RLI Corp. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2010. RLI is a specialty property and casualty insurer operating through casualty, property and surety segments. The financial statements are unaudited and prepared under U.S. GAAP.
Financial Results and Key Metrics
| Metric | Three months ended June 30, 2010 | Three months ended June 30, 2009 | Six months ended June 30, 2010 | Six months ended June 30, 2009 |
|---|---|---|---|---|
| Net premiums earned | $121.8 million | $122.5 million | $238.0 million | $248.2 million |
| Consolidated revenue | $142.8 million | $144.7 million | $282.1 million | $254.6 million |
| Underwriting income | $30.8 million | $25.1 million | $43.5 million | $40.3 million |
| Earnings before taxes | $52.2 million | $46.5 million | $87.0 million | $44.1 million |
| Net earnings | $35.0 million | $34.1 million | $59.2 million | $32.3 million |
| Diluted EPS | $1.65 | $1.57 | $2.78 | $1.48 |
| Combined ratio | 74.7 | 79.5 | 81.7 | 83.7 |
Approximate net earnings margins were 24.5% for the second quarter and 21.0% for the first six months. Underwriting margins were approximately 25.3% and 18.3%, respectively. The filing does not present a separate consolidated operating cash balance; the balance sheet shows cash as zero or not separately reported.
- Cash flow: Six-month operating cash flow was $35.5 million versus $61.6 million in 2009. Investing activities used $5.1 million versus $58.7 million, while financing activities used $30.4 million versus $3.0 million.
- Investments: Total investments were $1.877 billion at June 30, 2010, including $1.490 billion of fixed income, $272.8 million of equities and $113.8 million of short-term investments. The portfolio had $117.4 million of net unrealized gains at fair value.
- Debt and capital: Long-term debt was $100.0 million of senior notes due January 2014, with a 5.95% coupon. Shareholders’ equity was $858.5 million; debt represented approximately 11.6% of total capital.
- Liquidity: Approximately $172.5 million of investments and other investments matured within one year, and $359.8 million within five years. A $25.0 million revolving credit facility, potentially expandable to $50.0 million, had no borrowings outstanding and expires May 31, 2011. Management stated that liquidity was sufficient for anticipated needs over the next 12 to 24 months.
- Dividends and repurchases: The quarterly dividend was $0.29 per share, and $0.57 per share was declared for the first six months. RLI repurchased 189,375 shares for $10.6 million in the second quarter and began a new $100 million repurchase authorization.
Material Changes Versus the Prior Comparable Period
- Six-month revenue increased 11%, primarily because 2010 included $10.8 million of net realized investment gains versus $27.8 million of net realized investment losses in 2009. The 2009 period also included $45.2 million of investment impairment losses; no OTTI losses were recognized in the first half of 2010.
- Six-month net earnings increased 84%, while diluted EPS increased to $2.78 from $1.48. The second-quarter net earnings increase was modest, rising to $35.0 million from $34.1 million.
- Net premiums earned declined 4% year to date, reflecting continued casualty contraction and rate softening. Gross premiums written increased 2% to $332.3 million, driven by property and surety growth.
- Six-month gross premiums written increased 19% in property and 5% in surety, while casualty declined 11%. Property growth included $23.4 million from a new crop reinsurance program.
- Underwriting income improved 8% year to date. The group combined ratio improved to 81.7 from 83.7, primarily reflecting lower loss ratios and favorable reserve development.
- Favorable prior-year reserve development contributed $30.9 million of pretax earnings in the first half of 2010 versus $27.0 million in 2009. The 2010 benefit was partly offset by $3.5 million of Midwest and Southeast storm losses and $1.6 million to reinstate exhausted marine reinsurance coverage.
- Comprehensive earnings declined to $56.7 million from $58.7 million for the first six months and to $23.2 million from $56.9 million for the second quarter, reflecting net unrealized investment losses in 2010 compared with unrealized gains in 2009.
Outlook, Commentary, Risks and Unusual Items
- Management emphasized underwriting profitability rather than premium growth or market share. The insurance market remained soft, with competitive pricing and declining rates, particularly affecting casualty.
- Management expects casualty growth to remain challenging because of rate deterioration, reduced construction activity and the continued re-underwriting of unprofitable specialty program business.
- Property expansion includes crop reinsurance, facultative reinsurance and industry loss warranty treaties. Crop reinsurance carries higher interim estimation risk, reporting lags and reliance on the cedent’s historical experience.
- Catastrophe exposure includes earthquakes, hurricanes, storms and other natural or man-made events. RLI limits exposure through regional policy limits, reinsurance and catastrophe modeling.
- Loss reserves are inherently uncertain and depend on claims emergence, inflation, legal and regulatory developments, settlement patterns, policy terms and economic conditions. Actual losses may differ materially from recorded reserves.
- The investment portfolio was concentrated primarily in investment-grade fixed income securities; approximately 90% of fixed income securities were rated A or better. Unrealized losses were less than 1% of invested assets, and management reported no OTTI charges in 2010 through June 30.
- A proposed accounting change concerning deferred policy acquisition costs could significantly affect insurance-company results if adopted as proposed. The prospective standard’s final effective date and transition requirements were not yet settled.
- RLI adopted ASU 2010-06 concerning fair-value disclosures without a significant impact. Second-quarter shareholders approved a new Long-Term Incentive Plan authorizing up to 2.0 million shares for awards.
- Management reported no material changes in legal proceedings or risk factors, and concluded that disclosure controls were effective with no material changes to internal control over financial reporting.
Facts Investors Should Verify
- Whether favorable reserve development, particularly in casualty and surety, is sustainable or represents a nonrecurring earnings benefit.
- The adequacy of unpaid-loss reserves, including exposure to casualty, marine, surety, crop reinsurance and catastrophe losses.
- The effect of continued rate softening and declining casualty premiums on future underwriting margins.
- The cash-collection timing and ultimate profitability of the new crop reinsurance business.
- Future realized and unrealized investment gains or losses, municipal-bond exposure and the impact of low interest rates on investment income.
- The maturity and refinancing implications of the $100 million senior notes due in 2014 and the expiration of the revolving credit facility in 2011.
- The final accounting requirements for deferred acquisition costs and any resulting effect on reported earnings, deferred policy acquisition costs and equity.