<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1995
-----------------------------------------------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
----------------- -------------------
Commission File Number 0-6612
-------------------------------------------------------
RLI CORP.
-----------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Illinois 37-0889946
--------------------------------- ----------------------------------
(State or other jurisdiction of (I.R.S. Employers Identification No.)
incorporation or organization)
9025 North Lindbergh Drive, Peoria, Illinois 61615
--------------------------------------------------- -----------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (309) 692-1000
--------------------------
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
-------------------- ------------------------------------------
Common Stock $1.00 par value New York Stock Exchange
6% Convertible Subordinated Debentures due 2003 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
X Yes No
------- -------
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the closing sale price of the Common Stock on February
29, 1996 as reported on the New York Stock Exchange, was $147,806,135. Shares
of Common Stock held directly or indirectly by each officer and director along
with shares held by the Company ESOP have been excluded in that such persons may
be deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
The number of shares outstanding of the Registrant's Common Stock, $1 par
value, on February 29, 1996 was 7,935,776.
DOCUMENTS INCORPORATED BY REFERENCES.
Portions of the Annual Report to Shareholders for the past year ended
December 31, 1995, are incorporated by reference into Parts I and II of this
document.
Portions of the Registrant's definitive Proxy Statement for the 1996 annual
meeting of security holders to be held May 2, 1996, are incorporated herein by
reference into Part III of this document.
Exhibit index is located on page 27 of this document.
Page 1 of 44
<PAGE>
PART I
Item 1. BUSINESS
(a) General Development of Business
As used in this Form 10-K, the term "Company" refers to RLI Corp. and
its subsidiaries and affiliates, unless the context otherwise indicates.
RLI Corp., which was incorporated in Illinois in 1965, merged into and
became a Delaware corporation in 1984. In May of 1993, RLI Corp. changed its
state of incorporation back to Illinois through a merger. RLI Corp. is a
holding company, which, through its subsidiaries, underwrites specialty property
and casualty insurance, administers extended service programs, markets computers
and automated practice management software to the ophthalmic industry,
distributes contact and other lenses, spectacle frames and sunglasses,
manufactures made-to-order spectacle and rigid gas permeable (RGP) lenses and
writes miscellaneous surety bonds.
SIGNIFICANT EVENT
NORTHRIDGE EARTHQUAKE
Refer to pages 24 through 31, Management's Discussion and Analysis from
the Company's Annual Report to Shareholders, as attached in Exhibit 13.
(b) Financial Information about Industry Segments
Selected information about industry segments is included herein as Item
8.
(c) Narrative Description of Business
RLI INSURANCE GROUP
RLI Insurance Group is composed primarily of two main insurance
companies. RLI Insurance Company, the principal subsidiary, writes multiple
lines of insurance on an admitted basis in all 50 states, the District of
Columbia and Puerto Rico. Mt. Hawley Insurance Company, a subsidiary of RLI
Insurance Company, writes multiple lines of insurance on an admitted basis in
Kansas and surplus lines insurance in the remaining 49 states, the District of
Columbia, Puerto Rico, the Virgin Islands and Guam. Other companies in the RLI
Insurance Group include: Replacement Lens Inc., License Express Services, Inc.,
RLI Aviation, Inc. and RLI Insurance Ltd.
Since 1977, when the Company first began underwriting specialty property
and casualty coverages for commercial risks, highly cyclical market conditions
and a number of other factors have influenced the Company's growth and
underwriting profits. The Company, as a "niche" company rather than an "all
lines" company, seeks to develop expertise and large homogeneous books of
business in areas generally overlooked by traditional markets.
In response to the soft market conditions of the early 1980's, which
were characterized by severe rate competition and excess underwriting capacity,
the Company limited its writings in specialty property and casualty lines and
terminated certain lines and sources of production.
2
<PAGE>
Significant rate increases resulted when the insurance market hardened
in late 1984. The Company responded by expanding its premium volume in targeted
lines. In 1987, and continuing through 1995, the industry again experienced
soft market conditions featuring intensified competition for admitted and
surplus lines insurers, resulting in rate decreases. The Company has
continually monitored its rates and controlled its costs in an effort to
maximize profits during this current soft market period. As a result of
Hurricane Andrew and other catastrophic losses, especially the Northridge
Earthquake of January 17, 1994, property rates hardened in California, Florida
and the wind belt, but remain soft in other areas of the country. During 1994
the Company did see rate increases of over 30% on the commercial property book
of business. The casualty book of business incurred flat to moderate decreases.
This trend continued during 1995. During 1995, rates for catastrophic driven
property business, especially in California, remained hard. Some softening is
expected for 1996.
The Company initially began to write specialty property and casualty
insurance primarily through independent underwriting agents. However, with the
opening of its first branch office in 1984, the Company began to shift its
marketing efforts from independent underwriting agents to wholly-owned branch
offices which market to wholesale producers. The Company also markets certain
products to retail producers from its Specialty Marketing Division located at
the home office. Although the Company still maintains agreements with two
underwriting agents, the majority of its specialty property and casualty
business is marketed through its Specialty Marketing and Surety divisions and
eight branch offices located in Los Angeles, California; San Diego, California;
San Francisco, California; St. Paul, Minnesota; Kansas City, Kansas; Hartford,
Connecticut; Atlanta, Georgia; and Chicago, Illinois. During 1995, an office
was established in Columbus, Ohio to underwrite Lenders' Single Interest inland
marine property insurance.
The following table provides for the year ended December 31, 1995 the
geographic distribution of the Company's risks insured as represented by direct
premiums earned for all product lines. For the year ended December 31, 1995, no
other state accounted for more than 2% of total direct premiums earned for all
product lines.
<TABLE>
<CAPTION>
Direct Premiums
State Earned Percent of Total
----- --------------- -----------------
<S> <C> <C>
California $103,619,169 39.2%
Texas 39,562,154 15.0
Florida 16,757,701 6.3
New York 14,683,741 5.6
Illinois 7,215,762 2.7
Michigan 6,475,145 2.4
Pennsylvania 5,817,933 2.2
All other 70,519,765 26.6%
------------ ------
Total direct premiums $264,651,370 100.00%
------------ ------
</TABLE>
The Company presently underwrites specialty property and casualty
insurance primarily in the following lines:
COMMERCIAL PROPERTY. The Company's commercial property coverage
consists primarily of excess and surplus lines and specialty insurance such as
fire and difference in conditions which includes earthquake, flood and collapse
coverages. The Company writes coverage for a wide range of commercial and
industrial classes such as office buildings, apartments, condominiums, certain
industrial and mercantile structures, and buildings under construction. The St.
Paul, Los Angeles, Hartford, Kansas City, San Francisco, Chicago, Columbus and
Atlanta branch offices are responsible for underwriting this coverage. In 1993,
1994, and 1995, net earned premiums totaled $24,370,000, $42,646,000, and
$49,430,000, or 14%, 22%, and 26%, respectively, of the Company's consolidated
revenues.
3
<PAGE>
GENERAL LIABILITY. The Company writes general liability coverages
through its St. Paul, Hartford, Chicago and Atlanta branch offices and through
one of its unaffiliated underwriting agents. The Company's general liability
business consists primarily of coverage for third party liability of commercial
insureds including manufacturers, contractors, apartments and mercantile. Net
earned premiums totaled $35,025,000, $35,160,000, and $36,499,000, or 20%, 18%,
and 19% of the Company's consolidated revenues for the years 1993, 1994, and
1995, respectively.
COMMERCIAL AND PERSONAL UMBRELLA LIABILITY. The Company's commercial
umbrella coverage is produced through its Kansas City, St. Paul, Atlanta, and
Hartford branch offices. The coverage is principally written in excess of
primary liability insurance provided by other carriers and, to a small degree,
in excess of primary liability written by the Company. The personal umbrella
coverage, which is produced through the Specialty Marketing Division, is written
in excess of the homeowners and automobile liability coverage provided by other
carriers. Net earned premiums totaled $16,764,000, $17,638,000, and
$18,092,000, or 10%, 9%, and 10% of the Company's consolidated revenues for the
years 1993, 1994, and 1995, respectively.
DIRECTORS' AND OFFICERS' LIABILITY. In December, 1990, the Company
established a new Directors' and Officers' Liability underwriting facility in
San Diego, California. Net earned premiums totaled $3,487,000, $5,680,000, and
$6,025,000, or 2%, 3%, and 3% of the Company's consolidated revenues for the
years 1993, 1994, and 1995, respectively.
EMPLOYER'S EXCESS INDEMNITY. In 1993, the Company began offering
Employer's Excess Indemnity coverage for businesses which have opted out of the
Workers' Compensation plan in the state of Texas. The coverage is similar to
accident and health, in that it indemnifies the employer for expenses resulting
from a work related injury or disease, excess of a self-insured retention (SIR).
The SIR can range from $50,000 to $500,000. The product is underwritten out of
the Kansas City branch office. Net earned premiums totaled $1,670,000,
$7,953,000, and $8,257,000, or 1%, 4%, and 4% of the Company's consolidated
revenues for 1993, 1994, and 1995, respectively.
CONTACT LENS. Up until January of 1994, contact lens insurance was
underwritten and marketed by the Company in the United States. In Canada, up
until January of 1994,the Company marketed contact lens policies underwritten by
Security National Insurance Company, an unaffiliated insurer, which business
was, in turn, reinsured by RLI Insurance Company. The Company generally
retained all risks associated with this coverage. This product has been phased
out and replaced by a "non-insurance" product in an effort to better serve the
needs of the Company's customers and to reduce expenses. The contact lens
insurance is processed by RLI Vision Corp. Net earned premiums totaled
$10,327,000, $4,833,000, and $743,000, or 7%, 3% and .4% of the Company's
consolidated revenues for the years 1993, 1994, and 1995, respectively.
OTHER. Smaller programs offered by the Company include: miscellaneous
professional liability, fidelity and surety, commercial multi-peril and accident
and health insurance. Net earned premiums from these lines totaled
$34,346,000, $26,274,000, and $14,422,000, or 20%, 14%, and 8% of the Company's
consolidated revenues for the years 1993, 1994, and 1995, respectively.
The target market for the Surety Division continues to be a wide range
of miscellaneous surety bonds which can be developed quickly and at relatively
little additional risk. By providing a high level of quick, efficient service,
the Company's newest venture will target business now handled by slow,
inflexible multi-line companies.
In June of 1995, a new facility was opened in Columbus, Ohio. This
facility specializes in writing single interest inland marine property insurance
for major lending institutions. This insurance covers the institution's
interest in property used as collateral for loans, in the event of the
borrower's default.
In March of 1992, License Express Services, Inc., an agent/agency/broker
licensing service subsidiary, was formed. Revenues for the period ended
December 31, 1995 amounted to $103,000. Review of this division's viability
during the 1996 planning cycle included recognition of strategic efforts by the
National Association of
4
<PAGE>
Insurance Commissioners to streamline and automate agent licensing efforts. The
uncertainty of the future and limited prospects of near-term profitability
resulted in the decision to withdraw this service from the agent licensing
market. An agreement has been negotiated to refer the customers of this
division to a competitor service in exchange for a stipulated royalty payment.
COMPETITION
The Company's specialty property and casualty insurance subsidiaries are
part of an extremely competitive industry which is cyclical and characterized by
periods of high premium rates and shortages of underwriting capacity followed by
periods of severe competition and excess underwriting capacity. Within the
United States alone, approximately 3,500 companies, both stock and mutual,
actively market property and casualty products. The combination of products,
service, pricing and other methods of competition vary from line to line. The
Company's principal methods of meeting this competition are innovative products,
marketing structure and quality service to the agents and policyholders at a
fair price. The Company competes favorably in part because of its sound
financial base and reputation, as well as its broad geographic penetration into
all 50 states, the District of Columbia and Puerto Rico. In the property and
casualty area, the Company has acquired experienced underwriting specialists in
its branch and home offices. In 1987, the insurance industry, in general,
entered into a "soft" or highly competitive period during which insurance rates
generally decreased. The specialty property and casualty market continues to be
soft with some rate increase in the property lines in California, Florida and
the wind belt during 1993 and 1994. The Company is maintaining its underwriting
and marketing standards by not seeking market share at the expense of earnings.
