RLI Corp. 2011 Second-Quarter Form 10-Q Summary
Business context and reporting period
RLI Corp. is a specialty property and casualty insurer operating primarily through casualty, property and surety segments. The filing covers the three and six months ended June 30, 2011, with comparisons to the same periods in 2010. The financial statements are unaudited and prepared under U.S. GAAP.
RLI completed its $135.9 million cash acquisition of Contractors Bonding and Insurance Company (CBIC) on April 28, 2011. CBIC’s results were included from the acquisition date.
Key financial metrics
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Consolidated revenue | $156.1 million | $142.8 million | $292.9 million | $282.1 million |
| Net premiums earned | $130.8 million | $121.8 million | $246.9 million | $238.0 million |
| Net investment income | $15.2 million | $16.8 million | $31.5 million | $33.4 million |
| Net realized investment gains | $10.1 million | $4.3 million | $14.5 million | $10.8 million |
| Net earnings | $47.4 million | $35.0 million | $73.8 million | $59.2 million |
| Diluted EPS | $2.22 | $1.65 | $3.46 | $2.78 |
| Comprehensive earnings | $50.1 million | $23.2 million | $81.9 million | $56.7 million |
| Underwriting income | $45.8 million | $30.8 million | $64.8 million | $43.5 million |
| Group combined ratio | 65.0 | 74.7 | 73.8 | 81.7 |
| Operating cash flow | Not separately provided | Not separately provided | $83.9 million | $35.5 million |
Q2 net earnings represented an approximately 30.4% net margin, compared with 24.5% in the prior-year quarter. Six-month net margin was approximately 25.2%, compared with 21.0% in 2010. The reported underwriting margin, calculated as underwriting income divided by net premiums earned, was approximately 35.0% in Q2 and 26.2% for the first six months.
- Q2 gross premiums written increased 10% to $210.5 million; six-month gross premiums written increased 6% to $353.8 million.
- Six-month underwriting income increased 49% to $64.8 million. The six-month combined ratio improved to 73.8 from 81.7, primarily because of greater favorable prior-year reserve development.
- Six-month favorable prior-year reserve development contributed $60.6 million of pretax earnings, compared with $30.9 million in 2010. Q2 favorable development contributed $48.4 million, compared with $22.0 million in the prior-year quarter.
- Q2 included $13.0 million of spring storm losses. Six-month results also included $1.0 million of reserves for Japan earthquake and tsunami losses, primarily in marine coverage.
- Income tax expense was $24.0 million in Q2 and $36.5 million for the first six months. Effective tax rates were 34% and 33%, respectively.
Balance sheet, liquidity and debt
| Balance-sheet item | June 30, 2011 | December 31, 2010 |
|---|---|---|
| Total assets | $2.730 billion | $2.515 billion |
| Total investments | $1.971 billion | $1.803 billion |
| Unpaid losses and settlement expenses | $1.173 billion | $1.174 billion |
| Unearned premiums | $363.0 million | $301.5 million |
| Total liabilities | $1.866 billion | $1.723 billion |
| Shareholders’ equity | $864.4 million | $791.4 million |
| Long-term debt | $100.0 million | $100.0 million |
- Invested assets increased $167.7 million from year-end, with short-term investments rising to $173.9 million from $39.8 million.
- The investment portfolio was primarily investment grade: fixed income represented 74.5% of stated investment value, equities 16.7%, and short-term investments 8.8%. Fixed-income duration was 4.4 years and the average rating was AA.
- Cash flow statements report no cash balance; liquidity is managed through operating cash flow, investments, a $25 million revolving credit facility that can increase to $50 million under specified conditions, and other financing capacity.
- Operating cash flow was $83.9 million, while investing cash flow was negative $75.1 million, including the CBIC acquisition. Financing cash flow was negative $8.8 million.
- Total debt was approximately $100.3 million, including $100.0 million of senior notes maturing in January 2014 and $0.3 million of CBIC short-term debt. No amounts were outstanding under the revolving credit facility.
- RLI paid a quarterly dividend of $0.30 per share and repurchased 47,100 shares for $2.8 million during Q2. Approximately $91.3 million remained under the repurchase program.
Material changes versus the prior comparable period
- Revenue increased 9% in Q2 and 4% for the first six months, driven by premium growth, CBIC, crop reinsurance and other newer products.
- Net earnings increased 35% in Q2 and 25% for the first six months, with significant contributions from favorable reserve development and realized investment gains.
- Net investment income declined 9.5% in Q2 and 5.6% for the first six months because of lower interest rates and the acquisition of lower-yielding, shorter-duration CBIC bonds. Approximately 60% of the acquired CBIC fixed-income portfolio had been sold and reinvested in higher-yielding securities by June 30.
- Casualty six-month gross premiums written declined 3%, while property increased 15% and surety increased 14%. The casualty combined ratio improved to 72.1 from 88.0; property was 79.1 versus 78.8; and surety was 67.3 versus 68.7.
- CBIC contributed $7.9 million of net premiums earned in the first six months and was approximately break-even during Q2, with a $0.2 million underwriting loss and $0.3 million of net investment income.
- Goodwill and intangibles increased by $30.3 million from year-end, reflecting CBIC goodwill and identifiable intangible assets. The purchase accounting analysis remained preliminary and could be adjusted during the one-year measurement period.
- Unrealized investment losses declined to $10.6 million at June 30 from $15.1 million at December 31, 2010. No OTTI losses were recognized in the periods presented.
Outlook, management commentary, risks and unusual items
- Management stated that the insurance marketplace remained soft, with pricing pressure and a weak economy particularly affecting casualty business. The company emphasized underwriting profitability rather than premium growth or market share.
- A catastrophe-model revision increased modeled hurricane loss potential and caused certain risk tolerances to be exceeded. RLI purchased additional 2011 wind reinsurance, modified underwriting guidelines and began reducing continental wind exposure with the goal of returning exposures within risk tolerance before year-end.
- Key insurance risks include catastrophe losses, casualty reserve uncertainty, inflation, legal and regulatory changes, adverse claims development, reinsurance recoverability and economic conditions affecting surety customers.
- Management believes June 30 loss reserves were reasonable, but acknowledges that actual ultimate losses may differ materially from estimates. Casualty and crop reserves carry comparatively high estimation uncertainty.
- The company expects operating cash flows, investment liquidity and financing capacity to meet anticipated needs over the next 12 to 24 months. A $50 million customer cash deposit temporarily increased operating cash flow and funds held; management expected the amount to flow out in the following quarter when the customer supplied a customary letter of credit.
- Management reported no material changes in legal proceedings or risk factors and concluded that disclosure controls were effective. CBIC’s internal controls were excluded from the 2011 annual assessment while integration activities continued.
- No specific earnings, premium or combined-ratio guidance was provided in the filing.
Important facts for investors to verify
- How much of the earnings increase is sustainable underwriting performance versus unusually high favorable prior-year reserve releases.
- Whether casualty pricing pressure, targeted re-underwriting and the planned reduction in wind exposure affect future premium volume and margins.
- Final CBIC purchase accounting, including the valuation of VOBA, acquired agency relationships, intangible assets and related tax effects.
- Subsequent development of spring storm, Japan earthquake, hurricane and other catastrophe reserves.
- Future investment income after repositioning the CBIC portfolio and continued exposure to interest-rate and equity-market movements.
- The timing of repayment or replacement of the $50 million customer deposit and any resulting effect on operating cash flow and funds held.
- Refinancing or repayment plans for the $100 million senior notes due in January 2014, together with restrictions on dividends from the principal insurance subsidiary.