RLI Corp. 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. This unaudited Form 10-Q covers the three and six months ended June 30, 2012, with comparisons to the corresponding 2011 periods.
The filing includes Contractors Bonding and Insurance Company (CBIC), acquired in April 2011. CBIC contributed six months of results in 2012 versus two months in the comparable 2011 period.
Financial Performance and Key Metrics
| Metric | Q2 2012 | Q2 2011 | Six Months 2012 | Six Months 2011 |
|---|---|---|---|---|
| Net premiums earned | $141.6 million | $130.8 million | $278.9 million | $246.9 million |
| Consolidated revenue | $155.7 million | $156.1 million | $319.7 million | $292.9 million |
| Net earnings | $24.7 million | $45.0 million | $52.8 million | $72.7 million |
| Diluted EPS | $1.15 | $2.11 | $2.45 | $3.41 |
| Comprehensive earnings | $30.6 million | $47.8 million | $69.5 million | $80.7 million |
| Underwriting income | $21.6 million | $42.1 million | $36.6 million | $63.0 million |
| Combined ratio | 84.7 | 67.8 | 86.9 | 74.5 |
Q2 net earnings declined 45% year over year, while six-month net earnings declined 27%. Consolidated revenue was essentially flat in the quarter because higher premiums were offset by lower realized investment results and investment income. Six-month revenue increased 9%, primarily reflecting 13% growth in net premiums earned and the additional CBIC contribution.
The six-month effective tax rate was 32%, compared with 33% in 2011; the Q2 rate was 32%, compared with 34% in 2011. Cash dividends declared were $0.32 per share in Q2 and $0.62 per share for the first six months, versus $0.30 and $0.59, respectively, in the prior-year periods.
Underwriting and Segment Results
- Casualty: Six-month gross written premiums increased 25% to $188.7 million, but underwriting income fell to $11.6 million from $31.4 million. The combined ratio increased to 91.0 from 72.3.
- Property: Six-month gross written premiums increased 5% to $161.1 million. Underwriting income declined to $11.6 million from $17.5 million. Q2 recorded a $0.3 million underwriting loss and a 100.6 combined ratio, primarily reflecting $13.7 million of spring storm losses.
- Surety: Six-month gross written premiums increased 15% to $56.2 million. Underwriting income was $13.3 million versus $14.2 million, and the combined ratio increased to 74.9 from 68.3. Q2 underwriting income improved to $10.9 million from $8.8 million.
Group gross premiums written increased 15% for the first six months to $405.9 million and 9% in Q2 to $229.9 million. Pricing was described as stabilizing in selected lines, although management continued to characterize the broader market as competitive and soft.
Cash Flow, Balance Sheet, Debt and Liquidity
- Operating cash flow was negative $32.1 million for the first six months of 2012 versus positive $83.9 million in 2011. The principal driver was a $50.0 million cash outflow when collateral on a large commercial surety account was returned and replaced with a letter of credit.
- Investing cash flow was negative $8.6 million, compared with negative $75.1 million in 2011, which included the $135.9 million CBIC acquisition.
- Financing cash flow was negative $8.4 million, including $13.2 million of cash dividends paid.
- Cash declined to $32.2 million from $81.2 million at December 31, 2011; short-term investments increased to $65.9 million from $23.9 million.
- Total investments and cash were $1.91 billion, total assets were $2.69 billion, and shareholders’ equity was $853.7 million, up from $792.6 million at year-end 2011.
- Long-term debt remained $100.0 million, consisting of senior notes bearing approximately 5.95% interest and maturing January 15, 2014. Debt represented 10.5% of total capital.
- The company had no borrowings under its $25.0 million revolving credit facility, which may be increased to $50.0 million under certain conditions and expires May 31, 2014.
Management stated that operating cash flow, investments and financing resources should provide sufficient liquidity for anticipated needs over the next 12 to 24 months. Insurance subsidiary dividend payments are subject to Illinois regulatory limits; management noted that more than $14.0 million of additional dividends from RLI Insurance Company before December 15, 2012 would require regulatory approval.
Material Changes, Unusual Items and Management Commentary
- Favorable prior-year reserve development contributed $30.2 million of pretax earnings in Q2 and $37.9 million in the first six months, compared with $48.4 million and $60.6 million, respectively, in the prior-year periods.
- Spring storm losses totaled $13.7 million in both the Q2 and six-month 2012 results. The property segment absorbed most of the current-year storm impact.
- Net realized investment results changed from a $10.1 million gain in Q2 2011 to a $0.7 million loss in Q2 2012. The 2012 quarter included $1.2 million of OTTI charges on equity securities that the company no longer intended to hold.
- Net investment income declined 4% for the first six months because of lower reinvestment rates. The fixed-income portfolio had an average duration of 4.7 years and an average rating of AA; 88% was rated A or better.
- RLI retrospectively adopted ASU 2010-26 on deferred policy acquisition costs. The adoption reduced December 31, 2011 deferred acquisition costs by $40.3 million and shareholders’ equity by $26.2 million, net of tax, or $1.24 per share. It increased Q2 2011 policy acquisition costs by $3.7 million and reduced revised Q2 2011 earnings by $2.4 million.
- CBIC contributed $6.4 million of pretax earnings in Q2 2012, including $5.3 million of underwriting income and $1.1 million of investment income; its results included $6.5 million of favorable prior-year reserve development.
- Management continued to emphasize underwriting profitability over premium growth and stated that the company had achieved underwriting profitability for 16 consecutive years through the filing period.
Risks, Contingencies and Outlook
- Results remain sensitive to loss reserve estimates, claims inflation, litigation, legal and regulatory changes, claim frequency and severity, and future reserve development.
- Property results are exposed to earthquakes, hurricanes, fires, marine losses and crop-related events. The company manages catastrophe exposure through geographic limits, reinsurance and catastrophe modeling.
- Surety losses may increase if adverse economic conditions weaken contractors or other insureds.
- Investment results are exposed to equity-market volatility, interest rates, credit quality and other-than-temporary impairment judgments. The company’s equity allocation was approximately 21% of invested assets.
- Reinsurance recoverables create counterparty and estimation risk; reinsurance does not relieve RLI of its obligations to policyholders.
- Management stated that no material changes occurred in legal proceedings or risk factors, and that disclosure controls and procedures were effective as of June 30, 2012.
- The filing provides no formal quantitative earnings guidance. Management’s stated outlook emphasizes continued selective underwriting, expansion through specialty products, pricing discipline and sufficient liquidity.
Investor Verification Checklist
- Verify the sustainability of favorable reserve development, particularly the $37.9 million six-month benefit and the concentration in recent casualty accident years.
- Assess whether the higher current-year loss ratios and 86.9 combined ratio represent a temporary effect from storms and mix or a broader deterioration in underwriting performance.
- Review the timing and terms of the $100.0 million senior notes maturing in January 2014 and the company’s refinancing or repayment plans.
- Monitor cash flow normalization after the $50.0 million collateral return and the regulatory limits on dividends from the principal insurance subsidiary.
- Evaluate exposure to catastrophe losses, crop reinsurance settlement risk and future development of unpaid loss reserves.
- Reconcile reported comparative results for the retrospective deferred acquisition cost accounting change when assessing year-over-year trends.
- Track investment income pressure from lower yields and potential OTTI charges in the equity portfolio.