RATINGS
During 1992, the A.M. Best rating for RLI Insurance Company, the
principal subsidiary of the Company, was upgraded to "A" (Excellent). During
1993, Mt. Hawley Insurance Company's (an indirect subsidiary of the Company)
A.M. Best rating was upgraded from "A-" (Excellent) to "A" (Excellent). During
1995, A.M. Best reaffirmed "A" (Excellent) ratings for both RLI Insurance
Company and Mt. Hawley Insurance Company. Ratings for the industry range from
"A++" (Superior) to "F" (In Liquidation) and some companies are not rated.
Publications of A.M. Best indicate that the "A" and "A-" (Excellent) ratings are
assigned to those companies that in A.M. Best's opinion have achieved excellent
overall performance when compared to the standards established by A.M. Best and
have a strong ability to meet their obligations to policyholders over a long
period of time. In evaluating a company's financial and operating performance,
A.M. Best reviews the company's profitability leverage and liquidity as well as
the company's spread of risk, the quality and appropriateness of its
reinsurance, the quality and diversification of its assets, the adequacy of its
policy or loss reserves, the adequacy of its surplus, its capital structure and
the experience and objectives of its management. A.M. Best's ratings are based
on factors relevant to policyholders, agents, insurance brokers and
intermediaries and are not directed to the protection of investors.
In conjunction with RLI Corp.'s July, 1993 issuance of $46 million of
6.00% Convertible Debentures due 2003, the Company applied for and received a
debt rating from two of the major debt rating agencies - Standard & Poor's
Ratings Group and Moody's Investor Service. Each of these security review firms
assigned investment grade ratings to the new debt issue.
Moody's reviews corporations and assigns ratings exclusively for the
purpose of grading bonds according to investment quality. Their rating symbols
range from "Aaa" (highest) to "C" (lowest). The Company's new debt issue
received a rating of "Baa3" classifying them as medium grade obligations, i.e.
they are neither highly protected nor poorly secured. Moody's assigns this
rating to companies when interest payments and principal security appear
adequate for the present but certain protective elements may be lacking, or may
be characteristically unreliable over any great length of time.
5
<PAGE>
Standard & Poor's assigns ratings to corporate debt that range from
"AAA" (highest) to "CCC" (lowest). Standard & Poor's assigned RLI's Convertible
Debentures a rating of "BBB-" based on the Company's adequate capitalization and
its disciplined underwriting approach. This classification deems the issuer to
have adequate capacity to pay interest and repay principal. Standard & Poor's
assigns this rating when the issuer normally exhibits adequate protection to
debtholders, yet adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this capacity than in higher rated categories.
REINSURANCE
The Company reinsures a significant portion of its specialty property
and casualty insurance exposure, paying to the reinsurer a portion of the
premiums received on such policies. Earned premiums ceded to non-affiliated
reinsurers totaled $108,272,000, $125,458,000 and $131,772,000 in 1993, 1994,
and 1995, respectively. Insurance is ceded principally to reduce net liability
on individual risks and to protect against catastrophic losses. Although
reinsurance does not legally discharge an insurer from its primary liability for
the full amount of the policies, it does make the assuming reinsurer liable to
the insurer to the extent of the insurance ceded.
During the period 1993 through 1995, certain of the Company's reinsurers
were unable to meet their obligations to the Company under reinsurance treaties.
As reserves were previously established for the uncollectible amounts, the
effects of the insolvent reinsurers on net earnings for 1993 through 1995 were
immaterial. The Company continually monitors the financial stability of its
reinsurers and establishes reserves for uncollectible reinsurance balances on a
regular basis. As a result of these reviews, the Company reevaluates its
position with respect to its reinsurance. During 1993, 1994, and 1995, the
Company provided $1,163,278, $1,000,000, and $613,296 for uncollectible
reinsurance balances. Currently the Company attempts to purchase reinsurance
from a limited number of financially strong reinsurers. Retention levels are
adjusted each year to maintain a balance between the growth in surplus and the
cost of reinsurance. At December 31, 1995, the Company had prepaid reinsurance
premiums and reinsurance recoverables on paid and unpaid losses and settlement
expenses with American Re-Insurance Company (rated A+ "superior" by A.M. Best
Company) and Lloyds of London that amounted to $50,886,661 and $19,593,757,
respectively. All other reinsurance balances recoverable, when considered by
individual reinsurer, are less than 10% of shareholders' equity.
The following table sets forth the largest reinsurers in terms of
amounts recoverable, the total amounts recoverable net of reinsurance payables
from such reinsurers as of December 31, 1995 and the amounts of written premium
ceded by the Company to such reinsurers during 1995.
<TABLE>
<CAPTION>
Gross Reinsurer Ceded
Exposure as of Percent Premiums Percent
December 31, 1995 of Total Written of Total
----------------- -------- ------- --------
<S> <C> <C> <C> <C>
American Re-Insurance Co. $50,886,661 20.93% $19,567,724 13.89%
Lloyds of London 19,593,757 8.06 17,658,920 12.47
Employers Re 12,763,642 5.25 7,203,799 5.11
General Reins Corp. 8,835,778 3.63 5,567,212 3.95
TransAtlantic Reinsurance 12,505,000 4.82 15,954,368 11.32
NAC Reinsurance Corporation 9,367,974 3.85 4,388,507 3.11
Security Ins Co of Hartford 5,869,269 2.41 4,279,075 3.04
TIG Insurance Co 6,182,575 2.54 1,042,859 0.74
All other reinsurers 117,936,468 48.51 65,320,789 46.37
------------ ------ ------------ -------
Total ceded exposure $243,155,123 100.00% $140,983,253 100.00%
------------ ------ ------------ -------
------------ ------ ------------ -------
</TABLE>
6
<PAGE>
As of December 31, 1995, the Company held $24,925,074 in irrevocable
letters of credit, $5,026,740 under trust agreements and $2,865,012 in cash to
collateralize a portion of the total amount recoverable.
Since 1992, the Company has purchased non-proportional contracts. This
allows the Company to retain a larger percentage of the premium and a larger
portion of the initial loss risk. Under non-proportional reinsurance, the
ceding company retains losses on a risk up to a specified amount and the
reinsurers assume any losses above that amount. Since 1989, through its various
reinsurance programs, the Company has generally limited its maximum retained
exposure on any one risk to $1,000,000. The Company sought to limit its net
aggregate exposure to a single catastrophic event in 1995 to less than 10% of
shareholders' equity by purchasing various types of reinsurance.
The Company increased its commercial property reinsurance protection in
1995. Through implementation of this change, the Company reduced its net
aggregate exposure on a single catastrophic event from 20% to 10% of
shareholders' equity. Using computer-assisted techniques, the Company
quantifies and monitors its exposure to earthquake risk, the most significant
catastrophe exposure to the Company. Detail is captured for each location
covered for earthquake risk and the Probable Maximum Loss (PML) for each risk is
determined. The PML calculation for each risk includes all faults to which the
risk is exposed. Richter scale magnitudes used in the PML calculations are
determined and applied separately for each fault. The Company uses the greater
of the magnitude of an earthquake which only occurs every 100 years or 6.5 on
the Richter scale in its PML calculations. Several widely accepted methods are
used to estimate the magnitude of the 100 year event for each fault.
Underwriting decisions are based on the PML as determined by the system, which
calculates PML's on over 200 faults. Portfolio runs are made regularly to
determine the Company's overall exposure on each fault from all risks covered.
Total exposure after facultative reinsurance is managed by the Company to fall
within the limits covered by the Company's chosen net retention, working layer
treaty reinsurance and catastrophe reinsurance.
FACTORS AFFECTING SPECIALTY PROPERTY AND CASUALTY PROFITABILITY
The profitability of the specialty property and casualty insurance
business is generally subject to many factors, including rate competition, the
severity and frequency of claims, natural disasters, state regulation of premium
rates, default of reinsurers, interest rates, general business conditions,
regulatory measures and court decisions that define and expand the extent of
coverage and the amount of compensation due for injuries or losses. One of the
distinguishing features of the property and casualty insurance business is that
its product must be priced before the ultimate claims costs can be known. In
addition, underwriting profitability has tended to fluctuate over cycles of
several years' duration. Insurers generally had profitable underwriting
results in the late 1970's, substantial underwriting losses in the early 1980's
and somewhat smaller underwriting losses in 1986 and 1987. During the years
1988 through 1992, underwriting losses increased due to increased rate
competition and the frequency and severity of catastrophic losses, although
pre-tax operating income remained profitable due to investment income gains.
During 1995 the industry's statutory combined ratio is estimated to be 107.2.
The Company believes that certain other factors affect its ability to
underwrite specialty lines successfully, including:
7
<PAGE>
SPECIALIZED UNDERWRITING EXPERTISE. The Company employs experienced
professionals in its branch offices. Each office restricts its production and
underwriting of business to certain classes of insurance reflecting the
particular areas of expertise of its key underwriters. In accepting risks, all
independent and affiliated underwriters are required to comply with risk
parameters, retention limits and rates prescribed by the Company's home office
underwriting group, which reviews submissions and periodically audits and
monitors underwriting files and reports on losses over $100,000. Compensation
of senior underwriters is substantially dependent on the profitability of the
business for which they are responsible. The loss of any of these professionals
could have an adverse effect on the Company's underwriting abilities and
earnings in these lines.
The Company's Underwriting Policy limits extension of binding authority
to independent agents. The Company's product distribution falls into distinct
categories, with binding authority following the categorization.
BROKER BUSINESS. The largest volume of broker generated premium is
Commercial Property, General Liability, Commercial Umbrella and Employer's
Excess Indemnity. This business is produced through wholesale brokers who are
not affiliated with the Company. Only a Company underwriter has the authority
to bind the Company on such risks.
INDEPENDENT AGENT BUSINESS. The Specialty Marketing Division writes
program business such as Personal Umbrella, Residential Earthquake, and the
In-Home Business Policy. Each of these programs involves detailed eligibility
criteria which are incorporated into strict underwriting guidelines. The
programs involve prequalification of each risk using the "smart" system
accessible by the independent agent. The independent agent cannot bind the risk
unless they receive approval through the Company's "smart" system.
UNDERWRITING AGENTS. One independent agent is authorized to underwrite
and bind business on behalf of the Company within limited underwriting
guidelines as follows: General Liability business up to a limit of $1,000,000
written for a variety of risks, primarily in Texas and Louisiana.
With rare exceptions, producers of business who are not Company
employees are compensated on the basis of direct commissions with no provision
for any contingent profit commission. There are a few volume incentives for
producers handling association business, with the increased commission involved
being tied to the program's underwriting profit. This represents less than 5%
of the business.
RETENTION LIMITS. The Company limits its net retention of single and
aggregate risks through the purchase of reinsurance. See "Business -- Specialty
Property and Casualty Insurance Segment -- Reinsurance." The amount of
reinsurance available fluctuates according to market conditions. Reinsurance
arrangements are subject to annual renewal. Any significant reduction in the
availability of reinsurance or increase in the cost of reinsurance could
adversely affect the Company's ability to insure specialty property and casualty
risks at current levels or to add to the amount thereof.
CLAIMS ADJUSTMENT ABILITY. The Company has a professional claims
management team with proven experience in all areas of multi-line claims work.
This team supervises and administers all claims and directs all outside legal
and adjustment specialists. Whether a claim is being handled by the Company's
claim specialist or has been assigned to a local attorney or adjuster, detailed
attention is given to each claim to minimize loss expenses while providing for
loss payments in a fair and equitable manner.
8
<PAGE>
EXPENSE CONTROL. Management continues to review all areas of the
Company's operations to streamline the organization, emphasizing quality and
customer service, while minimizing expenses. These strategies will help to
contain the growth of future costs. Maintaining and improving underwriting and
other key organizational systems continues to be paramount as a means of
supporting the Company's orderly growth in anticipation of a market rebound, as
it is the Company's philosophy to retain its talented insurance professionals
and to build infrastructure in spite of the soft market. Other operating
expenses as a percent of gross written premiums for the years 1993, 1994 and
1995 were 6%, 5%, and 5%, respectively.
