 6.4%, 5.5% and 5.7%; expected dividend
yields of 2.2%, 2.6% and 2.9%; expected lives of 10 years; and expected
volatility of 21.5%, 23.6% and 23.8%.
Information on the range of exercise prices for options outstanding as of
December 31, 2000, is as follows:
Options Outstanding Options Exercisable
Weighted-
Average Weighted- Weighted-
Outstanding Remaining Average Exercisable Average
Range of as of Contractual Exercise as of Exercise
Exercise Price 12/31/00 Life Price 12/31/00 Price
$ 0.00 - $16.88 64,689 4.1 $16.48 64,689 $16.48
$16.89 - $21.10 81,976 5.3 $18.36 70,476 $18.35
$21.11 - $29.54 88,726 6.2 $26.10 56,925 $26.15
$29.55 - $33.76 281,155 8.7 $31.77 34,415 $32.02
$33.77 - $37.98 10,625 7.8 $35.09 4,175 $35.49
$37.99 - $42.20 123,877 7.4 $41.96 49,707 $41.97
651,048 7.2 $29.78 280,387 $25.62
46
POST-RETIREMENT BENEFITS OTHER THAN PENSION
The Company does not provide post-retirement or post-employment benefits to
employees and therefore does not have any liability under FASB Statement No.
106, "Employer's Accounting for Post-retirement Benefits Other Than Pensions" or
FASB Statement No. 112, "Employers' Accounting for Post-employment Benefits."
9.>STATUTORY INFORMATION AND DIVIDEND RESTRICTIONS
The Company's insurance subsidiaries maintain their accounts in conformity with
accounting practices prescribed or permitted by state insurance regulatory
authorities that vary in certain respects from GAAP. In converting from
statutory to GAAP, typical adjustments include deferral of policy acquisition
costs, a provision for deferred federal income taxes, the inclusion of statutory
nonadmitted assets, and the inclusion of net unrealized holding gains or losses
in shareholders' equity relating to fixed maturities.
The following table includes selected information for the Company's
insurance subsidiaries as filed with insurance regulatory authorities. For 1999,
consolidated net income, statutory basis, includes the results of UIC and PIC
only from the date of acquisition, January 29, 1999.
Year ended December 31,
(in thousands) 2000 1999 1998
Consolidated net income,
statutory basis $ 14,833 $ 22,147 $ 29,404
Consolidated surplus,
statutory basis $309,945 $286,247 $314,484
Dividend payments to the Company from its principal insurance subsidiary
are restricted by state insurance laws as to the amount that may be paid without
prior notice or approval of the regulatory authorities of Illinois and
California. The maximum dividend distribution is limited by Illinois and
California law to the greater of: 10% of RLI Insurance Company's policyholder
surplus as of December 31 of the preceding year or the net income of RLI
Insurance Company for the 12-month period ending December 31 of the preceding
year. Therefore, the maximum dividend distribution that can be paid by RLI
Insurance Company during 2001 without prior notice or approval is $31.0 million
- -- 10% of RLI Insurance Company's 2000 policyholder surplus. The actual amount
paid to the Company during 2000 was $11.9 million.
10.>COMMITMENTS AND CONTINGENT LIABILITIES
The Company is involved in certain legal proceedings and disputes considered by
management to be ordinary and incidental to the business, or which have no
foundation in fact. Management believes that valid defenses exist as to all such
litigation and disputes and is of the opinion that these will not have a
material effect on the Company's financial statements.
The Company leases regional office facilities and automobiles under
operating leases expiring in various years through 2005. Minimum future rental
payments under noncancellable operating leases are as follows:
2001 $1,585,185
2002 1,417,308
2003 1,102,419
2004 743,549
2005 571,698
Total minimum future rental payments $5,420,159
11.>ACQUISITION
On January 29, 1999, RLI Insurance Company purchased Underwriters Indemnity
Holdings (UIH) for $40.7 million. The purchase was financed entirely through
short-term debt. UIH was the insurance holding company for Planet Indemnity
Company and Underwriters Indemnity Company. As a property/casualty insurance
group, these companies have combined to offer primarily surety and inland marine
coverages on commercial risks relating to the exploration, drilling, producing
and gathering activities of the oil and gas industry. Also provided to a lesser
degree were control of well and general liability insurance. The genuine value
of this operation was found almost exclusively in the surety operations. The
casualty book was considered incidental to the overall business while the
property business contained deficient premiums to an unknown extent. All
property coverages were nonrenewed in accordance with allowable policy
provisions.
