RLI CORP quarterly report, Q3 FY2011

RLI Corp. 2011 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. This unaudited Form 10-Q covers the three and nine months ended September 30, 2011, compared with the corresponding 2010 periods. The April 28, 2011 acquisition of Contractors Bonding and Insurance Company (CBIC) is included from the acquisition date.

Key Financial Metrics

Metric	Q3 2011	Q3 2010	9M 2011	9M 2010
Net premiums earned	$146.6 million	$128.3 million	$393.4 million	$366.4 million
Consolidated revenue	$162.3 million	$149.6 million	$455.2 million	$431.8 million
Net earnings	$26.1 million	$28.0 million	$99.9 million	$87.2 million
Diluted EPS	$1.22	$1.33	$4.68	$4.11
Comprehensive earnings	$11.7 million	$58.4 million	$93.6 million	$115.2 million
Operating cash flow	Not separately provided	Not separately provided	$115.9 million	$87.9 million
Underwriting income	$24.7 million	$21.7 million	$89.5 million	$65.2 million
Group combined ratio	83.1%	83.1%	77.2%	82.2%

Q3 net earnings margin was approximately 16.1%, compared with 18.7% in Q3 2010. The nine-month net earnings margin was approximately 22.0%, compared with 20.2% in the prior-year period. The effective tax rate was 32% for the quarter and 33% for the nine-month period.

Q3 gross premiums written increased 17% to $184.0 million. Nine-month gross premiums written increased 10% to $537.8 million.
Nine-month segment combined ratios were 68.2% for casualty, 88.8% for property and 75.5% for surety.
At September 30, 2011, total assets were $2.79 billion, shareholders’ equity was $867.5 million and long-term debt was $100.0 million.
Debt represented approximately 10.3% of total capital. The senior notes bear interest at 5.95% and mature January 15, 2014.
Total investments were $2.02 billion, including $1.53 billion of fixed-income securities, $331.3 million of equities and $156.0 million of short-term investments.
The company reported no cash balance on the condensed cash flow statements; liquidity was primarily maintained through investments, operating cash flow and available credit facilities.
The company had no borrowings under its $25 million revolving credit facility, which could be increased to $50 million under certain conditions.
The quarterly dividend was $0.30 per share. Management reported 141 consecutive quarters of dividends and 36 consecutive years of dividend increases.

Material Changes Versus the Prior Comparable Period

Q3 revenue increased 8%, primarily because CBIC contributed $12.0 million of net premiums earned. Nine-month revenue increased 5%, with CBIC contributing $19.9 million of net premiums earned.
Q3 net earnings declined 7%, despite higher premiums, because net realized investment results declined from a $4.5 million gain to a $0.2 million loss and investment income decreased 5%.
Nine-month net earnings increased 15% and diluted EPS increased 14%, supported by higher underwriting income and favorable prior-year reserve development.
Nine-month underwriting income rose to $89.5 million from $65.2 million. Favorable prior-year reserve development contributed $92.0 million in 2011 versus $53.8 million in 2010.
Q3 favorable prior-year reserve development was $31.4 million versus $23.0 million in the prior-year quarter.
Property underwriting weakened materially in Q3, producing a $1.9 million loss and a 103.2% combined ratio, compared with $5.3 million of income and an 89.4% combined ratio in Q3 2010. Hurricane Irene and marine and crop losses were significant contributors.
Surety underwriting income declined to $2.9 million from $7.5 million in Q3. A $2.4 million increase in contract surety IBNR reserves was largely associated with claims against a single risk.
Casualty underwriting income increased to $23.8 million from $9.0 million in Q3, helped by $28.8 million of favorable reserve releases.
Other comprehensive earnings declined substantially because unrealized investment losses were $14.3 million after tax in Q3 and $6.3 million for the nine months, compared with gains of $30.5 million and $28.0 million, respectively, in the 2010 periods.
Goodwill and intangibles increased to $60.7 million from $26.2 million at year-end, primarily due to the CBIC acquisition. Total shareholders’ equity increased from $791.4 million to $867.5 million.

Guidance, Outlook, Commentary, Risks and Unusual Items

Management did not provide quantitative earnings or premium guidance. It emphasized underwriting profitability over premium growth or market share.
The insurance market remained soft, with price competition and weak economic conditions pressuring casualty growth. Management expects these conditions to continue challenging casualty premium growth.
Catastrophe exposure includes earthquakes, hurricanes, wind events, crop and hail losses, and other property perils. Following changes to catastrophe models, the company purchased additional 2011 wind reinsurance, tightened underwriting guidelines and began reducing continental wind exposure.
Q3 and nine-month 2011 results included Hurricane Irene losses of $6.5 million and $6.5 million, respectively; nine-month results also included $13.0 million of spring storm losses and $1.0 million of Japan earthquake and tsunami reserves.
Current-year adverse loss experience on marine and contract surety totaled $4.8 million in the first nine months and in Q3, according to the filing.
The company recorded $0.3 million of other-than-temporary impairment charges on equity securities during Q3 and the first nine months. No securitized fixed-income bonds were impaired.
Loss reserves are inherently uncertain and may be affected by claims emergence, inflation, legal and regulatory developments, changes in policy terms, catastrophe experience and economic conditions. Management stated that reserves at September 30, 2011 represented a reasonable provision.
The CBIC purchase price allocation remained preliminary. The valuation of value of business acquired and related tax effects were still being evaluated and could be adjusted within one year of acquisition.
Cash flow benefited from $62.0 million of customer deposits and collateral held in lieu of letters of credit. Management characterized these amounts as timing-related and expected to flow out when letters of credit are provided or collateral is released.
Management expected operating cash flow, investments and financing capacity to meet anticipated liquidity needs for the next 12 to 24 months.
No material changes to legal proceedings or risk factors were reported. Disclosure controls were considered effective; CBIC’s internal controls were excluded from the 2011 annual assessment as permitted for a recent acquisition.

Important Facts for Investors to Verify

Assess the sustainability of earnings excluding the unusually large favorable prior-year reserve development, particularly the $92.0 million recognized in the first nine months.
Monitor property and surety loss trends, including Hurricane Irene, marine, crop and single-risk contract surety exposure.
Review the final CBIC purchase accounting, including value of business acquired, goodwill, intangible assets and any subsequent adjustments.
Evaluate the effect of lower reinvestment yields, shorter portfolio duration and equity-market volatility on future investment income and book value.
Confirm the timing and eventual release of the $62.0 million of customer deposits and collateral recorded through funds held and short-term investments.
Review the January 2014 maturity of the $100.0 million senior notes and the availability of the revolving credit facility.
Consider catastrophe-model revisions, additional reinsurance costs and the company’s planned reduction in wind exposure.
Reconcile reported cash flow and liquidity because the filing reports operating, investing and financing cash flows but no cash balance on the condensed cash flow statements.