ENVIRONMENTAL EXPOSURES. The Company is subject to environmental claims
and exposures through its commercial umbrella, general liability, and assumed
reinsurance lines of business. Within these lines, the Company's environmental
exposures include environmental site cleanup, asbestos removal, and mass tort
liability. The majority of the exposure is in the excess layers of the
Company's commercial umbrella and assumed reinsurance books of business.
The following table represents inception-to-date paid and unpaid
environmental exposure data (including incurred but not reported losses) for the
periods ended 1994 and 1995:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Inception-to-date December 31
(in thousands) 1994 1995
- -------------------------------------------------------------------------------
<S> <C> <C>
Loss and LAE payments
Gross $ 3,549 $ 5,117
Ceded ( 2,933) ( 3,842)
- -------------------------------------------------------------------------------
Net $ 616 $ 1,275
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Unpaid losses and LAE at end of year
Gross $15,519 $20,154
Ceded ( 9,875) ( 13,398)
- -------------------------------------------------------------------------------
Net $ 5,644 $ 6,756
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
</TABLE>
Although the Company's environmental exposure is limited as a result of
entering the liability lines after the industry had already recognized it as a
problem, Management cannot determine the Company's ultimate liability within any
reasonable degree of certainty. This ultimate liability is difficult to assess
due to evolving legislation on such issues as joint and several liability,
retroactive liability, and standards of cleanup. Additionally, the Company
participates primarily in the excess layers, making it even more difficult to
assess the ultimate impact.
LOSSES AND SETTLEMENT EXPENSES
Many years may elapse between the occurrence of an insured loss, the
reporting of the loss to the insurer and the insurer's payment of that loss.
To recognize liabilities for unpaid losses, insurers establish reserves, which
are balance sheet liabilities. The reserves represent estimates of future
amounts needed to pay claims and related expenses with respect to insured
events which have occurred.
9
<PAGE>
When a claim is reported, the claims department establishes a "case
reserve" for the estimated amount of the ultimate payment. The estimate
reflects the informed judgment of professional claims personnel, based on the
Company's reserving practices and the experience and knowledge of such personnel
regarding the nature and value of the specific type of claim. Estimates for
losses incurred but not yet reported are determined on the basis of statistical
information, including the Company's past experience. The Company does not use
discounting (recognition of the time value of money) in reporting its estimated
reserves for losses and settlement expenses.
The reserves are closely monitored and reviewed by management, with
changes reflected as a component of earnings in the current accounting period.
For lines of business without sufficiently large numbers of policies or that
have not accumulated sufficient development statistics, industry average
development patterns are used. To the extent that the industry average
development experience improves or deteriorates, the Company will adjust prior
accident years' reserves for the change in development patterns. Additionally,
there may be future adjustments to reserves should the Company's actual
experience prove to be better or worse than industry averages.
As part of the reserving process, historical data is reviewed and
consideration is given to the anticipated impact of various factors such as
legal developments and economic conditions, including the effects of inflation.
The reserving process provides implicit recognition of the impact of inflation
and other factors affecting claims payments by taking into account changes in
historic payment patterns and perceived probable trends. Changes in reserves
from the prior years' estimates are calculated based on experience as of the end
of each succeeding year (loss and settlement expense development). The estimate
is increased or decreased as more information becomes known about the frequency
and severity of losses for individual years. A redundancy means the original
estimate was higher than the current estimate; a deficiency means that the
current estimate is higher than the original estimate.
Due to the inherent uncertainty in estimating reserves for losses and
loss adjustment expenses, there can be no assurance that the ultimate liability
will not exceed amounts reserved, with a resulting adverse effect on the
Company. Based on the current assumptions used in calculating reserves,
Management believes the Company's overall reserve levels at December 31, 1995
are adequate to meet its future obligations.
10
<PAGE>
The table which follows is a reconciliation of the Company's unpaid
losses and settlement expenses for the years 1993, 1994, and 1995.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------
(Dollars in thousands) 1993 1994 1995
---- ---- ----
<S> <C> <C> <C>
Unpaid losses and settlement
expenses at beginning of year:
Gross $268,043 $310,767 $394,966
Ceded (137,591) (145,208) (199,737)
------- ------- -------
Net 130,452 165,559 195,229
------- ------- -------
Increase (decrease) in incurred losses and
settlement expenses:
Current accident year 81,589 100,535 62,619
Prior accident years (1,852) 1,107 23,271
----- ----- ------
Total incurred 79,737 101,642 85,890
------ ------ ------
Loss and settlement expense payments for
claims incurred:
Current accident year (18,743) (36,501) (10,600)
Prior accident years (24,726) (36,026) (48,023)
------ ------ ------
Total paid (43,469) (72,527) (58,623)
------ ------ ------
Insolvent reinsurer charge off (221) 643 514
Loss reserves commuted (940) (88) (1,376)
----- ----- -----
Unpaid losses and settlement
expenses at end of year $165,559 $195,229 $221,648
-------- -------- --------
-------- -------- --------
Unpaid losses and settlement
expenses at end of year:
Gross $310,767 $394,966 $418,986
Ceded (145,208) (199,737) (197,338)
------- -------- -------
Net $165,559 $195,229 $221,648
-------- -------- --------
-------- -------- --------
</TABLE>
Explanation of significant components of reserve development by calendar
year are as follows:
1993 During 1993 favorable development was reported in the other and products
liability lines. These lines showed overall favorable development of
$1,349,000. The favorable development was primarily isolated to the
1988 and 1990 accident years due to a reduction in the estimated
ultimate loss. This was offset by unfavorable development in the 1982
and 1983 accident years due to development of a products liability
claim. Unfavorable development also occurred in the 1992 accident year
due to increases in the estimated ultimate loss for this accident year.
11
<PAGE>
Favorable development also resulted from a reduction in the Company's
estimate of unpaid unallocated loss adjustment expenses.
1994 During 1994, the Company experienced approximately $1,107,000 of adverse
development on loss reserves. This development resulted from
approximately $2,512,000 of adverse development in the other liability
and products liability lines of business. Approximately $1,000,000 of
this development related to one individual claim. The remainder of the
adverse development is related to changes in loss reserves on prior
years related to the professional liability business written by RLI from
1987 through 1993. The Company has withdrawn from this line of
business.
Offsetting the adverse development experience in the other liability and
products liability lines of business was approximately $1,644,000 of
favorable development on the property line of business. This favorable
development resulted from individual claim estimates where the claims
closed for less than the recorded reserves.
1995 During 1995, the Company experienced approximately $23,300,000 of
adverse development on loss reserves. This development resulted from
approximately $27,300,000 of adverse development in the property line
due to the 1994 Northridge earthquake. Excluding the earthquake
development, the Company experienced approximately $4,000,000 of
favorable development. Approximately $1,000,000 of this favorable
development occurred in the property line excluding the earthquake, with
the remaining $3,000,000 occurring in the other liability and products
liability lines. The liability development was the result of IBNR
reserve decreases made possible by lower than expected tail development
on two liability programs.
The table on the following page presents the development under generally
accepted accounting principles of the Company's balance sheet reserves
for 1986 through 1995. The top line of the table shows the reserves at
the balance sheet date for each of the indicated periods. This
represents the estimated amount of losses and settlement expenses
arising in all prior years that are unpaid at the balance sheet date,
including losses that had been incurred but not yet reported to the
Company. The lower portion of the table shows the re-estimated amount
of the previously recorded reserves based on experience as of the end of
each succeeding year. The estimate changes as more information becomes
known about the frequency and severity of claims for individual periods.
12
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------------------------------------------
(Dollars in thousands) 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Liability for unpaid
losses and settlement
expenses at end of
year $57,088 $66,169 $89,197 $95,953 $103,302 $110,844 $130,452 $165,559 $195,229 $221,648
Paid (cumulative)
as of:
One year later 18,631 10,170 17,312 14,302 19,297 23,561 24,725 36,026 48,023
Two years later 23,341 21,860 26,093 26,685 35,963 37,763 46,342 63,675
Three years later 29,874 28,052 37,137 40,341 44,088 49,462 64,364
Four years later 30,071 35,459 47,617 44,714 52,322 57,085
Five years later 33,785 42,010 48,937 51,153 56,413
Six years later 38,536 41,698 53,670 54,546
Seven years later 37,661 44,995 56,254
Eight years later 39,216 46,113
Nine years later 40,080
Liability re-estimated
as of:
One year later 56,793 67,033 86,230 91,646 101,251 108,249 128,600 166,666 218,499
Two years later 59,797 67,939 85,120 89,112 98,505 105,747 132,850 164,218
Three years later 59,338 68,697 84,426 87,981 95,690 107,777 132,377
Four years later 58,847 69,904 84,931 87,403 97,041 106,326
Five years later 60,794 69,670 84,217 90,030 96,490
Six years later 60,547 70,486 87,585 88,982
Seven years later 61,329 72,074 86,593
Eight years later 63,327 72,540
Nine years later 63,719
Net cumulative
redundancy
(deficiency) $(6,631) $(6,371) $ 2,604 $ 6,971 $ 6,812 $ 4,518 $(1,925) $ 1,341 $(23,271)
Gross liability $310,767 $394,966 $418,986
Reinsurance
recoverable (145,208) (199,737) (197,338)
--------- --------- ---------
Net liability $165,559 $195,229 $221,648
Gross re-estimated
liability $309,716 $437,649
Re-estimated
recoverable (145,498) (219,150)
--------- --------
Net re-estimated
liability $164,218 $218,499
Gross cumulative
redundancy
(deficiency) $1,051 $(42,683)
</TABLE>
13
<PAGE>
The Company's loss reserves at the end of any particular calendar year
are based upon the premiums received and earned as of the end of that particular
year. Reinsurance premiums and losses, especially foreign, are not, in many
cases, received and recorded until after the calendar year. The loss
development as displayed includes losses incurred in a particular calendar year
that relate to premiums reported, recorded and earned subsequent to that year.
The following table adjusts the cumulative redundancy (deficiency), as shown in
the foregoing table, for the estimated losses associated with such late reported
premiums.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------------------------------------
1986 1987 1988 1989 1990 1991 1992 1993 1994
---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Cumulative redundancy
(deficiency) per above $( 6,631) $( 6,371) $ 2,604 $6,971 $6,812 $4,518 $(1,925) $ 1,341 $(23,271)
Estimated losses
associated with late
reported premiums 1,600 1,356
------- ------- ------- ------- ------ ------ ------- ------ -------
Adjusted cumulative
redundancy
(deficiency) $ (5,031) $( 5,015) $ 2,604 $ 6,971 $6,812 $4,518 $(1,925) $ 1,341 $(23,271)
-------- -------- ------- ------- ------ ------ ------- ------- -------
-------- -------- ------- ------- ------ ------ ------- ------- -------
</TABLE>
See discussion of calendar year development for 1992, 1993, and 1994 on pages 11
and 12.
14
<PAGE>
OPERATING RATIOS
PREMIUMS TO SURPLUS RATIO
The following table shows, for the periods indicated, the Company's
insurance subsidiaries' statutory ratios of net premiums written to
policyholders' surplus. While there is no statutory requirement applicable to
the Company which establishes a permissible net premiums written to surplus
ratio, guidelines established by the National Association of Insurance
Commissioners provide that this ratio should generally be no greater than 3 to
1.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------
(Dollars in thousands) 1991 1992 1993 1994 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Statutory net
premiums written $84,188 $110,895 $136,728 $131,164 $130,453
Policyholders' surplus $88,605 $100,585 $152,262 $136,125 $172,313
Ratio .9 to 1 1.1 to 1 .9 to 1 1.0 to 1 .8 to 1
</TABLE>
GAAP AND STATUTORY COMBINED RATIOS
The underwriting experience of the Company is best indicated by its GAAP
combined ratio, which is the sum of (a) the ratio of incurred losses and
settlement expenses to net premiums earned (loss ratio) and (b) the ratio of
policy acquisition costs and other operating expenses to net premiums earned
(expense ratio).