The acquisition was accounted for under the purchase method of accounting
for business combinations. RLI Corp.'s 1999 financial statements include the
results of UIH's operations from January 29, 1999, through December 31, 1999.
Accounting guidance derived primarily from APB 16 regarding business
combinations dictates that the purchase price be allocated to the assets
acquired less liabilities assumed with any excess being recorded as goodwill.
The allocation of the purchase price results in goodwill of $32.0 million that
will be amortized over 20 years.
47
The table below summarizes, on a pro forma basis, the Company's
consolidated results of operations as if the purchase of UIH had taken place as
of January 1, 1998.
Years ended December 31,
(in thousands, except per share data) 1999 1998
Consolidated revenue $224,560 $175,446
Net earnings 25,489 29,490
Net earnings per share:
Basic $2.52 $2.80
Diluted $2.49 $2.77
The dilutive effect on pro forma earnings was the result of recognizing
pre-acquisition premium deficiency and reserve strengthening on the property
business. As indicated above, the Company does not intend to pursue this line of
business and consequently, does not anticipate any future earnings impact.
12.>INDUSTRY SEGMENT INFORMATION
The following table summarizes the Company's segment data as specified by
FASB Statement No. 131, "Disclosures about Segments of an Enterprise and Related
Information." As prescribed by the pronouncement, reporting is based on the
internal structure and reporting of information as it is used by Company
management.
The segments of the property/casualty operations of the Company include
property, casualty and surety. The property segment is comprised of insurance
products providing physical damage coverage for commercial and personal risks.
These risks are exposed to a variety of perils including earthquakes, fires and
hurricanes. Losses are developed in a relatively short period of time.
The casualty segment includes liability products where loss and related
settlement expenses must be estimated, as the ultimate disposition of claims may
take several years to fully develop. Policy coverage is more significantly
impacted by evolving legislation and court decisions.
The surety segment offers a selection of small- and medium-sized
commercial products related to the statutory requirement for bonds on
construction and energy-related projects. The results of this segment are
characterized by relatively low loss ratios. However, expense ratios tend to be
higher due to the high volume of transactions at lower premium levels.
The investment income segment is the by-product of the interest and
dividend income streams from the Company's investments in fixed-income and
equity securities. Interest and general corporate expenses include the cost of
debt and other director and shareholder relations costs incurred for the benefit
of the corporation, but not attributable to the operations of other segments.
Investee earnings represent the Company's share in Maui Jim, Inc. earnings. The
Company owns approximately 44% of the unconsolidated investee, which operates in
sunglass and optical goods industries.
The following table provides data on each of the Company's segments as
used by company management. The net earnings of each segment are before taxes,
and include revenues (if applicable), direct product or segment costs (such as
commissions, claims costs, etc.), as well as allocated support costs from
various overhead departments. While depreciation and amortization charges have
been included in these measures via the Company's expense allocation system, the
related assets are not allocated for management use and, therefore, are not
included in this schedule. Goodwill amortization resulting from the UIH
acquisition was allocated entirely to the surety segment.
48
Depreciation
Net Earnings Revenues and Amortization
(in thousands) 2000 1999 1998 2000 1999 1998 2000 1999 1998
Property $ 4,990 $ 17,064 $ 19,800 $ 60,063 $ 51,390 $ 52,281 $1,169 $1,047 $1,048
Casualty 3,461 (2,328) (2,292) 136,801 118,472 71,736 1,690 1,381 993
Surety 3,633 2,399 (719) 34,739 25,412 18,307 2,165 2,037 280
Net investment income 29,046 26,015 23,937 29,046 26,015 23,937 79 68 81
Realized gains 2,847 4,467 1,853 2,847 4,467 1,853
General corporate expense
and interest on debt (8,663) (6,195) (6,195) 76 112 113
Equity in earnings of
unconsolidated investee 2,979 1,613 1,337
Total segment earnings
before income taxes 38,293 43,035 37,721
Income taxes 9,600 11,584 9,482
Total $ 28,693 $ 31,451 $ 28,239 $263,496 $225,756 $168,114 $5,179 $4,645 $2,515
13.>UNAUDITED INTERIM FINANCIAL INFORMATION
