RLI Corp. 2016 Form 10-K Summary
Business Context and Reporting Period
RLI Corp. is an Illinois-based specialty property and casualty insurance holding company. Its principal subsidiaries write admitted insurance, excess and surplus lines, surety, and specialty reinsurance throughout the United States and certain territories. Operations are organized into casualty, property and surety segments, with no material foreign operations. This Form 10-K covers the fiscal year ended December 31, 2016; fourth-quarter data is included in the filing but the filing is an annual report, not a quarterly filing.
Management reported a 21st consecutive year of underwriting profitability. The company employed 943 associates at year-end and maintained strong insurer financial-strength ratings: A+ Superior from A.M. Best, A+ Strong from Standard & Poor’s, and A2 Good from Moody’s for the applicable insurance groups.
Key Financial Metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Gross premiums written | $874.9 million | $853.6 million | +2% |
| Net premiums earned | $728.6 million | $700.2 million | +4% |
| Consolidated revenue | $816.3 million | $794.6 million | +3% |
| Net earnings | $114.9 million | $137.5 million | -16% |
| Diluted EPS | $2.59 | $3.12 | -17% |
| Operating cash flow | $174.5 million | $152.6 million | +14% |
| GAAP combined ratio | 89.5% | 84.5% | 5.0 points worse |
| Underwriting income | $76.1 million | $108.6 million | -30% |
| Total investments and cash | $2.02 billion | $1.95 billion | +4% |
| Shareholders’ equity | $823.6 million | $823.5 million | Approximately flat |
| Total debt | $148.7 million | $148.6 million | Approximately flat |
Net earnings were reduced by weaker underwriting results, lower favorable reserve development, higher catastrophe losses, and a $7.2 million non-cash goodwill impairment charge related to medical professional liability. Net investment income declined to $53.1 million from $54.6 million because of lower yields and reinvestment rates. Net realized gains were $34.6 million, including equity and fixed-income gains partially offset by the goodwill impairment and other losses.
Net loss and loss adjustment expense reserves increased to $851.1 million from $805.9 million. Gross reserves were $1.14 billion, offset by $288.2 million of reinsurance recoverables. Favorable prior-year reserve development was $42.0 million in 2016, compared with $65.4 million in 2015.
Segment Performance and Material Changes
| Segment | 2016 Net Premiums Earned | 2016 Underwriting Income | 2016 Combined Ratio | 2015 Combined Ratio |
|---|---|---|---|---|
| Casualty | $454.8 million | $36.3 million | 92.0% | 88.8% |
| Property | $152.2 million | $12.8 million | 91.6% | 83.1% |
| Surety | $121.6 million | $27.0 million | 77.8% | 71.5% |
- Casualty gross premiums written increased 8%, led by commercial transportation, professional services, small commercial, healthcare liability, and new energy-related offerings. Commercial transportation experienced $15.4 million of adverse prior-year development because of worsening commercial auto loss trends.
- Property gross premiums written declined 11% amid continued rate pressure in catastrophe-exposed property lines. The company phased out recreational vehicle business and began curtailing treaty property reinsurance because of poor profitability and challenging market conditions.
- Surety gross premiums written increased 2%. Commercial surety was selectively reduced in favor of higher-quality, lower-risk accounts, while energy and contract surety experienced higher current-year losses.
- Crop reinsurance ended after the 2015 crop year, and facultative reinsurance was discontinued in 2015. These exits reduced premium volume but were not material to underwriting income.
- Catastrophe losses totaled $16.3 million in 2016, including spring storms and Hurricane Matthew, versus $12.1 million in 2015.
- The company acquired Associations Liability Insurance Agency’s assets for $1.2 million in February 2016 and recorded a $7.2 million goodwill impairment in medical professional liability. A related contingent earn-out was eliminated, reducing 2016 expenses by $1.5 million.
Cash Flow, Debt and Liquidity
- Operating cash flow was $174.5 million. Investing activities used $53.6 million, while financing activities used $113.7 million, primarily reflecting shareholder dividends.
- The company paid $122.5 million of total cash dividends in 2016, including an $87.9 million special dividend of $2.00 per share. Ordinary dividends declared were $0.79 per share.
- Long-term debt consisted of approximately $150 million of 4.875% senior notes due September 2023, carried at $148.7 million net of discount and issuance costs. Interest expense was $7.4 million.
- RLI maintained a $40 million revolving credit facility, potentially expandable to $65 million, with no borrowings outstanding. RLI Insurance Company and Mt. Hawley also had approximately $25 million of aggregate Federal Home Loan Bank borrowing capacity, with no borrowings outstanding.
- Cash, short-term investments, and investments maturing within one year totaled approximately $43.4 million. Management stated that operating cash flow, investment cash flow, and financing capacity should meet anticipated liquidity needs for the next 12 to 24 months.
- Insurance subsidiaries had statutory surplus of $860.0 million and a net premiums written-to-surplus ratio of 0.9 to 1. Management stated that capital levels exceeded all NAIC risk-based-capital action levels.
Guidance, Outlook, Risks and Unusual Items
Management expected 2017 underwriting margins to remain under pressure because of excess industry capital, competition, declining rates, higher loss trends, and more aggressive litigation. The company expected a larger casualty segment, incremental surety growth, and a smaller property segment. Management anticipated approximately $20 million of 2017 gross premium reduction from phasing out recreational vehicle and assumed specialty treaty reinsurance business, but did not expect a corresponding decline in underwriting income because those products had produced underwriting losses.
Management expected positive overall underwriting income in 2017 absent significant catastrophe events. It identified commercial auto, litigation trends, bodily injury costs, catastrophe losses, reserve adequacy, reinsurance availability and pricing, investment-market volatility, regulatory restrictions, cybersecurity, and competition as significant risks.
Catastrophe reinsurance effective January 1, 2017 provided limits of $300 million above a $25 million retention for California earthquake, $325 million above a $25 million retention for non-California earthquake, and $225 million above a $25 million retention for other perils, subject to company participation in excess layers. The filing stated that modeled 2017 catastrophe losses had a 99.6% likelihood of remaining below 8.7% of policyholders’ surplus, but actual losses could differ materially.
Legal proceedings arising in the ordinary course of insurance and corporate operations were not expected by management to have a material adverse effect. The filing reported effective disclosure controls and effective internal control over financial reporting; KPMG issued an unqualified audit opinion.
Most Important Facts to Verify
- Whether commercial auto loss trends produce further adverse reserve development, particularly in transportation.
- Whether the $851.1 million net reserve balance remains adequate as long-tail casualty claims develop.
- The sustainability of the 89.5% combined ratio as favorable prior-year reserve releases diminish.
- The profitability and execution of newer casualty products, including healthcare, energy, cyber liability, and representations and warranties coverage.
- The effect of continued property-market rate declines and the planned exits from recreational vehicle and treaty reinsurance business.
- Reinsurance recoverability, concentration among major reinsurers, and the adequacy of catastrophe limits after company co-participations.
- Holding-company liquidity and dividend capacity, given regulatory restrictions on dividends from insurance subsidiaries.
- Investment sensitivity to interest rates and equity markets: a 100-basis-point rate increase was estimated to reduce fixed-income fair value by $85.1 million, while a 10% equity-market decline was estimated to reduce equity fair value by $31.6 million.