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------
GAAP 1991 1992 1993 1994 1995
---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C>
Loss ratio 60.6 60.3 63.3 72.5 64.4
Expense ratio 24.6 31.1 33.9 44.4 43.1
---- ---- ---- ----- -----
Combined ratio 85.2 91.4 97.2 116.9 107.5
---- ---- ---- ----- -----
---- ---- ---- ----- -----
</TABLE>
(1) Excluding the effects of the Northridge Earthquake, the GAAP combined
ratio for the years ended 1995 and 1994 would have been 86.2 and 91.1,
respectively.
The Company also calculates the statutory combined ratio, which is not
indicative of GAAP underwriting profits due to accounting for multiple-year
retrospectively-rated reinsurance contracts and policy acquisition costs
differently for statutory accounting purposes compared to GAAP. The statutory
combined ratio is the sum of (a) the ratio of statutory loss and settlement
expenses incurred to statutory net premiums earned (loss ratio) and (b) the
ratio of statutory policy acquisition costs and other underwriting expenses to
statutory net premiums written.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------
<S> <C> <C> <C> <C> <C>
Statutory 1991 1992 1993 1994 1995
---- ---- ---- ---- ----
Loss ratio 56.8 58.9 65.8 73.4 63.6
Expense ratio 34.8 36.9 22.1 (3) 43.5 42.9
---- ---- ---- ---- ----
Combined ratio 91.6 95.8 87.9 (3) 116.9 (4) 106.5 (4)
---- ---- ---- ----- -----
---- ---- ---- ----- -----
Industry combined ratio 108.8 (2) 115.7 (2) 106.9 (2) 108.4 (2) 105.3 (1)
----- ----- ----- ----- -----
----- ----- ----- ----- -----
</TABLE>
15
<PAGE>
(1) Source: Insurance Information Institute. Estimated for the year ended
December 31, 1995.
(2) Source: A.M. Best Aggregate & Averages -- Property-Casualty (1995
Edition).
(3) Contingent commission income recorded during 1993, from the cancellation
of a multiple-year retrospectively-rated reinsurance contract, reduced
the statutory combined and expense ratio by 10.3 points.
(4) Excluding the effects of the Northridge Earthquake, the statutory
combined ratio for the years ended 1995 and 1994 would have been 85.3
and 89.7, respectively.
RLI VISION CORP.
The Company believes that it was the world's largest provider of contact
lens insurance between 1965 and 1993. In 1993, due to changes in the ophthalmic
market place, the Company began converting its contact lens insurance book of
business over to a non-insurance contact lens purchase plan called Total Lens
Care. Beginning January 1, 1994, the Company no longer offered contact lens
insurance. In the late 1970's, the Company became a third party administrator
of ophthalmic practitioners' extended service programs. The Company further
expanded its operations in 1985 when it developed and marketed an office
automation computer system for eyecare professionals. The Company became a
contact lens wholesale distributor in 1990.
On May 4, 1995, RLI Vision Corp. (formerly known as RLI Professional
Technologies, Inc.), a wholly-owned subsidiary of RLI Corp., acquired through
merger, Target Industries, Inc., a wholesale optical goods distributor of
contract lenses, Rx spectacles, frames and sunglasses, located in Cohasset,
Massachusetts. As consideration, RLI Corp. issued 313,500 shares of its common
stock. The combined enterprise is now doing business under the name of RLI
Vision Corp. This business combination has been accounted for as a pooling-of-
interests. The consolidated financial statements and related financial
information for periods prior to the combination have been restated to include
the accounts and results of operations of Target Industries, Inc.
RLI Vision Corp.'s revenues, as restated to include Target Industries,
Inc. revenues, of $29,195,000, $33,974,000 and $34,595,000, in 1993, 1994, and
1995, respectively, represented 17%, 18% and 18% of the Company's consolidated
revenues after eliminations in such years.
CONTACT LENS INSURANCE PROCESSING
While the Company no longer offers contact lens insurance, policies will
be in effect and honored through February, 1996. Claims will be processed by RLI
Vision Corp. under an agreement with RLI Insurance Company.
TOTAL LENS CARE
Total Lens Care is a contact lens purchase plan which offers patients
discounted prices on contact lenses in exchange for an annual membership fee. As
of December 31, 1995, approximately 200,000 patients had enrolled in Total Lens
Care, generating $4,576,601 in fees for the year ended December 31, 1995.
Presently, 65% of the patients renew their TLC memberships as they expire.
EXTENDED SERVICE PROGRAMS
The Company administers approximately 6,900 individual ophthalmic
practitioners' extended service programs which entitle enrolled patients to
receive certain goods and services at discounted costs. At December 31, 1995,
approximately 310,000 patients were enrolled in such programs. Revenues for the
same period amounted to $1,874,111.
In 1990, the Company introduced Vision Care Advantage (VCA), an eye care
cost containment program offered nationwide to employers, unions and groups. In
exchange for an enrollment fee, VCA members receive specified ophthalmic goods
and services at discounted costs from a panel of approximately 4,500
participating practitioners. For the period ended December 31, 1995, revenues
amounted to $132,976.
16
<PAGE>
CONTACT LENSES
In order to take advantage of its purchasing power, in 1990 the Company
opened the RLI Service Center which purchases contact lenses at wholesale costs
for distribution to RLI Insurance Company and private practitioners. In 1992,
the Company opened a distribution center in southern California to better
compete in the west-coast market. Consolidated revenue from contact lens
distribution out of all sites was $19,268,768 in soft lenses and $1,285,730 in
RGP lenses in 1995.
OPHTHALMIC LENS LAB
As a result of the acquisition of Target Industries, RLI Vision now
operates its own spectacle Rx laboratories. In 1995, spectacle Rx revenue was
$3,376,972, up 9% over 1994.
RLISYS PRACTICE AUTOMATION SYSTEMS
The Company's office automation software, formally known as RLISYS, is
designed to assist ophthalmic practitioners in the management of their patient,
accounting, insurance and marketing records. In 1993, the Company ceased
offering hardware to complement the software and adopted a monthly licensing
pricing structure. The Company is the single largest provider of ophthalmic
software and has installed over 3,000 systems in eyecare professionals' offices
throughout the United States. The Company provides users with training, support
and supplies for their systems. In addition, the Company continually evaluates
the system and develops enhancements designed to meet the changing needs of the
ophthalmic community.
COMPETITION AND INDUSTRY POSITION
In regards to TLC and Extended Service, competition stems from
ophthalmic practitioners who offer their own membership plans. These
independently-operated programs are believed by the Company to be the largest
source of competition.
The contact lens distribution facilities operate in a very competitive
market, with the cost of goods sold comprising nearly 79% of lens sales revenue.
With such low margins, volume affects profitability. The Company believes that
the total wholesale contact lens distribution market generates approximately
$600 million in annual sales, $150 million (25%) of which is sold through
distributors. The Company is one of approximately 50 distribution facilities in
the United States. The Company's 1995 contact lens sales totaled $20,553,000.
The Company considers itself the leader in office automation software,
having captured 23% of the automated optometrist market. It is believed that the
elimination of the large up-front purchase price and a switch to a monthly-
licensing pricing structure, will make the RLISYS system much more affordable
and enable the Company to increase its market share both through practitioners
automating for the first time and practitioners converting to RLISYS from other
software vendors.
INVESTMENTS
The investment portfolios of the Company are managed by an Investment
Committee of the Board of Directors. The Company follows an investment policy
that is reviewed quarterly and revised periodically.
17
<PAGE>
Investments of the highest quality and marketability are critical for
preserving claims paying ability. Virtually all of RLI's fixed income
investments are U.S. Government securities or AA or better rated taxable and tax
exempt issues. Common stock portfolios are limited to securities listed on
national exchanges and listed by the Securities Valuation Office of the National
Association of Insurance Commissioners. The investment portfolio serves
primarily as the funding source of loss reserves and secondly as a source of
income. For these reasons, RLI's primary investment criteria are quality and
liquidity, followed by yield.
During 1995, operating cash flows were used to acquire fixed income
instruments composed almost entirely of intermediate-term U.S. Government and
Agency securities and municipal securities. The tax-exempt component of the
fixed maturity portfolios increased $14.7 million, to $106.8 million; and
comprises 36.1% of the Company's fixed maturity portfolios, unchanged from year
end 1994. Net purchases of taxable U.S. Government and Government Agency
securities amounted to $22.2 million in 1995; these taxable securities comprise
63.0% ($186.2 million) of the fixed income portfolios. Investment grade
corporate securities in the fixed income portfolios totaled $2.7 million at the
end of 1995, up slightly from the 1994 level of $2.5 million.
Equity portfolios increased $49.9 million from $104.1 million at the end
of last year to $154.0 million at the end of 1995. During 1995, net common
equity investments totaling $15.5 million were purchased and pretax unrealized
appreciation of equity securities totaled $34.4 million. Equity securities as a
percentage of cash and invested assets increased to 32.4% at the end of 1995
from 24.5% at year end 1994. Combined cash and short-term investments decreased
$35.5 million in 1995 to 5.3% of cash and total invested assets from 14.3% in
1994. The Company's short-term investments consist of U.S. Government and
Agency backed money market funds and the highest rated commercial paper.
RLI's mix of fixed income securities continues to be biased in favor of
U.S. Government and Agency securities due to their high liquidity and almost
risk-free nature. The mixture of tax-exempt and taxable instruments within the
fixed income portfolios is decided at the time of purchase on the basis of
available after-tax returns and overall taxability of all invested assets.
Almost all securities reviewed for purchase are either U.S. Government, Agency,
or high grade municipal debt instruments. As part of its investment philosophy,
the Company attempts to avoid exposure to default risk by holding, almost
exclusively, instruments ranked in the top two grades of investment security
quality by Standard & Poor's and Moody's (i.e. AAA and AA). Interest rate risk
is minimized by the Company's policy of purchasing securities with limited call
provisions.
The Company follows a program of matching assets to anticipated
liabilities to ensure its ability to hold securities until maturity. The
Company's known debt and long-term accounts payable are added to the estimate of
its unpaid losses and settlement expenses, by line of business. These
anticipated liabilities are then factored against ultimate payout patterns and
the resulting payout streams are fully funded with the purchase of fixed-income
securities of like maturity. Management believes that interest rate risk can
best be minimized by such asset/liability matching.
<TABLE>
<CAPTION>
Aggregate maturities for the fixed maturity securities are as follows:
Maturity Par Amortized Fair Carrying
Year Value Cost Value Value
-------- -------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
1996 $17,670,000 $17,630,139 $17,788,259 $17,638,672
1997 19,640,000 19,618,969 19,950,236 19,637,385
1998 30,950,000 31,246,389 32,423,703 31,388,458
1999 37,885,000 38,367,149 40,744,005 38,942,963
2000 31,580,000 32,423,834 34,100,788 32,784,417
2001 19,350,000 20,233,445 20,947,597 20,227,870
2002 24,460,000 25,662,858 26,353,026 25,667,448
2003 41,155,000 41,408,041 41,872,419 41,427,626
2004 18,295,000 18,317,544 18,627,591 18,306,272
2005 28,790,000 29,295,646 30,782,099 29,312,375
2006 4,185,000 4,124,770 4,241,337 4,124,770
18
<PAGE>
2007 3,100,000 3,105,254 3,612,205 3,105,255
2008 525,000 525,000 556,432 525,000
2009 5,000,000 5,256,988 5,476,470 5,256,988
2010 8,000,000 8,411,848 8,601,440 8,411,848
--------- --------- --------- ---------
$290,585,000 $295,627,874 $306,077,607 $296,757,347
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
Under generally accepted accounting principles, equity and fixed income
securities are carried at fair market value, except that a company that can
demonstrate its ability to hold fixed income securities until their originally
scheduled maturity is permitted to carry such securities at amortized cost. RLI
Corp. has chosen to carry most of its fixed income securities at amortized cost
as it believes it has constructed its fixed income portfolios to match expected
liability payouts and thus has the ability and intention to hold such securities
until originally scheduled maturity. Consequently, fluctuations in the market
value of most bonds are not reflected in the financial statements and do not
affect shareholders' equity. At December 31, 1995, the Company's equity
securities valued at $154.0 million, accounted for 32.4% of total cash and
invested assets and 89.4% of the combined statutory surplus of its insurance
subsidiaries. At December 31, 1995, net pretax unrealized capital appreciation
of equity securities was $51.4 million.