Selected quarterly information is as follows:
(in thousands, except per share data) First Second Third Fourth Year
2000
Net premiums earned $53,186 $57,644 $61,251 $59,522 $231,603
Net investment income 6,937 7,085 7,461 7,563 29,046
Net realized investment gains (121) 34 604 2,330 2,847
Earnings before income taxes 8,996 9,282 9,840 10,175 38,293
Net earnings 6,540 6,962 7,380 7,811 28,693
Basic earnings per share(1) $0.66 $0.71 $0.75 $0.80 $2.92
Basic operating earnings per share(1)(2) $0.67 $0.71 $0.71 $0.64 $2.73
Diluted earnings per share(1) $0.66 $0.70 $0.74 $0.78 $2.89
Diluted operating earnings per share(1)(2) $0.67 $0.70 $0.70 $0.63 $2.70
1999
Net premiums earned $45,789 $47,672 $50,992 $50,821 $195,274
Net investment income 6,234 6,194 6,737 6,850 26,015
Net realized investment gains 23 2,235 2,265 (56) 4,467
Earnings before income taxes 8,659 12,285 11,941 10,150 43,035
Net earnings 6,578 9,021 8,471 7,381 31,451
Basic earnings per share(1) $0.63 $0.89 $0.85 $0.74 $3.11
Basic operating earnings per share(1)(2) $0.63 $0.75 $0.70 $0.75 $2.82
Diluted earnings per share(1) $0.63 $0.88 $0.84 $0.74 $3.08
Diluted operating earnings per share(1)(2) $0.63 $0.74 $0.69 $0.74 $2.79
(1)Since the weighted-average shares for the quarters are
calculated independently of the weighted-average shares
for the year, and due to the exclusion of the antidilutive
effects as discussed in note 1K, quarterly earnings per
share may not total to annual earnings per share.
(2)Operating earnings per share is calculated by reducing net
earnings by the after-tax impact of net realized
investment gains.
49
REPORT OF INDEPENDENT AUDITORS>
The board of directors and shareholders, RLI Corp.
We have audited the accompanying consolidated balance sheets of RLI Corp.
and Subsidiaries as of December 31, 2000 and 1999, and the related consolidated
statements of earnings and comprehensive earnings, shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
2000. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of RLI Corp.
and Subsidiaries at December 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2000, in conformity with accounting principles generally
accepted in the United States of America.
KPMG LLP
January 10, 2001
KPMG
Certified Public Accountants
303 East Wacker Drive
Chicago, IL 60601
Statement of Financial Reporting Responsibility>
The management of RLI Corp. and Subsidiaries is responsible for the preparation
and for the integrity and objectivity of the accompanying financial statements
and other financial information in this report. The financial statements have
been prepared in accordance with generally accepted accounting principles and
include amounts that are based on management's estimates and judgments.
The accompanying financial statements have been audited by KPMG LLP
(KPMG), independent certified public accountants, selected by the audit
committee and approved by the shareholders. Management has made available to
KPMG all the Company's financial records and related data, including minutes of
directors' meetings. Furthermore, management believes that all representations
made to KPMG during its audit were valid and appropriate.
Management has established and maintains a system of internal controls
throughout its operations that are designed to provide assurance as to the
integrity and reliability of the financial statements, the protection of assets
from unauthorized use, and the execution and recording of transactions in
accordance with management's authorization. The system of internal controls
provides for appropriate division of responsibility and is documented by written
policies and procedures that are updated by management as necessary. As part of
its audit of the financial statements, KPMG considers certain aspects of the
system of internal controls to the extent necessary to form an opinion on the
financial statements and not to provide assurance on the system of internal
controls. Management considers the recommendations of its internal auditor and
independent public accountants concerning the Company's internal controls and
takes the necessary actions that are cost effective in the circumstances to
respond appropriately to the recommendations presented. Management believes that
as of December 31, 2000, the Company's system of internal controls was adequate
to accomplish the objectives described herein.
The audit committee is comprised solely of four non-employee directors and
is charged with general supervision of the audits, examinations and inspections
of the books and accounts of RLI Corp. and Subsidiaries. The independent public
accountants and the internal auditor have ready access to the audit committee.
