RLI CORP quarterly report, Q2 FY2016

Business Context and Reporting Period

RLI Corp. is a specialty property and casualty insurer operating through casualty, property and surety segments in admitted and excess-and-surplus markets. This unaudited Form 10-Q covers the three and six months ended June 30, 2016, compared with the corresponding 2015 periods.

Financial Performance and Position

MetricQ2 2016Q2 2015Six months 2016Six months 2015
Net premiums earned$180.2 million$172.3 million$357.1 million$341.3 million
Consolidated revenue$196.0 million$190.6 million$397.7 million$386.4 million
Underwriting income$26.0 million$34.8 million$47.3 million$52.5 million
Combined ratio85.5%79.8%86.7%84.6%
Net earnings$29.1 million$37.2 million$60.5 million$67.8 million
Diluted EPS$0.65$0.84$1.36$1.54
Comprehensive earnings$48.1 million$12.3 million$101.3 million$35.3 million
  • Approximate net earnings margin was 14.8% in Q2 2016 versus 19.5% in Q2 2015, and 15.2% for the first six months versus 17.5% in the prior-year period.
  • Premium growth was led by casualty and surety. Six-month gross written premiums increased 2% to $446.9 million; casualty rose 8% and surety 5%, while property declined 14%.
  • Six-month underwriting income represented approximately 13.2% of net premiums earned, compared with 15.4% in 2015. The Q2 underwriting margin was approximately 14.4%, compared with 20.2%.
  • Net investment income declined 2% for the first six months to $26.4 million, reflecting the lower yield environment. Net realized gains were $14.1 million, including a $7.2 million non-cash goodwill impairment charge.
  • Operating cash flow was $69.6 million for the first six months, compared with $71.1 million in 2015. Investing cash flow used $39.8 million and financing cash flow used $11.2 million, producing an $18.6 million increase in cash.
  • At June 30, 2016, total assets were $2.89 billion, shareholders’ equity was $913.5 million, and total investments and cash were $2.10 billion. Cash and short-term investments totaled $43.1 million.
  • Long-term debt was $148.6 million, consisting primarily of senior notes due in 2023 with a 4.875% coupon. Debt represented approximately 14% of total capital. No borrowings were outstanding under the $40 million revolving credit facility or the Federal Home Loan Bank facility.
  • The investment portfolio was allocated approximately 77.7% to fixed income, 19.0% to equities, 1.2% to other invested assets and 2.1% to cash and short-term investments. Fixed-income duration was 5.0 years and the portfolio’s average rating was AA-.
  • The quarterly dividend was $0.20 per share, up $0.01 from the prior quarter. RLI reported 160 consecutive quarters of dividends and 41 consecutive years of dividend increases.

Material Changes Versus the Prior Comparable Period

  • Revenue increased 3% in both the quarter and first six months, primarily from higher premiums, but net earnings declined 22% in Q2 and 11% for the first six months.
  • Underwriting profitability weakened: the consolidated combined ratio increased to 85.5% from 79.8% in Q2 and to 86.7% from 84.6% for the first six months. The primary driver was less favorable prior-year reserve development, partly offset by lower storm losses.
  • Prior-year reserve development contributed $17.3 million of pretax earnings in Q2 2016 versus $35.5 million in Q2 2015, and $29.8 million for the first six months versus $43.5 million.
  • Casualty underwriting income declined to $20.2 million for the first six months from $24.5 million, and its combined ratio worsened to 90.8% from 87.8%. Property underwriting income increased modestly to $13.4 million, while its combined ratio improved to 82.5% from 84.4%. Surety underwriting income declined to $13.6 million and its combined ratio worsened to 77.2% from 73.8%.
  • Comprehensive earnings increased substantially because other comprehensive income shifted to a $40.8 million after-tax unrealized gain from a $32.5 million loss in 2015, primarily due to lower interest rates and stronger equity prices.
  • Medical professional liability goodwill was impaired by $7.2 million after premium declines and adverse loss experience triggered a fair-value review. The related contingent earn-out liability was revalued, reducing quarterly expense by $0.8 million.
  • RLI acquired the assets of Associations Liability Insurance Agency, Inc. for $1.2 million, including $0.9 million paid in cash and a $0.3 million contingent earn-out value.
  • The company exited crop and facultative reinsurance businesses, contributing to the property premium decline. No shares were repurchased during 2016; $87.5 million remained under the repurchase authorization.

Outlook, Commentary, Risks and Unusual Items

  • Management emphasized underwriting profitability over premium growth, citing intense competition, alternative capital and soft pricing, particularly in excess-and-surplus property markets.
  • RLI stated that operations have generated underwriting profit for 20 consecutive years, but results remain exposed to catastrophe losses, reserve-estimation uncertainty, pricing competition, economic conditions, regulation, court decisions and changes in law.
  • Casualty claims have long development periods and are exposed to inflation, legislation and litigation trends. Property results are sensitive to earthquakes, hurricanes, windstorms, fires and other catastrophes; RLI identifies earthquake exposure, including on the West Coast, as its largest catastrophe exposure.
  • Storm losses were $4.0 million in Q2 and $4.3 million for the first six months, compared with $7.4 million and $7.4 million, respectively, in the prior-year periods as presented in management’s discussion.
  • Investment risks include equity-price risk, interest-rate risk, issuer credit risk and limited foreign-currency and commodity exposure. Unrealized gains can materially affect comprehensive income and book value without immediately affecting net earnings.
  • Management expected operating cash flow and investments to provide sufficient liquidity for the next 12 to 24 months. Holding-company liquidity included approximately $60 million of unrestricted liquid assets versus estimated annual holding-company expenditures of approximately $45 million.
  • Dividends from the principal insurance subsidiary are subject to Illinois insurance-law limitations. RLI Insurance paid $26.4 million of ordinary dividends to RLI Corp. in the first six months of 2016, and $51.8 million of its net assets were available for ordinary dividends at June 30, 2016.
  • Management reported no material changes in legal proceedings or risk factors, and concluded that disclosure controls and procedures were effective.

Facts Investors Should Verify

  • Reconcile the reported $14.1 million of six-month net realized gains with the $7.2 million goodwill impairment charge and underlying investment gains.
  • Assess whether reduced favorable reserve development, particularly in casualty and surety, continues to pressure combined ratios.
  • Monitor medical professional liability premium trends, adverse loss development and any further goodwill or earn-out valuation changes.
  • Evaluate property premium declines following the exits from crop and facultative reinsurance and continuing excess-and-surplus pricing pressure.
  • Track interest rates, investment yields, equity-market performance and the resulting volatility in comprehensive income and shareholders’ equity.
  • Review statutory capital, dividend capacity and restrictions on upstreaming funds from insurance subsidiaries to the holding company.
  • Confirm the effects and implementation timing of the prospective accounting standards discussed in the filing, including insurance disclosures, financial instruments, leases, stock compensation and credit losses.