The Company's investment results are summarized in the following table:
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------
(Dollars in thousands) 1991 1992 1993 1994 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Average invested
assets (1) $225,546 $260,616 $343,441 $410,058 $445,562
Investment
income (2)(3) 12,742 13,483 16,857 20,133 22,029
Realized gains
(losses) (3) 1,234 921 254 (3,595) 457
Change in unreal-
ized appreciation/
depreciation (3)(4) 8,528 3,546 7,945 (5,749) 36,037
Annualized return
on average
invested assets 10.0% 6.9% 7.3% 2.6% 13.1%
</TABLE>
(1) Average of amounts at beginning and end of each year.
(2) Investment income, net of investment expenses, including non-debt interest
expense.
(3) Before income taxes.
(4) Relates to available-for-sale fixed maturities and equity securities.
REGULATION
STATE REGULATION
The Company's insurance subsidiaries are highly regulated by insurance
regulators in their states of incorporation as well as the states in which they
do business. Such regulations, among other things, limit the amount of
dividends and other distributions the subsidiaries can pay without prior
approval of the insurance department in the states in which they are physically
and/or commercially domiciled, and impose restrictions on the amount and type of
investments they may have. Certain states also regulate the rates insurers may
charge for certain property/casualty products.
19
<PAGE>
These regulations are designed to ensure financial solvency of insurance
companies and to require fair and adequate service and treatment for
policyholders. They are enforced through the granting and revoking of licenses
to do business, licensing of agents and brokers, monitoring of trade practices,
policy form approval, fair and equitable premium and commission rates, and
minimum reserve and capital requirements. The procedures are administered by
the various state departments of insurance and are supplemented by periodic
reporting procedures and periodic examinations.
The quarterly and annual financial reports to the states utilize
accounting principles which are different than the generally accepted accounting
principles used in shareholders' reports. The statutory accounting principles,
in keeping with the intent to assure policyholder protection, are based, in
general, on a liquidation concept while generally accepted accounting principles
are based on a going concern concept.
Under the laws of most states and provinces, regulatory authorities have
relatively broad discretion with respect to granting, renewing and revoking
brokers' and agents' licenses to transact business in the state. The manner of
operating in particular states may vary according to the licensing requirements
of the particular state, which may, among other things, require a firm operate
in the state through a corporation. In a few states and provinces, licenses are
issued only to individual residents or locally-owned business entities. In such
cases, the Company has arrangements with residents or business entities licensed
to act in the state.
As an insurance holding company, RLI Corp. is subject to regulation by
the states in which its insurance subsidiaries are domiciled or transact
business. Most states have enacted legislation that requires each insurance
company in a holding company system to register with the insurance regulatory
authority of its state of domicile and furnish to it financial and other
information concerning the operations of companies within the holding company
system that may materially affect the operations, management or financial
condition of the insurers within the system. All transactions within a holding
company system affecting insurers must be fair, and the insurer's policyholder
surplus following any transaction must be both reasonable in relation to its
outstanding liabilities and adequate for its needs. Notice to applicable
regulators is required prior to the consummation of certain transactions
affecting insurance subsidiaries of the holding company system.
CALIFORNIA EARTHQUAKE AUTHORITY--The California Insurance Commissioner
has been authorized to establish a state residential earthquake program. The
most recent proposals for the program include industry participation, investment
of private capital and reinsurance commitments. As the Company writes an
insignificant amount of residential homeowner's insurance, it does not appear
that the legislation will impact the Company in any significant manner.
PROPOSITION 103 (RATE ROLLBACK INITIATIVE)--In November 1988, California
voters approved Proposition 103, which requires insurance premium rates for
certain lines of business to be rolled back twenty percent (20%) from the rates
in effect in November 1987. As a result, in 1994 and 1993, the Company reduced
pretax earnings by $71,280 and $416,400, respectively. No additional provision
was made during 1995. The above amounts include interest for 1994 and 1993 in
the amount of $71,280 and $259,200, respectively. The total amount of deferred
premiums and interest accrued as of December 31, 1995, was $2.5 million.
The state of California maintains that the Company is not in compliance with
Proposition 103 and that the required amount of premiums to be returned is $6.5
million plus accrued interest. The Company maintains it had reduced rates by
20% or more on its most significant lines of business. This reduction is at
issue with the California Department of Insurance. While it is impossible to
predict the outcome, Management believes that the amount accrued is adequate to
cover the ultimate rollback, if any. The matter has been set for hearing in
March of 1996.
20
<PAGE>
ASSESSMENTS AGAINST INSURERS
Under insurance insolvency or guaranty laws in most states in which the
Company operates, insurers doing business therein can be assessed for
policyholder losses covered by insolvent insurance companies. The amount and
timing of any future assessments on the Company under these laws cannot be
reasonably estimated and are beyond the control of the Company. Recent
financial difficulties of insurance companies increase the probability of
assessments under these laws. Most of these laws do provide, however, that an
assessment may be excused or deferred if it would threaten an insurer's
financial strength. The Company generally accrues the full amount of the
assessment upon notification.
LEGISLATION AT FEDERAL LEVEL
Although the federal government generally does not directly regulate the
insurance business, federal initiatives often have an impact on the business in
a variety of ways. Current and proposed federal measures which may
significantly affect the insurance business include employee benefits
regulation, limitation on anti-trust immunity, minimum solvency requirements and
removal of barriers preventing banks from engaging in the insurance business.
The Company is monitoring the following federal proposals:
NATURAL DISASTER ACT--Recent natural disasters such as Hurricane Andrew,
the Midwestern floods and the Northridge Earthquake have sparked debate on the
best way to provide affordable insurance coverage for such events. At this
time, the Company supports the proposed Natural Disaster Act as the most
desirable alternative.
MCCARRAN-FERGUSON ACT--The repeal of the McCarran-Ferguson Act has long
been a topic of considerable debate. Congress has conducted numerous hearings
on the issue, but has taken no action. The current legislature is inclined to
drop the proposal.
SUPERFUND REFORM (ENVIRONMENTAL LIABILITY)--Environmental liability and
the methods of funding the cleanup of polluted sites received considerable
attention in Congress during 1995. The Superfund Reform '95 Coalition lobbied
for reform of the original law including full repeal of the retroactive
liability standard. In the past, insurance industry supporters have suggested a
general tax on all insurers to pay for the cleanup rather than requiring
retroactive liability. The Company would not be significantly affected by any
retroactive tax assessments since the Company did not write a large volume of
liability insurance prior to 1984. However, if a tax is levied against current
liability writers for prior pollution losses, the Company could have some tax
exposure.
NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS
The National Association of Insurance Commissioners (NAIC) facilitates
the regulation of multi-state companies through uniform reporting requirements,
standardized procedures for financial examinations, and uniform regulatory
procedures embodied in model acts and regulations. Current developments address
the reporting and regulation of the adequacy of capital and surplus.
The NAIC has developed Property-Casualty Risk-Based Capital (RBC)
standards that relate an insurer's reported statutory surplus to the risks
inherent in its overall operations. The RBC formula uses the statutory annual
statement to calculate the minimum indicated capital level to support asset
(investment and credit) risk and underwriting (loss reserves, premiums written,
and unearned premium) risk. The NAIC model law calls for various levels of
regulatory action based on the magnitude of an indicated RBC capital deficiency,
if any. The RBC standards became effective for 1994 annual statement filings.
The Company continues to monitor its subsidiaries' internal capital requirements
and the NAIC's RBC developments. The Company has determined that its capital
levels are well in excess of the minimum capital requirements for all RBC action
levels. Management believes that its capital levels are sufficient to support
the level of risk inherent in its operations.
21
<PAGE>
AGENCY LICENSES AND TRADEMARKS
Replacement Lens Inc. and RLI Insurance Agency Ltd., or their designated
employees, must be licensed to act as resident or non-resident brokers or agents
by regulatory authorities in the states or provinces in which they operate.
Replacement Lens Inc. obtained service mark registration of the letters
"RLI" in 1978 and currently maintains such registration in 47 states. Such
registration protects the mark from deceptively similar use by the Company's
competitors. The duration of this registration is ten years for all states
except three in which registration is limited to five years unless renewed.
Duration of the registration in the State of Wisconsin is twenty years.
CLIENTELE
No significant part of the Company's or its subsidiaries' business is
dependent upon a single client or upon a very few clients, the loss of any one
of which would have a material adverse effect on the Company.
EMPLOYEES
The Company employs a total of 570 associates. Of that total, 222 work
for RLI Vision Corp. and 348 work for RLI Insurance Company. Of the 570 total
associates, 57 are part-time and 513 are full-time.
(d) Financial Information about Foreign and Domestic Operations and Export
Sales.
For purposes of this discussion, foreign operations are not considered
material to the Company's overall operations.
22
<PAGE>
ITEM 2.PROPERTIES
The Company owns a two-story, 80,000 square foot building in Peoria,
Illinois, which serves as the Corporate Headquarters for RLI Corp., RLI
Insurance Company and Mt. Hawley Insurance Company. Two RLI Insurance Company
Branch Offices also lease office space in this building.
Located on the same 29.2 acre campus, is a 2,500 square foot facility
leased to a day care facility, and a 600 square foot condominium, attached to
the day care building.
The Company also owns a 12,800 square foot building near the
headquarters building. Nearly 9,800 square feet of this building are used as
warehouse storage for records and equipment. The remaining 3,000 square feet is
leased to RLI Vision Corp., as a part of its contact lens distribution center.
In addition, the Company owns a 19,000 square foot building near the
headquarter building that is leased to RLI Vision Corp., which is used as the
subsidiary's headquarters.
RLI Vision Corp. also owns a 16,000 square foot building located in
Cohasset, Massachusetts, a 2,700 square foot office condominium building located
in Bedford, Massachusetts, and a 3,000 square foot building located in
Lewistown, Maine, as well as the 10 acres on which these buildings are located.
All other operations of RLI Corp. lease the office space which they need
in various locations throughout the country.
Item 3. LEGAL PROCEEDINGS
The Company is involved in certain legal proceedings and disputes
considered by management to be ordinary and incidental to the business or which
have no foundation in fact. Management believes that valid defenses exist as to
all such litigation and disputes, and is of the opinion that these will not have
a material effect on the Company's consolidated financial statements.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted by the Company to a vote of security holders
during the fourth quarter of the fiscal year covered by this report.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Refer to the Corporate Data on page 53 of the Annual Report to
Shareholders for the year ended December 31, 1995 attached in Exhibit 13.
Item 6. SELECTED FINANCIAL DATA
Refer to the Selected Financial Data on pages 22 through 23 of the
Annual Report to Shareholders for the year ended December 31, 1995 attached in
Exhibit 13.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Refer to the Management's Discussion and Analysis of Financial Condition
and Results of Operations on pages 24 through 31 of the Annual Report to
Shareholders for the year ended December 31, 1995 attached in Exhibit 13.
23
<PAGE>
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Refer to the consolidated financial statements and supplementary data
included on pages 32 through 49 of the Annual Report to Shareholders for the
year ended December 31, 1995 attached in Exhibit 13. (See Index to Financial
Statements and Schedules attached on page 27.)
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no changes in accountants or disagreements with accountants
on any matters of accounting principles or practices or financial statement
disclosure.
PART III
Items 10 to 13.
