RLI Corp. 2012 Third-Quarter Form 10-Q Summary
Business Context and Reporting Period
RLI Corp. is a specialty property and casualty insurer operating through casualty, property and surety segments. The filing covers the three and nine months ended September 30, 2012, compared primarily with the corresponding 2011 periods. Results include Contractors Bonding and Insurance Company (CBIC), acquired in April 2011.
Key Financial Metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Net premiums earned | $149.9 million | $146.6 million | $428.8 million | $393.4 million |
| Consolidated revenue | $169.6 million | $162.3 million | $489.4 million | $455.2 million |
| Net earnings | $25.5 million | $24.0 million | $78.2 million | $96.7 million |
| Diluted EPS | $1.19 | $1.12 | $3.64 | $4.53 |
| Underwriting income | $18.5 million | $21.5 million | $55.1 million | $84.6 million |
| Combined ratio | 87.7% | 85.3% | 87.1% | 78.5% |
| Operating cash flow | Not separately provided | Not separately provided | $13.2 million | $115.9 million |
Q3 net margin was approximately 15.0%, compared with approximately 14.8% in Q3 2011. Nine-month net margin was approximately 16.0%, compared with approximately 21.2% in the prior-year period. Comprehensive earnings were $46.5 million in Q3 and $116.0 million for the first nine months, benefiting from unrealized investment gains.
- Gross premiums written increased 6% in Q3 to $195.9 million and 12% for the first nine months to $601.8 million.
- Q3 segment underwriting income was $10.8 million for casualty, a $0.3 million loss for property, and $8.0 million for surety.
- For the first nine months, underwriting income was $22.4 million for casualty, $11.3 million for property, and $21.4 million for surety.
- Net investment income declined 11% in Q3 to $14.2 million and 7% for the first nine months to $44.3 million because of lower reinvestment rates and increased allocation to tax-exempt municipal securities.
- Net realized investment gains were $5.5 million in Q3 and $16.2 million for the first nine months. The nine-month amount includes a $1.2 million second-quarter OTTI charge on equity securities.
- At September 30, total assets were $2.75 billion, shareholders’ equity was $894.4 million, and investments and cash totaled $2.0 billion.
- Cash was $31.3 million, while short-term investments were $82.2 million. Long-term debt was unchanged at $100.0 million, consisting of senior notes maturing in January 2014.
Material Changes Versus the Prior Comparable Period
- Revenue grew, primarily from premium growth across all segments and the inclusion of a full nine months of CBIC operations versus five months in 2011.
- Net earnings declined 37% for the first nine months despite higher revenue. The primary driver was lower favorable prior-year reserve development: $58.4 million in 2012 versus $92.0 million in 2011.
- Q3 favorable reserve development was $20.5 million, down from $31.4 million in Q3 2011.
- Loss experience included $15.0 million of spring storm losses and $5.0 million of Hurricane Isaac losses during the first nine months, along with adverse 2012 crop reinsurance experience from drought conditions.
- The nine-month group combined ratio worsened to 87.1% from 78.5%, principally because the loss ratio increased to 45.1% from 36.1%. The expense ratio improved modestly to 42.0% from 42.4%.
- Surety improved materially, with its nine-month combined ratio declining to 73.2% from 78.7%. Casualty weakened to 88.6% from 69.2%, while property increased to 92.6% from 89.4%.
- Operating cash flow fell to $13.2 million from $115.9 million, primarily because a $50.0 million collateral balance held on a commercial surety account was returned and replaced by a letter of credit.
- Shareholders’ equity increased from $792.6 million at December 31, 2011 to $894.4 million at September 30, 2012, aided by comprehensive earnings. The company declared quarterly dividends of $0.32 per share, up from $0.30 in Q3 2011.
Outlook, Risks, Contingencies and Unusual Items
Management stated that its principal objective remains underwriting profitability rather than premium growth or market share. Management reported signs of stabilizing or improving pricing in selected lines, but characterized the insurance market as generally competitive and soft.
- Property results remain exposed to hurricanes, earthquakes, storms, crop losses and other catastrophe events. The company initiated price increases and exited unprofitable inland marine and cargo accounts, and exited the marine yacht business because of adverse loss experience.
- Loss reserves are inherently uncertain, particularly in casualty business, and may develop favorably or unfavorably as claims mature. Management believes reserves at September 30, 2012 provide a reasonable provision, but actual ultimate losses may differ materially.
- Reinsurance recoverables totaled $336.6 million and remain subject to reinsurer credit risk and estimation risk.
- The investment portfolio had a fair value of approximately $2.0 billion, including $402.1 million of equities, creating exposure to equity prices, interest rates, credit quality and unrealized volatility. Unrealized losses were less than 1% of invested assets at quarter-end.
- Liquidity was described as sufficient for expected needs over the next 12 to 24 months. The company had approximately $110.6 million of investments maturing within one year, an undrawn $25.0 million revolving credit facility that could be increased to $50.0 million under specified conditions, and additional reverse-repurchase capacity.
- The $100.0 million senior notes mature in January 2014. Debt represented approximately 10.1% of total capital at September 30, 2012.
- Dividend payments from RLI Insurance Company are subject to Illinois insurance-law restrictions. Management stated that more than $1.0 million in additional dividends before December 15, 2012 would require regulatory approval.
- The company adopted new deferred policy acquisition cost guidance retrospectively. Adoption reduced December 31, 2011 shareholders’ equity by $26.2 million, net of tax, and reduced book value by $1.24 per share.
- No material changes were reported in legal proceedings or risk factors. Management concluded that disclosure controls and procedures were effective.
Important Facts for Investors to Verify
- Whether favorable reserve development continues at the reduced 2012 level and whether casualty reserves experience adverse development.
- The ultimate severity of spring storms, Hurricane Isaac and drought-related crop losses, including the final settlement of the 2011 crop treaty year.
- Whether pricing improvements and account exits offset ongoing competition and expense pressure.
- The liquidity and refinancing plan for the $100.0 million of senior notes maturing in January 2014.
- The effect of lower reinvestment yields and the 21% equity allocation on future investment income, realized gains and book value.
- The availability of dividends from the insurance subsidiary under Illinois regulatory limits.
- The effect of retrospective acquisition-cost accounting on reported trends, book value and comparability with prior periods.