RLI Corp. 2013 Form 10-K Summary
Business context and reporting period
RLI Corp. is a specialty property and casualty insurer operating primarily through four U.S. insurance subsidiaries. Its businesses span specialty admitted insurance, excess and surplus lines, property reinsurance, casualty, property and surety coverage. The filing covers the fiscal year ended December 31, 2013; quarterly information identifies fourth-quarter 2013 net earnings of $33.9 million and diluted EPS of $0.77.
Gross premiums written were generated primarily in the United States. Casualty represented the principal growth engine, while property and surety remained comparatively stable. RLI employed 870 associates at year-end.
Key financial metrics
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Gross premiums written | $843.2 million | $784.8 million | +7% |
| Net premiums earned | $630.8 million | $576.6 million | +9% |
| Consolidated revenue | $705.6 million | $660.8 million | +7% |
| Net earnings | $126.3 million | $103.3 million | +22% |
| Diluted EPS | $2.90 | $2.39 | +21% |
| Underwriting income | $106.8 million | $63.6 million | +68% |
| GAAP combined ratio | 83.1 | 89.0 | Improved 5.9 points |
| Net operating cash flow | $135.0 million | $36.2 million | Increased substantially |
| Total investments and cash | $1.92 billion | $1.84 billion | +4% |
| Total assets | $2.74 billion | $2.64 billion | +4% |
| Shareholders’ equity | $829.0 million | $796.4 million | +4% |
| Statutory surplus | $859.2 million | $684.1 million | +26% |
Net earnings benefited from stronger underwriting, favorable prior-year reserve development and a benign catastrophe year. Pretax earnings were $175.7 million, and the effective tax rate was 28.1%. Net investment income declined 10% to $52.8 million as reinvestment yields remained below portfolio averages, while net realized investment gains were $22.0 million.
The $1.9 billion investment portfolio was approximately 75% fixed income and 22% equities at fair value. The fixed-income portfolio had an average duration of 5.0 years; 88% of fixed-income investments were rated A or better. No other-than-temporary impairment losses were recorded in 2013.
Segment performance and material changes
| Segment | 2013 gross premiums written | 2013 underwriting income | 2013 combined ratio | Key change |
|---|---|---|---|---|
| Casualty | $457.0 million | $55.6 million | 82.8 | Premiums +17%; growth in umbrella, transportation and professional services |
| Property | $272.7 million | $27.6 million | 86.2 | Premiums -3%; improved from lower catastrophe activity |
| Surety | $113.5 million | $23.6 million | 77.9 | Premiums essentially flat; competitive pressure increased |
- Casualty net premiums earned increased to $324.0 million from $267.7 million. Commercial and personal umbrella, transportation, professional services and package products drove growth. RLI reduced exposure to underperforming habitational general liability business, reducing its share of the general liability book from approximately 50% in 2012 to approximately 25% at year-end 2013.
- Property net premiums earned were $200.1 million, broadly flat with 2012. Crop reinsurance and recreational vehicle coverage grew, but property reinsurance, marine and other property declined because of competition and underwriting actions.
- Surety net premiums earned were $106.6 million, also broadly flat. Underwriting income declined from $26.5 million to $23.6 million as favorable reserve development moderated and competition increased.
- Prior accident-year reserves developed favorably by $72.5 million in 2013, compared with $64.6 million in 2012 and $110.1 million in 2011. Net unpaid losses and LAE declined to $774.5 million from $798.6 million.
- RLI issued $150.0 million of senior notes due September 2023 at 4.875% interest and redeemed its $100.0 million of notes due January 2014. Year-end debt was $149.6 million, or approximately 15% of total capital.
- RLI paid a $64.5 million special dividend, or $1.50 per share, in December 2013, compared with $106.3 million, or $2.50 per share, in 2012. Ordinary dividends declared increased to $0.67 per share from $0.63.
Liquidity, capital and cash flow
- Operating cash flow was $135.0 million, compared with $36.2 million in 2012. Investing cash flow was a use of $101.9 million, largely reflecting purchases of fixed-income investments and property and equipment. Financing cash flow was a use of $37.9 million after debt refinancing and dividends.
- Cash, short-term investments and investments maturing within one year totaled approximately $74.8 million at year-end; an additional $170.5 million matured within one to five years.
- The company had $32.0 million of liquid assets at the holding company, approximately equal to annual holding-company expenditures, and no borrowings under its $25.0 million revolving credit facility. Management stated that operating cash flow, investment cash flow and financing capacity should meet anticipated needs for the next 12 to 24 months.
- The principal insurance subsidiary paid $40.0 million of ordinary dividends to RLI Corp. in 2013. Approximately $92.7 million of its net assets were available for ordinary dividends without prior regulatory approval at year-end, subject to applicable statutory limits.
- Insurance financial strength ratings were affirmed at A+ by A.M. Best for the principal group and CBIC, A+ by Standard & Poor’s for RLI Insurance and Mt. Hawley, and A2 by Moody’s for the principal group.
Outlook, management commentary and risks
Management expected moderate organic premium growth in 2014, with greater growth from recreational vehicle, professional services and package products. It expected underwriting income to continue absent unusual catastrophe events, but cautioned that 2013’s results would be difficult to replicate because catastrophe activity was unusually light.
- Pricing improvements since late 2011 were expected to moderate or reverse as excess capital and alternative reinsurance capacity increased competition.
- Management expected falling property prices, particularly in Florida wind and California earthquake markets, and did not expect meaningful growth in catastrophe exposures.
- Casualty growth was expected to continue, but weak economic conditions, limited rate increases and investment in new products could constrain margin improvement.
- Surety was expected to have a flat top line as competition, higher commissions and looser market terms pressured underwriting discipline.
- Investment income was expected to be approximately flat year over year, with rising yields providing only a gradual benefit.
- Major risks include catastrophe losses, adverse loss-reserve development, environmental and asbestos liabilities, reinsurance-collectability risk, investment and interest-rate volatility, competition, regulatory restrictions and the availability of dividends from insurance subsidiaries.
- Modeled catastrophe losses are inherently uncertain. Under the January 1, 2014 catastrophe program, management estimated a 99.6% likelihood that a single event loss would be below 8% of year-end 2013 policyholders’ surplus.
- Reserve estimates remain judgmental and sensitive to loss emergence, expected loss ratios and actual claims activity. For general liability, the filing illustrates potential reserve changes of approximately $37.7 million favorable to $38.8 million unfavorable under simultaneous adverse or favorable assumption changes.
Important facts for investors to verify
- Whether favorable prior-year reserve development of $72.5 million and unusually low catastrophe losses can be sustained or are masking underlying current-year trends.
- The effect of increasing competition and alternative capital on renewal pricing, reinsurance costs and catastrophe exposure.
- The performance and reserve adequacy of rapidly growing casualty products, including professional services, medical professional liability, transportation and package business.
- The sensitivity of investment income, accumulated other comprehensive income and shareholders’ equity to higher interest rates and equity-market declines.
- The collectability and concentration of reinsurance recoverables, which totaled approximately $362.1 million including prepaid premiums and recoverables; nearly 95% was due from reinsurers rated A or better.
- Regulatory limits on dividends from insurance subsidiaries and the adequacy of holding-company liquidity for debt service, corporate expenses and shareholder distributions.
- The filing’s stated legal conclusion that ordinary-course litigation and insurance claims are not expected to have a material adverse effect, while recognizing that actual outcomes and reserve estimates may differ materially.