Pursuant to General Instructions G(3) of Form 10-K, Items 10 to 13,
inclusive, have not been restated or answered since the Company intends to file
within 120 days after the close of its fiscal year with the Securities and
Exchange Commission a definitive proxy statement pursuant to Regulation 14A
under the Securities Exchange Act of 1934, which proxy statement involves the
election of directors. The information required in these items 10 to 13,
inclusive, is incorporated by reference to that proxy statement.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (l-2) Consolidated Financial Statements and Schedules. See Index to
Financial Statements and Schedules attached.
(3) Exhibits. See Exhibit Index on page 27.
(b) No reports on Form 8-K were filed during the last quarter of 1995.
(c) Exhibits. See Exhibit Index on page 27.
(d) Financial Statement Schedules. The schedules included on attached pages
28 through 38 as required by Regulation S-X are excluded from the
Company's Annual Report to Shareholders. See Index to Financial
Statements and Schedules on page 27. There is no other financial
information required by Regulation S-X which is excluded from the
Company's Annual Report to Shareholders.
24
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
RLI Corp.
(Registrant)
By: /s/Joseph E. Dondanville
------------------------------------
J. E. Dondanville
Vice President, Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: March 7, 1996
----------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By: /s/Gerald D. Stephens
------------------------------------
G. D. Stephens, President
(Principal Executive Officer)
Date: March 7, 1996
----------------------------------
* * * * *
By: /s/Joseph E. Dondanville
------------------------------------
J. E. Dondanville, Vice President,
Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: March 7, 1996
----------------------------------
* * * * *
By: /s/Gerald D. Stephens
------------------------------------
G. D. Stephens, Director
Date: March 7, 1996
----------------------------------
* * * * *
By: /s/Bernard J. Daenzer
------------------------------------
B. J. Daenzer, Director
Date: March 7, 1996
----------------------------------
* * * * *
By: /s/Richard J. Haayen
------------------------------------
R. J. Haayen, Director
Date: March 7, 1996
----------------------------------
* * * * *
By: /s/William R. Keane
------------------------------------
W. R. Keane, Director
Date: March 7, 1996
----------------------------------
* * * * *
25
<PAGE>
By: /s/Gerald I. Lenrow
------------------------------------
G. I. Lenrow, Director
Date: March 7, 1996
----------------------------------
* * * * *
By: /s/John S. McGuinness
------------------------------------
J. S. McGuinness, Director
Date: March 7, 1996
----------------------------------
* * * * *
By: /s/Edwin S. Overman
------------------------------------
E. S. Overman, Director
Date: March , 1996
----------------------------------
* * * * *
By: /s/Edward F. Sutkowski
------------------------------------
E. F. Sutkowski, Director
Date: March 7, 1996
----------------------------------
* * * * *
By: /s/Robert O. Viets
------------------------------------
R. O. Viets, Director
Date: March 7, 1996
----------------------------------
* * * * *
26
<PAGE>
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
Reference (Page)
<S> <C>
DATA SUBMITTED HEREWITH:
Report of Independent Auditors 28
Schedules:
I. Summary of Investments - Other than Investments
in Related Parties at December 31, 1995. 29
II. Condensed Financial Information of Registrant
for the three years ended December 31, 1995. 30 - 34
III. Supplementary Insurance Information for the
three years ended December 31, 1995. 35 - 36
IV. Reinsurance for the three years ended
December 31, 1995. 37
V. Valuation and Qualifying Accounts 38
VI. Supplemental Information Concerning Property-
Casualty Insurance Operations for the three
years ended December 31, 1995. 35 - 36
</TABLE>
Schedules other than those listed are omitted for the reason that they are
not required, are not applicable or that equivalent information has been
included in the financial statements, and notes thereto, or elsewhere herein.
27
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
RLI Corp.:
Under date of January 25, 1996, we reported on the consolidated balance sheets
of RLI Corp. and subsidiaries as of December 31, 1995 and 1994, and the related
consolidated statements of earnings, shareholders' equity, and cash flows for
each of the years in the three-year period ended December 31, 1995, as contained
in the 1995 annual report to shareholders. These consolidated financial
statements and our report thereon are incorporated by reference in the annual
report on Form 10-K for the year 1995. In connection with our audits of the
aforementioned consolidated financial statements, we also have audited the
related financial statement schedules as listed in the accompanying index.
These financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statement schedules based on our audits.
In our opinion, the financial statement schedules, when considered in relation
to the basic consolidated financial statements taken as a whole, present fairly,
in all material respects, the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, in 1994 the
Company adopted the provisions of the Financial Accounting Standards Board's
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," and in 1993 the Company adopted the
provisions of the Financial Accounting Standards Board's Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes."
KPMG Peat Marwick LLP
Chicago, Illinois
January 25, 1996
28
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE I--SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS
IN RELATED PARTIES
DECEMBER 31, 1995
<TABLE>
<CAPTION>
Column A Column B Column C Column D
Amount
at Which
Shown in
Fair the Balance
Type of Investment Cost(1) Value Sheet
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Fixed maturities:
Bonds:
Held-to-maturity
United States government and government agencies
and authorities $148,846,846 $156,517,125 $148,846,846
States, municipalities and political subdivisions 102,292,482 103,931,411 102,292,482
Foreign governments 498,208 509,260 498,208
- -------------------------------------------------------------------------------------------------------------------------
Total held-to-maturity 251,637,536 260,957,796 251,637,536
- -------------------------------------------------------------------------------------------------------------------------
Available-for-sale
United States government and government agencies
and authorities 33,730,335 34,767,197 34,767,197
All other corporate bonds 10,260,003 10,352,614 10,352,614
- -------------------------------------------------------------------------------------------------------------------------
Total available-for-sale 43,990,338 45,119,811 45,119,811
- -------------------------------------------------------------------------------------------------------------------------
Total fixed maturities 295,627,874 306,077,607 296,757,347
- -------------------------------------------------------------------------------------------------------------------------
Equity securities, available-for-sale:
Common stock:
Public utilities 34,002,905 47,747,375 47,747,375
Banks, trusts and insurance companies 9,353,637 15,684,039 15,684,039
Industrial, miscellaneous and all other 59,224,292 90,526,121 90,526,121
- -------------------------------------------------------------------------------------------------------------------------
Total equity securities 102,580,834 153,957,535 153,957,535
- -------------------------------------------------------------------------------------------------------------------------
Short-term investments 23,874,732 23,874,732 23,874,732
- -------------------------------------------------------------------------------------------------------------------------
Total investments $422,083,440 $483,909,874 $474,589,614
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
Note: See notes 1D and 2 of Notes to Consolidated Financial Statements.
(1) Original cost of equity securities and, as to fixed maturities, original
cost reduced by repayments and adjusted for amortization of premiums or accrual
of discounts.
29
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
DECEMBER 31, 1994 AND 1995
<TABLE>
<CAPTION>
1994 1995
(restated)
- ------------------------------------------------------------------------------------
ASSETS
<S> <C> <C>
Cash $ 1,426,075 $ 236,902
Investments in consolidated subsidiaries, at equity 173,544,318 199,299,589
Equity securities available-for-sale, at fair value
(Cost--$6,897,359 in 1994 and $6,667,195 in 1995) 6,369,104 8,138,847
Investment in Rabbi Trust 1,717,187 2,817,965
Deferred debt costs 1,052,030 928,865
Income taxes recoverable 2,556,129 537,838
Property and equipment 1,119,976 1,090,713
Other assets 288,507 238,615
- ------------------------------------------------------------------------------------
Total assets $188,073,326 $213,289,334
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable, current $ 911,666 $ 1,163,723
Notes payable, short-term 2,800,000
Long-term debt:
Convertible debentures 46,000,000 46,000,000
Industrial development bonds 6,255,000
Deferred compensation--Rabbi Trust 1,717,187 2,817,965
Interest payable--Convertible debentures 1,265,000 1,265,000
Other liabilities 754,512 634,930
- ------------------------------------------------------------------------------------
Total liabilities 56,903,365 54,681,618
- ------------------------------------------------------------------------------------
Shareholders' equity:
Common stock ($1 par value, authorized
12,000,000 shares, issued 6,762,905 shares
in 1994 and 8,453,449 in 1995) 6,762,905 8,453,449
Other shareholders' equity 127,807,805 153,544,590
Treasury shares at cost (604,015 shares in 1994
and 602,567 shares in 1995) (3,400,749) (3,390,323)
- ------------------------------------------------------------------------------------
Total shareholders' equity 131,169,961 158,607,716
- ------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $188,073,326 $213,289,334
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
</TABLE>
See notes to condensed financial information.
NOTE: See also Notes to Consolidated Financial Statements.
30
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
CONDENSED STATEMENTS OF EARNINGS
YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1993 1994 1995
(restated) (restated)
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net investment income (expense) $ 62,362 $ 146,815 $ 69,603
Selling, general, and administrative expenses 1,679,686 2,845,289 2,093,019
Interest expense on debt 1,855,697 3,431,464 3,347,378
- ---------------------------------------------------------------------------------------------------------------------------
(3,473,021) (6,129,938) (5,541,278)
Income tax benefit (1,499,612) (2,312,907) (2,147,995)
- ---------------------------------------------------------------------------------------------------------------------------
Net loss before equity in net earnings of subsidiaries
and cumulative effect of accounting change (1,973,409) (3,817,031) (3,393,283)
Equity in net earnings (loss) of subsidiaries 17,014,460 (958,840) 11,342,824
- ----------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) before cumulative effect of accounting change 15,041,051 (4,775,871) 7,949,541
Cumulative effect to January 1, 1993 of initial application of
SFAS 109 "Accounting for Income Taxes" 906,576
- ----------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $15,947,627 $(4,775,871) $7,949,541
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
See notes to condensed financial information.
NOTE: See also Notes to Consolidated Financial Statements.
31
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1993 1994 1995
(restated) (restated)
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Losses before equity in net earnings of subsidiaries $ (1,066,833) $ (3,817,031) $(3,393,283)
Adjustments to reconcile net losses to net
cash provided by operating activities:
Write-down of investments 10,000 9,597
Other items, net (9,988) 445,597 (407,586)
Change in:
Affiliate balances payable (33,356) (10,058) 135,916
Federal income taxes (1,349,388) (1,034,695) 1,658,597
Deferred debt costs (1,187,938) 135,908 123,165
- ---------------------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (3,637,503) (4,270,682) (1,883,191)
- ---------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchase of:
Equity securities, available-for-sale (5,380,075) (1,995,106) (857,883)
Property and equipment (85,888) (1,054,894) (9,600)
Sale of:
Equity securities, available-for-sale 300,000 433,263 1,004,380
Capital contributions to subsidiaries (32,500,000)
Cost of investment in related parties (4,765,619)
Cash dividends received-subsidiaries 2,768,947 6,340,282 7,823,965
- ----------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (39,662,635) 3,723,545 7,690,862
- ----------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Payments on debt (745,000) (6,255,000)
Proceeds from issuance of debt 46,000,000 2,800,000
Fractional share paid 4,010
Treasury shares reissued 4,043,970 2,513,375 33,667
Cash dividends paid (3,132,338) (3,461,217) (3,849,521)
- ----------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 46,911,632 (1,692,842) (7,266,844)
- ----------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 3,611,494 (2,239,979) (1,189,173)
Cash at beginning of year 54,560 3,666,054 1,426,075
- ----------------------------------------------------------------------------------------------------------------------------
Cash at end of year $ 3,666,054 $ 1,426,075 $ 236,902
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
Interest paid on outstanding debt for 1993, 1994, and 1995 amounted to $682,500,
$3,345,714, and $3,372,479, respectively.
See notes to condensed financial information.
NOTE: See also Notes to Consolidated Financial Statements.
32
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
NOTES TO CONDENSED FINANCIAL STATEMENTS
The accompanying condensed financial statements should be read in conjunction
with the consolidated financial statements and notes thereto of RLI Corp. and
subsidiaries (the Company).
(1) Significant Event
In September 1995, the Company strengthened loss reserves related to the January
17, 1994 Northridge Earthquake. While relatively minor development had occurred
throughout the first six months of 1995, the third quarter claim-by-claim review
indicated that greater future development was likely. The overall 1995 impact
from the Northridge Earthquake was a reduction to after-tax earnings by $18.6
million or $2.37 per share.
