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
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six 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 ratio | 85.5% | 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.