Jonathan E. Michael Joseph E. Dondanville, CPA
President, CEO Vice President, CFO
50
SELECTED FINANCIAL DATA
THE FOLLOWING IS SELECTED FINANCIAL DATA OF RLI CORP. AND
SUBSIDIARIES FOR THE 11 YEARS ENDED DECEMBER 31, 2000
(amounts in thousands, except per share data) 2000 1999 1998 1997 1996
OPERATING RESULTS
Gross sales $ 469,760 370,057 316,863 306,383 301,500
Total revenue $ 263,496 225,756 168,114 169,424 155,354
Net operating earnings (loss)(1) $ 26,842 28,547 27,035 28,233 25,035
Net earnings (loss) $ 28,693 31,451 28,239 30,171 25,696
Comprehensive earnings (loss)(2) $ 42,042 20,880 51,758 66,415 41,970
Net cash provided from operating activities $ 53,118 58,361 23,578 35,022 48,947
Net premiums written to statutory surplus 84% 79% 46% 54% 64%
GAAP combined ratio 94.8 91.2 88.2 86.8 87.4
Statutory combined ratio 95.8 90.1(4) 88.4 90.4 89.1
FINANCIAL CONDITION
Total investments $ 756,111 691,244 677,294 603,857 537,946
Total assets $1,281,323 1,170,363 1,012,685 911,741 845,474
Unpaid losses and settlement expenses $ 539,750 520,494 415,523 404,263 405,801
Total debt $ 78,763 78,397 39,644 24,900 46,000
Total shareholders' equity $ 326,654 293,069 293,959 266,552 200,039
Statutory surplus $ 309,945 286,247 314,484 265,526 207,787
SHARE INFORMATION
Net operating earnings (loss) per share:
Basic(3) $ 2.73 2.82 2.58 2.71 2.54
Diluted(3) $ 2.70 2.79 2.54 2.50 2.22
Net earnings (loss) per share:
Basic(3) $ 2.92 3.11 2.69 2.90 2.60
Diluted(3) $ 2.89 3.08 2.65 2.66 2.28
Comprehensive earnings (loss) per share:(2)
Basic(3) $ 4.28 2.06 4.92 6.38 4.25
Diluted(3) $ 4.23 2.04 4.87 5.76 3.62
Cash dividends declared per share $ 0.59 0.55 0.51 0.47 0.44
Book value per share $ 33.32 29.68 28.44 24.70 20.46
Closing stock price $ 44.69 34.00 33.25 39.85 26.70
Stock split 125%
Weighted average shares outstanding:
Basic(3) 9,817 10,124 10,514 10,402 9,871
Diluted(3) 9,945 10,222 10,638 11,714 12,105
Common shares outstanding 9,804 9,873 10,335 10,793 9,777
54
(amounts in thousands, except per share data) 1995 1994 1993 1992 1991 1990
OPERATING RESULTS
Gross sales 293,922 295,966 266,480 220,048 215,498 181,216
Total revenue 155,954 156,722 143,100 117,582 102,343 92,958
Net operating earnings (loss)(1) 7,648 (2,403) 14,118 15,599 15,986 14,998
Net earnings (loss) 7,950 (4,776) 15,948 16,207 16,800 14,267
Comprehensive earnings (loss)(2) 31,374 (8,513) 21,175 18,548 22,430 11,952
Net cash provided from operating activities 24,649 27,041 73,629 43,619 22,918 45,388
Net premiums written to statutory surplus 76% 108% 94% 110% 95% 112%
GAAP combined ratio 107.5 116.9 97.2 91.4 85.2 85.1
Statutory combined ratio 106.5 116.9 87.9(7) 95.8 91.6 92.2
FINANCIAL CONDITION
Total investments 471,599 413,835 401,609 281,113 237,932 213,160
Total assets 810,200 751,086 667,650 526,351 483,572 432,380
Unpaid losses and settlement expenses 418,986 394,966 310,767 268,043 244,667 235,807
Total debt 48,800 52,255 53,000 7,000 9,400 7,000
Total shareholders' equity 158,608 131,170 140,706 117,393 99,678 79,851
Statutory surplus 172,313 136,125 152,262 100,585 88,605 70,410
SHARE INFORMATION
Net operating earnings (loss) per share:
Basic(3) 0.78(5) (0.25)(5) 1.49 1.74 1.81 1.70
Diluted(3) 0.78(5) (0.25)(5) 1.42 1.74 1.81 1.70
Net earnings (loss) per share:
Basic(3) 0.81(5) (0.49)(5) 1.68(8) 1.81 1.90 1.61
Diluted(3) 0.81(5) (0.49)(5) 1.60(8) 1.81 1.90 1.61
Comprehensive earnings (loss) per share:(2)
Basic(3) 3.20(5) (0.87)(5) 2.23(8) 2.07 2.54 1.35
Diluted(3) 2.77(5)(6) (0.87)(5) 2.10(8) 2.07 2.54 1.35
Cash dividends declared per share 0.41 0.36 0.34 0.32 0.30 0.27
Book value per share 16.16 13.37 14.60 13.04 11.27 9.03
Closing stock price 20.00 13.12 16.96 15.84 10.56 9.28
Stock split 125%
Weighted average shares outstanding:
Basic(3) 9,812 9,733 9,499 8,949 8,842 8,842
Diluted(3) 9,812 9,732 10,451 8,949 8,842 8,842
Common shares outstanding 9,814 9,812 9,639 9,002 8,842 8,842
(1)For all periods presented, net operating earnings represent the Company's
net earnings reduced by after-tax realized gains. For 1993, the financial
impact of FASB Statement No. 109 has also been deducted in arriving at
operating earnings.