The additional development resulted, in part, from hidden damages and increased
business interruption losses on the Company's excess policies which, in 1994,
were estimated by adjusters to be well within coverage limits of the primary and
underlying excess layers. Also contributing to the increased development were
unanticipated building code enactments, escalating construction costs, and the
impact of reopened claims as a result of the involvement of public adjusters.
(2) Convertible Debentures
On July 28, 1993, RLI Corp. issued $46.0 million of 6.0% convertible debentures
which mature July 15, 2003 and pay interest semi-annually. RLI Corp. received
$45,080,000 in net proceeds from the issue of which $30,500,000 was contributed
to the insurance subsidiaries and $2,000,000 to RLI Vision Corp., the ophthalmic
subsidiary. The balance has been retained for general corporate purposes. RLI
Corp. incurred underwriting and related costs associated with the issuance of
the debentures of $1,245,000 which will be amortized over a 120-month period.
(3) Acquisition
On May 4, 1995, RLI Vision Corp. (formerly known as RLI Professional
Technologies, Inc.), a wholly-owned subsidiary of RLI Corp., acquired through
merger, Target Industries, Inc., a wholesale optical goods distributor of
contact lenses, Rx spectacles, frames and sunglasses, located in Cohasset,
Massachusetts. As consideration, RLI Corp. issued 313,500 shares of its common
stock. The combined enterprise is now doing business under the name of RLI
Vision Corp. This business combination has been accounted for as a
pooling-of-interests. The consolidated financial statements and related
financial information for periods prior to the combination have been restated to
include the accounts and results of operations of Target Industries, Inc.
(4) Income Taxes
The Company files a consolidated income tax return. Tax provisions for 1993,
1994, and 1995 were computed and apportioned to the subsidiaries on the basis of
separate tax return liabilities.
The Company adopted SFAS 109, "Accounting for Income Taxes" as of January 1,
1993. The cumulative effect of this change allocated to RLI Corp. of $906,576 is
shown as a separate component on the RLI Corp. income statement. The cumulative
effect of the charge allocated to the subsidiaries of $758,424 is included in
the "Equity in net earnings of subsidiaries."
(continued)
33
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
NOTES TO CONDENSED FINANCIAL STATEMENTS
(5) Deferred Compensation
The Company has a directors deferred compensation plan, and excess ESOP plan for
key employees, through which shares of RLI Corp. common stock are purchased by
the Company for the directors and key employees. In 1993, the Company funded
these plans by establishing Rabbi Trusts. Since the assets of the Rabbi Trusts
are subject to claims of the Company's general creditors, such assets are
recorded as "Investment in Rabbi Trusts" in the accompanying balance sheet. A
corresponding liability for the same amount, which represents the Company's
liability to its directors and key employees, is reflected as "Deferred
Compensation--Rabbi Trusts."
(6) Stock Split
In the second quarter of 1995, the Company announced a 5-for-4 stock split.
Share and per share data have been restated to reflect the impact of the split.
34
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION
SCHEDULE VI--SUPPLEMENTARY INFORMATION CONCERNING
PROPERTY-CASUALTY INSURANCE OPERATIONS
YEARS ENDED DECEMBER 31, 1993, 1994, AND 1995
<TABLE>
<CAPTION>
Column A Column B Column C (1) Column E (1) Column F Column H
Incurred
Deferred Unpaid Losses and
policy losses and settlement
acquisition settlement Unearned Premiums expenses
Segment costs expenses, net premiums, net earned Current year
- ------------------------------------------------------------------------------------------------------------
Year ended
December 31, 1993
<S> <C> <C> <C> <C> <C>
RLI Insurance Group $18,722,395 $165,558,994 $72,362,259 $125,989,278 $ 81,589,111
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
Year ended
December 31, 1994
RLI Insurance Group $19,208,212 $195,229,244 $78,839,454 $140,184,488 $100,534,321
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
Year ended
December 31, 1995
RLI Insurance Group $15,806,911 $221,648,494 $75,824,217 $133,468,133 $ 62,618,745
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
</TABLE>
NOTE 1: The Company adopted Statement of Financial Accounting Standards No.
113, "Accounting and Reporting for Reinsurance of Short-Duration and
Long-Duration Contracts" ("SFAS 113"), in the first quarter of 1993. This
resulted in grossing up assets and liabilities for ceded reinsurance
recoverables on unpaid losses and ceded unearned premiums with no impact on
earnings or shareholders' equity. Included above is unpaid losses and settlement
expenses and unearned premiums net of applicable ceded amounts. See the
consolidated balance sheets for gross and ceded amounts.
NOTE 2: Investment income is not allocated to the segments, therefore net
investment income (column G) has not been provided.
35
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION
SCHEDULE VI--SUPPLEMENTARY INFORMATION CONCERNING
PROPERTY-CASUALTY INSURANCE OPERATIONS
(CONTINUED)
YEARS ENDED DECEMBER 31, 1993, 1994, AND 1995
<TABLE>
<CAPTION>
Column A Column H Column I Column J Column K
Incurred
Losses and
settlement Policy Other Net
expenses acquisition operating Premiums
Segment Prior year costs expenses written
- ---------------------------------------------------------------------------------------------------
Year ended
December 31, 1993
<S> <C> <C> <C> <C>
RLI Insurance Group $(1,851,708) $27,640,459 $15,062,838 $143,531,051
- --------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------
Year ended
December 31, 1994
RLI Insurance Group $ 1,107,345 $47,106,098 $15,142,384 $146,661,684
- ---------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------
Year ended
December 31, 1995
RLI Insurance Group $23,271,250 $43,042,045 $14,470,053 $130,452,895
- ---------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------
</TABLE>
36
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE IV--REINSURANCE
FOR THE YEARS 1993, 1994, AND 1995
<TABLE>
<CAPTION>
Column A Column B Column C Column D Column E Column F
Percentage
Ceded to Assumed of Amount
Gross Other From Other Net Assumed to
Amount Companies Companies Amount Net
- --------------------------------------------------------------------------------------------------------------------------------
1993
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
RLI Insurance Group
premiums earned $233,757,304 $108,272,489 $504,463 $125,989,278 .4%
- --------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
1994
- --------------------------------------------------------------------------------------------------------------------------------
RLI Insurance Group
premiums earned $265,453,514 $125,458,397 $189,371 $140,184,488 .1%
- --------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
1995
- --------------------------------------------------------------------------------------------------------------------------------
RLI Insurance Group
premiums earned $264,651,370 $131,771,599 $588,362 $133,468,133 .4%
- --------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
NOTES: Column B, "Gross Amount" includes only direct premiums earned.
37
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE V--VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 3, 1993, 1994, AND 1995
<TABLE>
<CAPTION>
Column A Column B Column C Column D Column E
Balance at Amounts Balance
beginning of charged to Amounts Amounts at end
period expense written-off commuted of period
- ------------------------------------------------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C> <C> <C>
1993 Allowance for
insolvent reinsurers $15,380,668 $1,163,278 $ (2,234) $ (939,564) $15,602,148
1994 Allowance for
insolvent reinsurers $15,602,148 $1,000,000 $(1,054,748) -- $15,547,400
1995 Allowance for
insolvent reinsurers $15,547,400 $ 613,296 $261,373 $ (85,923) $16,336,146
</TABLE>
38
<PAGE>
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION OF DOCUMENT REFERENCE (PAGE)
2.1 Plan of Reorganization Incorporated by reference to the
and Agreement of Merger Company's Quarterly
Form 10-Q for the First Quarter
ended March 31, 1993.
2.2 Articles of Merger Incorporated by reference to the
Company's Quarterly
Form 10-Q for the Second Quarter ended
June 30, 1993.
3.1 Articles of incorporation Incorporated by reference to the
Company's Quarterly Report
on Form 10-Q for the Second Quarter
ended June 30, 1993.
3.2 By-Laws
Incorporated by reference to the
Company's Quarterly Report
on Form 10-Q for the Second Quarter
ended June 30, 1993.
4.1 Indenture dated July Incorporated by reference to the
28, 1993 between the Company's Registration
Company and Norwest Bank Statement on Form S-3 filed on
July 21, 1993.
Minnesota, National
Association as Trustee
10.1 Executive Achievement Incorporated by reference to the
Target Salary Plan Company's Registration
Statement on Form S-2 filed on
August 22, 1985,
File No. 0-6612.
10.2 The William R. Keane/ Incorporated by reference to the
RLI Corp. Director Company's Registration
Deferred Compensation Statement on Form 10-Q for the Second
Plan Quarter ended June 30, 1993.
10.3 The RLI Corp. Directors' Incorporated by reference to the
Irrevocable Trust Company's Registration
Agreement Statement on Form 10-Q for the Second
Quarter ended June 30, 1993.
10.4 Key Employee Excess Incorporated by reference to the
Benefit Plan for Company's Annual Form 10-K/A for the
Gerald D. Stephens year ended December 31, 1992.
10.5 RLI Corp. Incentive Incorporated by reference to Company's
Stock Option Plan Registration Statement on Form S-8
filed on March 11, 1996, File
No. 333-01637
10.9 Reinsurance Agreements Incorporated by reference to the
between the Company and Company's Annual Form 10-K/A for the
American Re-Insurance year ended December 31, 1992.
Company
10.10 Reinsurance Agreements Incorporated by reference to the
between the Company and Company's Annual Form 10-K/A
Lloyds of London for the year ended December 31, 1992.
10.11 Reinsurance Agreements Incorporated by reference to the
between the Company Company's Annual Form 10-K/A for the
and NAC Reinsurance Corp. year ended December 31, 1992.
11.0 Statement re computation Attached page 41.
of per share earnings
13.1 Refer to the Annual Attached Exhibit 13.
Report to Shareholders
for the year ended
December 31, 1995, pages
22-49 and 53.
39
<PAGE>
EXHIBIT NO. DESCRIPTION OF DOCUMENT REFERENCE (PAGE)
21.1 Subsidiaries of the Attached page 42.
Registrant
23.1 Consent of KPMG Peat Attached page 43.
Marwick LLP
23.2 Consent of KPMG Peat Incorporated by reference to the
Marwick LLP Company's Registration
Statement on Form S-3 filed
July 21, 1993.
23.3 Consent of Kirkland &
Ellis Incorporated by reference to the
Company's Registration Statement on
Form S-3 filed July 21, 1993.
24.1 Powers of Attorney Incorporated by reference to the
Company's Registration Statement on
Form S-3 filed on July 21, 1993.
27 Financial Data Schedule Attached Exhibit 27
29.1 Information from reports Attached page 44
furnished to state
insurance regulatory
authorities
40
<PAGE>
EXHIBIT 11.0
RLI CORP. AND SUBSIDIARIES
COMPUTATION OF PER SHARE EARNINGS
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994, AND 1995
<TABLE>
<CAPTION>
1993 1994 1995
(restated) (restated)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Primary
Net earnings (loss) $15,947,627 $(4,775,871) $ 7,949,541
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
Earnings (loss) per share $2.10 $(0.61) $1.01
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding 7,599,563 7,786,004 7,849,799
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
Fully Diluted
Net earnings (loss) $15,947,627 $(4,775,871) $ 7,949,541
Reduction of interest expense on assumed conversion
of convertible debentures (net of tax) 762,450 Note (1) Note (1)
Reduced amortization of deferred loan costs on assumed
conversion of convertible debentures (net of tax) 37,091 Note (1) Note (1)
- -----------------------------------------------------------------------------------------------------------------------
Adjusted net earnings (loss) $16,747,168 $(4,775,871) $ 7,949,541
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
Earnings (loss) per share (1) $2.00 $(0.61) $1.01
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding (1) 7,599,563 7,786,004 7,849,799
Dilutive effect of convertible debentures (2) 761,012 Note (1) Note (1)
Adjusted weighted average shares outstanding 8,360,575 7,786,004 7,849,799
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
NOTES:
(1) Fully diluted earnings per share calculations are based on the weighted
average number of shares of common stock and common stock equivalents
outstanding for the period, assuming full conversion of all convertible
debentures into common stock. Net earnings are adjusted for purposes of this
calculation to eliminate interest and amortization of debt issuance costs on the
convertible debentures net of related income taxes. When the conversion of
convertible debentures increases the earnings per share or reduces the loss per
share, the effect on earnings is antidilutive. Under these circumstances the
fully diluted net earnings or net loss per share is computed assuming no
conversion of the convertible debentures.
