RLI Corp. 10-Q Summary: Third Quarter 2014
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 Form 10-Q covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods. The interim financial statements are unaudited.
Key Financial Metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net premiums earned | $177.7 million | $163.7 million | $507.5 million | $462.4 million |
| Consolidated revenue | $197.7 million | $188.3 million | $571.9 million | $520.2 million |
| Underwriting income | $30.4 million | $31.8 million | $79.5 million | $77.2 million |
| Net earnings | $33.3 million | $37.6 million | $97.9 million | $92.4 million |
| Diluted EPS | $0.76 | $0.86 | $2.24 | $2.13 |
| Comprehensive earnings | $20.9 million | $35.7 million | $123.3 million | $74.5 million |
| GAAP combined ratio | 82.9 | 80.5 | 84.3 | 83.3 |
| Operating cash flow | Not separately provided | Not separately provided | $85.9 million | $81.7 million |
Q3 net earnings margin was approximately 16.8% of consolidated revenue, compared with approximately 20.0% in the prior-year quarter. The nine-month net earnings margin was approximately 17.1%, compared with approximately 17.8% in 2013.
- Q3 net premiums earned increased 9%; nine-month premiums increased 10%.
- Gross premiums written increased 3% in both Q3 and the first nine months, to $207.8 million and $669.4 million, respectively.
- Q3 underwriting income declined 4%, primarily because favorable prior-year reserve development was $15.3 million versus $19.7 million in the prior-year quarter.
- Nine-month underwriting income increased 3%, despite a lower favorable reserve-development benefit of $60.3 million versus $63.4 million in 2013.
- Net investment income increased 4% in Q3 and 6% for the nine months, while realized investment gains declined in Q3 to $5.7 million from $11.0 million but increased for the nine months to $22.6 million from $18.4 million.
- Effective tax rates were approximately 32% in both comparable Q3 periods and 32% for the first nine months of 2014 versus 31% in 2013.
Segment Performance
| Segment | 9M 2014 Premiums Earned | 9M 2014 Underwriting Income | 9M 2014 Combined Ratio | 9M 2013 Combined Ratio |
|---|---|---|---|---|
| Casualty | $281.5 million | $36.3 million | 87.1 | 83.2 |
| Property | $146.3 million | $19.5 million | 86.7 | 86.6 |
| Surety | $79.7 million | $23.7 million | 70.2 | 77.4 |
Casualty drove premium growth but experienced weaker underwriting results because reserve releases were lower than in 2013. Surety improved materially, benefiting from favorable reserve development and solid current accident-year performance. Property underwriting income was broadly stable.
Balance Sheet, Debt and Liquidity
- Total assets were $2.93 billion at September 30, 2014, versus $2.74 billion at December 31, 2013.
- Total investments and cash were $2.06 billion, including $1.55 billion of fixed-income securities, $419.0 million of equity securities and $77.0 million of cash.
- Shareholders’ equity increased to $933.5 million from $829.0 million, primarily reflecting net earnings and positive accumulated other comprehensive earnings.
- Long-term debt was $149.6 million, consisting primarily of senior notes maturing in 2023 with a 4.875% coupon. Debt represented 13.8% of total capital.
- Operating cash flow was $85.9 million for the first nine months. Cash increased to $77.0 million from $39.5 million at year-end 2013.
- Cash, short-term investments and investments maturing within one year totaled approximately $105.6 million; an additional $269.8 million matured within one to five years.
- The company had a $40.0 million revolving credit facility, expandable to $65.0 million under specified conditions, with no borrowings outstanding. Insurance subsidiaries also had access to Federal Home Loan Bank of Chicago liquidity, with no outstanding borrowings.
- Management stated that operating cash flow, investments and financing sources should be sufficient for anticipated needs over the next 12 to 24 months.
- The quarterly dividend was $0.18 per share. RLI reported 153 consecutive quarters of dividends and 39 consecutive years of dividend increases.
Material Changes, Outlook and Unusual Items
- Competitive conditions intensified, with softer reinsurance pricing and generally flat or declining rates in several property and surety lines. Management emphasized underwriting discipline over premium growth.
- RLI received provisional cancellation notices affecting the largest portion of its assumed crop business and a 50% reduction in remaining coverage. Crop premiums are expected to fall to less than $10 million in 2015 from approximately $50 million through the first nine months of 2014; management expects minimal underwriting-income impact.
- Spring storm losses were $7.3 million for the first nine months of 2014 versus $10.0 million in 2013. Hurricane Iselle and the American Canyon earthquake had less than $0.5 million of impact on 2014 accident-year results.
- Reserve releases materially supported results: $60.3 million of favorable prior-year development in the first nine months and $18.0 million in Q3. Such development may not recur.
- The company invested $5.3 million for a 20% interest in Prime Holdings Insurance Services and entered into a 25% quota-share treaty. Prime contributed $0.4 million of equity-method earnings and $7.4 million of assumed premiums during the first nine months.
- RLI early adopted ASU 2014-01 for qualified affordable housing investments and recorded a $9.9 million balance in a low-income housing tax credit partnership at quarter-end.
- Unrealized investment gains contributed $25.3 million to nine-month comprehensive earnings, while Q3 included a $12.4 million unrealized loss, primarily from the equity portfolio.
- No other-than-temporary impairment losses were recorded on the fixed-income or equity portfolios during the periods presented. Investment portfolio unrealized losses were reported at 0.3% of total invested assets.
- No material changes to reported risk factors were identified. Management stated that disclosure controls were effective and that no material changes affected internal control over financial reporting.
Risks and Contingencies
- Insurance results remain exposed to reserve-estimation uncertainty, casualty claim development, inflation, litigation, regulatory changes, catastrophes and adverse economic conditions affecting insureds.
- Property exposures include earthquakes, hurricanes, fires and crop-related weather losses. RLI manages catastrophe exposure through underwriting limits, reinsurance and modeling.
- Investment results are sensitive to equity prices, interest rates and credit quality. The fixed-income portfolio had a 4.6-year duration and an average rating of AA; approximately 85% was rated A or better.
- A putative shareholder class action and derivative lawsuit filed in July 2014 challenges adjustments to stock-option exercise prices following extraordinary dividends paid in 2011–2013. The action seeks, among other relief, shareholder voting and attorney fees, but not monetary damages. Management expects no material adverse effect, although the outcome is uncertain.
- Dividends from insurance subsidiaries to the holding company are subject to Illinois insurance-law restrictions. RLI Insurance Company paid $50.0 million of ordinary dividends to RLI Corp. during the first nine months of 2014, and $155.9 million of its net assets were identified as available for ordinary distribution at September 30.
Most Important Facts for Investors to Verify
- Whether the unusually large favorable reserve development continues or normalizes in subsequent periods.
- The earnings and capital impact of the crop-business cancellations expected in 2015.
- Casualty pricing, loss trends and the sustainability of the 87.1 combined ratio.
- Surety reserve quality and whether the 70.2 combined ratio reflects recurring performance or exceptional development.
- Exposure to equity-market declines and interest-rate changes within the $2.1 billion investment portfolio.
- Progress and potential costs of the stock-option litigation.
- Availability of insurance-subsidiary dividends and holding-company liquidity for debt service and shareholder dividends.