RLI Corp. 2017 Second-Quarter Form 10-Q Summary
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. The filing covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods. Financial statements are unaudited.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net premiums earned | $184.3 million | $180.2 million | $367.6 million | $357.1 million |
| Consolidated revenue | $196.2 million | $196.0 million | $393.1 million | $397.7 million |
| Net earnings | $26.2 million | $29.1 million | $46.0 million | $60.5 million |
| Diluted EPS | $0.59 | $0.65 | $1.03 | $1.36 |
| Comprehensive earnings | $36.8 million | $48.1 million | $68.4 million | $101.3 million |
| Operating cash flow | Not separately provided | Not separately provided | $74.6 million | $69.6 million |
| Underwriting income | $19.7 million | $26.0 million | $32.8 million | $47.3 million |
| Combined ratio | 89.3 | 85.5 | 91.1 | 86.7 |
Q2 net earnings margin was approximately 13.4%, compared with 14.8% in the prior-year quarter. Six-month net earnings margin was approximately 11.7%, compared with 15.2% in the prior-year period. The lower margins primarily reflected weaker underwriting results and lower realized investment gains.
- Gross premiums written declined 3.9% in Q2 to $240.9 million and 2.5% for the six months to $435.8 million. Net premiums earned increased 2.3% in Q2 and 2.9% for the six months.
- Six-month underwriting income declined 31% to $32.8 million. The combined ratio increased to 91.1 from 86.7, driven by a higher loss ratio of 50.0 versus 45.2; the expense ratio improved modestly to 41.1 from 41.5.
- Q2 underwriting income declined to $19.7 million, and the combined ratio increased to 89.3 from 85.5. The loss ratio rose to 49.0 from 44.5, while the expense ratio improved to 40.3 from 41.0.
- Net investment income was $13.2 million in Q2, up 1.5%, but declined 0.7% for the six months to $26.2 million.
- Six-month realized gains and losses changed to a $0.7 million net loss from a $14.1 million gain in 2016. Q2 produced a $1.4 million net loss versus a $2.7 million gain.
- Equity in earnings of unconsolidated investees increased to $6.8 million in Q2 and $11.7 million for the six months, from $5.2 million and $8.9 million, respectively.
Balance sheet, debt and liquidity
- Total assets were $2.88 billion at June 30, 2017, up from $2.78 billion at December 31, 2016. Shareholders’ equity was $877.7 million, up from $823.6 million.
- Investments and cash totaled $2.10 billion, including $1.65 billion of fixed income securities, $387.8 million of equities, $39.4 million of cash and short-term investments, and $25.3 million of other invested assets.
- Unpaid losses and settlement expenses were $1.18 billion gross and $902.6 million net of reinsurance, compared with $1.14 billion and $851.1 million, respectively, at year-end.
- Long-term debt was $148.8 million, consisting primarily of 4.875% senior notes due September 2023. Debt represented 14.5% of total capital, and six-month interest expense was $3.7 million.
- Operating cash flow was $74.6 million. Investing activities used $57.2 million and financing activities used $14.2 million, resulting in a $3.1 million increase in cash to $21.4 million.
- Management reported approximately $55.4 million of cash, short-term investments and investments maturing within one year, plus $349.5 million maturing within one to five years. The $40 million revolving credit facility and Federal Home Loan Bank facility had no outstanding borrowings.
- Management stated that operating and investment cash flows should provide sufficient liquidity for anticipated needs over the next 12 to 24 months.
Material changes versus the prior comparable period
- Casualty remained the principal growth contributor, with six-month net premiums earned up 6.9%, but underwriting income fell to $1.8 million from $20.2 million. The casualty combined ratio increased to 99.3 from 90.8, reflecting adverse development in commercial transportation and medical professional liability and lower favorable reserve development.
- Property six-month net premiums earned declined 8.1% and underwriting income declined to $11.7 million from $13.4 million. Results were affected by product exits, competitive pricing, and a large fire loss.
- Surety underwriting income increased to $19.4 million from $13.6 million, and the combined ratio improved to 68.3 from 77.2, aided by favorable prior-year reserve development.
- Gross premium declines reflected exits from recreational vehicle and treaty reinsurance businesses and re-underwriting of commercial and public auto. Excluding these actions, management reported underlying growth in several product lines.
- Favorable prior-year reserve development contributed $15.1 million to Q2 pretax earnings and $20.5 million for the first six months, compared with $17.3 million and $29.8 million, respectively, in 2016.
- The effective tax rate fell to 23.0% in Q2 and 23.9% for the six months, from 31.3% and 31.2%. The decline was largely attributable to adoption of ASU 2016-09, which records excess tax benefits from share-based compensation through income tax expense.
- Other comprehensive earnings declined primarily because unrealized investment gains were lower: $10.6 million in Q2 and $22.4 million for the six months, versus $19.1 million and $40.8 million in 2016.
Guidance, outlook, risks and unusual items
- No quantitative earnings or premium guidance was provided. Management emphasized underwriting profitability over general premium growth and stated that competition, alternative capital and pricing pressure remain significant.
- Management reported 21 consecutive years of underwriting profitability and an average combined ratio of 87.4% over that period, but current results were affected by higher casualty loss trends, commercial auto performance, medical professional liability deterioration and a property fire loss.
- Medical professional liability produced additional non-cash impairment charges of $3.4 million in Q2: $1.8 million related to agency-relationship intangibles and $1.6 million related to goodwill. These charges were recorded as net realized losses.
- The first half also included $2.1 million of other-than-temporary impairment charges on two fixed-income securities that the company no longer intended to hold.
- Net storm losses were $3.0 million for the first six months and $2.6 million in Q2. Catastrophe exposure is concentrated principally in earthquakes and windstorms.
- Investment risks include equity-price risk, interest-rate risk and credit risk. The fixed-income portfolio had an average rating of AA-, 82.7% rated A or better, and a duration of approximately five years.
- Insurance subsidiaries’ dividends to the holding company are subject to Illinois regulatory restrictions. RLI Insurance Company paid $10.0 million of ordinary dividends to RLI Corp. during the first half, and only approximately $0.1 million of its net assets were unrestricted for ordinary dividends at June 30.
- The company had $20.2 million of unfunded commitments related to other invested assets. Approximately $30 million of undiscounted future lease liabilities would be recognized upon adoption of the new lease standard, with no materially different annual rental expense expected.
- Management reported no material changes to legal proceedings or risk factors, and concluded that disclosure controls and procedures were effective.
Most important facts for investors to verify
- Whether casualty loss trends, particularly commercial auto and medical professional liability, improve and whether further reserve strengthening or impairment charges are required.
- Whether the 91.1 six-month combined ratio normalizes without relying excessively on favorable prior-year reserve development.
- The sustainability of premium growth after product exits, re-underwriting actions and continued pricing competition.
- The quality and liquidity of the investment portfolio, including equity-market sensitivity, interest-rate exposure, below-investment-grade holdings and unrealized gains.
- The availability of holding-company liquidity and future dividend capacity given insurance-regulatory restrictions.
- The effect of the 2017 accounting adoption and future standards on earnings, cash-flow classification, equity securities and lease liabilities.