(2)See note 1.L to the consolidated financial statements.
(3)In July 1993, the Company issued $46.0 million of convertible debentures. In
July 1997, these securities were called for redemption. This conversion
created an additional 2.2 million new shares of RLI common stock.
(4)The statutory combined ratio presented includes the results of UIC and PIC
only from the date of acquisition, January 29, 1999.
(5)The combined effects of the Northridge Earthquake - including losses,
expenses and the reduction in revenue due to the reinstatement of reinsurance
coverages - reduced 1994 after-tax earnings by $25.0 million ($2.57 per basic
share, $2.10 per diluted share) and 1995 after-tax earnings by $18.6 million
($1.90 per basic share, $1.54 per diluted share).
(6)For 1995, diluted earnings per share on a GAAP basis were antidilutive. As
such, GAAP diluted and basic earnings per share were equal. Diluted
comprehensive earnings per share, however, were not antidilutive. The number
of diluted shares used for this calculation was 9,619.
(7)Contingent commission income recorded during 1993, from the cancellation of
a multiple-year, retrospectively-rated reinsurance contract, reduced the
statutory expense and combined ratio 10.3 points.
(8)Basic and diluted earnings per share include $.18 and $.16 per share,
respectively, from the initial application of FASB Statement No. 109
"Accounting for Income Taxes."
55
INVESTOR INFORMATION
CONTACTING RLI>
Corporate Headquarters
9025 N. Lindbergh Dr.
Peoria, IL 61615-1499
(309) 692-1000
(800) 331-4929
Fax: (309) 692-1068
www.rlicorp.com
Financial Information
For investor relations requests and management's perspective on specific issues,
contact RLI Treasurer Mike Price at (309) 693-5880 or at mprice@rlicorp.com.
For help with your shareholder account or for information about RLI stock or
dividends, call our transfer agent at (800) 468-9716.
ANNUAL MEETING>
The annual meeting of shareholders will be held at 2:00 p.m., CDT, on May 3,
2001, at the company's offices at 9025 North Lindbergh Drive, Peoria, Ill.
TRADING AND DIVIDEND INFORMATION>
Stock Price Dividends
2000 High Low Close Declared
1st Quarter $34.13 $26.50 $33.50 $.14
2nd Quarter 37.50 31.38 34.77 .15
3rd Quarter 38.75 33.75 38.38 .15
4th Quarter 44.69 37.56 44.69 .15
Stock Price Dividends
1999 High Low Close Declared
1st Quarter $33.63 $28.00 $29.25 $.13
2nd Quarter 38.81 27.88 38.75 .14
3rd Quarter 38.63 32.50 33.00 .14
4th Quarter 35.88 30.00 34.00 .14
RLI has paid and increased dividends for 24 consecutive years. RLI dividends
qualify for the enterprise zone dividend subtraction modification for Illinois
state income tax returns.
STOCK OWNERSHIP>
December 31, 2000 Shares %
Insiders 892,790 9.1
ESOP 1,265,591 12.9
Institutions & other public 7,645,581 78.0
Total Outstanding 9,803,962 100.0
RLI Common Stock Shareholders 4,168
SHAREHOLDER INQUIRIES>
Shareholders of record with requests concerning individual account balances,
stock certificates, dividends, stock transfers, tax information or address
corrections should contact the transfer agent and registrar at:
Wells Fargo Shareholder Services
P.O. Box 64854
St. Paul, MN 55164-0854
Phone: (800) 468-9716 or (651) 450-4064
Fax: (651) 450-4033
E-mail: stocktransfer@wellsfargo.com
DIVIDEND REINVESTMENT PLANS>
If you wish to sign up for an automatic dividend reinvestment and stock purchase
plan or to have your dividends deposited directly into your checking, savings or
money market accounts, send your request to the transfer agent and registrar.
REQUESTS FOR ADDITIONAL INFORMATION>
Additional copies of this report and the Annual Report to the Securities and
Exchange Commission, Form 10-K, are available without charge to any shareholder.
To have your name placed on a mailing list to receive copies of annual reports,
quarterly reports, and other shareholder materials, simply contact the treasurer
at our corporate headquarters.
56