(2) On July 28, 1993, RLI Corp. issued $46 million in 6.0% convertible
debentures which mature July 15, 2003. These debentures, unless previously
redeemed, are convertible at the option of the holder at any time prior to
maturity into RLI Corp. common stock at an adjusted conversion price of $26.00
per share, subject to adjustment in certain events. (See Note 4 in the "Notes to
Consolidated Financial Statements" for additional information.)
41
<PAGE>
EXHIBIT 13
SELECTED FINANCIAL DATA
The following is selected financial data of RLI Corp. and Subsidiaries for the
eleven years ended December 31, 1995:
<TABLE>
<CAPTION>
1985 1986 1987 1988 1989
- --------------------------------------------------------------------------------------------------------------------------------
OPERATING RESULTS
<S> <C> <C> <C> <C> <C>
Gross sales $161,273,603 195,805,801 151,492,336 143,785,384 149,230,331
Total revenue $69,619,102 111,029,407 106,846,379 104,279,172 89,984,262
Net earnings (loss) $4,321,537 10,978,773 13,965,174 7,253,913 8,200,264
Growth in shareholder value 14.6% 30.1% 26.2% 14.4% 18.1%
Net cash provided from operating activities $43,186,139 31,600,447 9,151,857 27,742,205 22,801,043
Net premiums written to statutory surplus 194% 190% 156% 131% 96%
GAAP combined ratio 101.3 93.5 84.4 96.1 97.8
Statutory combined ratio 102.5 89.5 84.7 98.3 99.5
FINANCIAL CONDITION
Total investments $100,410,988 131,902,026 152,777,063 165,956,870 177,025,151
Total assets $283,575,812 321,883,748 364,740,628 372,492,257 402,906,191
Unpaid losses and settlement expenses $119,457,576 159,383,894 194,707,865 217,230,839 230,523,717
Long-term debt $7,000,000 7,000,000 7,000,000 7,000,000 7,000,000
Total shareholders' equity $36,310,127 49,291,745 57,763,851 64,026,271 70,276,175
Statutory surplus $37,037,118 54,063,188 57,453,264 60,151,725 68,571,173
SHARE INFORMATION (1)
Earnings (loss) per share:
Primary $.68 1.46 1.82 .97 1.14
Fully-diluted (2) $.68 1.46 1.82 .97 1.14
Cash dividends declared per common share $.18 .22 .25 .27 .30
Book value $4.84 6.37 7.73 8.57 9.94
Closing stock price $10.10 11.00 7.70 6.10 6.80
Stock split 167% 150%
Weighted average number of common shares outstanding:
Primary 6,348,426 7,526,375 7,704,938 7,475,369 7,189,076
Fully-diluted (2) 6,348,426 7,526,375 7,704,938 7,475,369 7,189,076
Common shares outstanding 7,500,000 7,738,619 7,475,369 7,475,369 7,073,718
===============================================================================================
</TABLE>
(1) Share and per share data have been restated to reflect the 5-for-4 stock
split that occurred on June 21, 1995.
(2) See note 1K to the consolidated financial statements.
(3) 1993 and 1994 information has been restated to include the accounts and
results of Target Industries, Inc., acquired through merger in 1995. Years prior
to 1993 have not been restated due to their immateriality. See note 1B to the
consolidated financial statements.
22
<PAGE>
SELECTED FINANCIAL DATA
The following is selected financial data of RLI Corp. and Subsidiaries for the
eleven years ended December 31, 1995:
<TABLE>
<CAPTION>
1990 1991 1992 1993 (3) 1994 (3) 1995
(restated) (restated)
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING RESULTS
<S> <C> <C> <C> <C> <C> <C>
Gross sales $181,215,877 215,497,602 232,223,865 295,675,237 330,895,139 328,440,941
Total revenue 92,957,578 102,342,998 129,757,326 172,295,163 190,695,564 190,549,112
Net earnings (loss) 14,267,002 16,800,050 16,207,127 15,947,627 (4,775,871) 7,949,541
Growth in shareholder value 17.0% 28.1% 18.2% 21.2% (5.9)% 23.9%
Net cash provided from operating
activities 45,388,065 22,918,206 42,885,435 72,290,506 27,277,853 24,298,768
Net premiums written to statutory
surplus 112% 95% 110% 94% 108% 76%
GAAP combined ratio 85.1 85.2 91.4 97.2 116.9 107.5
Statutory combined ratio 92.2 91.6 95.8 87.9 (4) 116.9 106.5
FINANCIAL CONDITION
Total investments 213,160,198 237,932,089 283,299,088 403,642,919 416,532,508 474,589,614
Total assets 432,379,562 483,571,862 529,660,099 673,866,304 757,803,069 814,647,141
Unpaid losses and settlement expenses 235,806,989 244,666,938 268,042,761 310,767,026 394,966,040 418,985,960
Long-term debt 7,000,000 7,000,000 7,000,000 53,000,000 52,255,000 46,000,000
Total shareholders' equity 79,850,942 99,677,983 117,392,751 140,706,372 131,169,961 158,607,716
Statutory surplus 70,409,590 88,605,319 100,584,758 152,261,509 136,124,530 172,312,961
SHARE INFORMATION (1)
Earnings (loss) per share:
Primary 2.02 2.38 2.26 2.10 (5) (0.61) 1.01
Fully-diluted (2) 2.02 2.38 2.26 2.00 (5) (0.61) 1.01
Cash dividends declared per common share .34 .37 .40 .42 .45 .51
Book value 11.29 14.09 16.30 18.25 16.71 20.20
Closing stock price 11.60 13.20 19.80 21.20 16.40 25.00
Stock split 125%
Weighted average number of common shares
outstanding:
Primary 7,073,718 7,073,718 7,158,890 7,599,563 7,786,186 7,849,799
Fully-diluted (2) 7,073,718 7,073,718 7,158,890 8,360,575 7,786,186 7,849,799
Common shares outstanding 7,073,718 7,073,718 7,201,343 7,711,065 7,849,443 7,850,882
================================================================================================================================
</TABLE>
(1) Share and per share data have been restated to reflect the 5-for-4 stock
split that occurred on June 21, 1995.
(2) See note 1K to the consolidated financial statements.
(3) 1993 and 1994 information has been restated to include the accounts and
results of Target Industries, Inc., acquired through merger in 1995. Years prior
to 1993 have not been restated due to their immateriality. See note 1B to the
consolidated financial statements.
(4) Contingent commission income recorded during 1993, from the cancellation of
a multiple-year, retrospectively-rated reinsurance contract, reduced the
statutory expense and combined ratio 10.3 points.
(5) Primary and fully-diluted earnings per share include $.22 per share and
$.20 per share, respectively, related to the initial application of SFAS 109
"Accounting for Income Taxes."
23
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OVERVIEW
RLI Corp. (the Company) is a holding company which, through its subsidiaries,
underwrites specialty property and casualty insurance and provides a wide range
of services and products to the ophthalmic industry.
The most significant segment of the Company is RLI Insurance Group (the Group),
which provides specialty property and casualty coverages primarily for
commercial risks. This segment accounted for 70.0% of the Company's total
revenue for 1995. As a niche insurer, the Group offers products geared to the
needs of those insureds generally overlooked by traditional insurance markets.
The Group's product mix is split almost evenly between property and casualty
coverages.
The property and casualty insurance business is cyclical and influenced by many
factors, including price competition, economic conditions, natural disasters,
interest rates, state regulations, court decisions, and changes in the law. One
of the unique and challenging features of the property and casualty insurance
business is that products must be priced before costs are fully known, because
premiums are charged before claims are incurred.
Property insurance results are subject to the variability introduced by natural
and man-made disasters such as earthquakes, fires and hurricanes. The Company's
major catastrophe exposure is to losses caused by earthquakes, since 75.1% of
the Company's 1995 total property premiums were written in California. The
Company limits its net aggregate exposure to a catastrophic event by purchasing
reinsurance and through extensive use of computer-assisted modeling techniques.
These techniques provide estimates of the concentration of risks exposed to
catastrophic events. Utilizing this approach, the Company attempts to limit its
net aggregate exposure to a single catastrophic event to less than 10% of total
shareholders' equity.
The casualty portion of the Group's business consists largely of Commercial and
Personal Umbrella and General Liability coverages. In addition, the Group
provides In-Home Business Owners coverage, Directors & Officers Liability,
Employers Excess Indemnity (EEI-an alternative to the Texas state-run workers'
compensation system) and Surety Bonds. The casualty book of business is subject
to the risk of accurately estimating loss reserves since the ultimate
disposition of a casualty claim may take several years to fully develop. The
casualty line is additionally affected by evolving legislation and court
decisions that define and expand the extent of coverage and the amount of
compensation due for injuries or losses.
The ophthalmic segment, RLI Vision Corp. (RLI Vision), provides eyecare
professionals with products and services to meet the needs of their practice.
These include: wholesale distribution of soft contact lenses, spectacle frames
and sunglasses; third party administration of extended service programs;
manufacturing rigid gas permeable (RGP) contact lenses and spectacle lenses; and
RLISYS practice management software.
The ophthalmic industry is extremely competitive and constantly evolving. In
addition, it experiences some seasonal declines during the first and fourth
quarters of the year. Recent advancements in technology have dramatically
improved the outlook for consumers with vision problems. In order to thrive in
this industry, a company must be highly efficient and extremely sensitive to the
needs of the consumer.
The consolidated financial statements and related notes found on pages 32-49
should be read in conjunction with the following discussion.
SIGNIFICANT DEVELOPMENTS
NORTHRIDGE EARTHQUAKE
In September 1995, the Company strengthened loss reserves related to the January
17, 1994 Northridge Earthquake. While relatively minor development had occurred
throughout the first six months of 1995, the third quarter claim-by-claim review
indicated that greater future development was likely. The overall 1995 impact
from the Northridge Earthquake was a reduction to after-tax earnings by $18.6
million or $2.37 per share.
This additional development resulted, in part, from hidden damages and increased
business interruption losses on the Company's excess policies which, in 1994,
were estimated by adjusters to be well within coverage limits of the primary and
underlying excess layers. Also contributing to the increased development were
unanticipated building code enactments, escalating construction costs, and the
impact of reopened claims as a result of the involvement of public adjusters.
AVIATION DIVISION SALE
On February 1, 1995, the Company completed the sale of its aviation division,
Aviation Underwriting Specialists (AUS), to AVEMCO Corporation of Frederick,
Maryland, resulting in an immaterial gain to the Company. Soft market
conditions, which are anticipated to continue, were the major cause of the
division's downturn. AUS had generated $13.5 million in aviation insurance
premiums in 1994, a portion of which the AVEMCO Group assumed through a
reinsurance arrangement between AVEMCO Insurance Company and RLI Insurance
Company.
OPHTHALMIC ACQUISITION
On May 4, 1995, the Company's subsidiary, RLI Professional Technologies, Inc.,
announced the acquisition through merger of Target Indus-
24
<PAGE>
tries, Inc., a wholesale optical goods distributor of contact lenses, Rx
spectacles, frames, and sunglasses. As consideration, the Company issued
313,500 shares of its common stock and, accordingly, the transaction was
accounted for as a pooling-of-interests. The combined entity operates under the
name of RLI Vision Corp. The resulting operating and product synergies, along
with the combined ability to provide $35 million in products and services, bode
well for the future success of RLI Vision Corp.
STOCK SPLIT
In the second quarter of 1995, the Company announced a 5-for-4 stock split.
RESTATEMENT
As a result of the merger with Target Industries, Inc., financial information
for 1993, 1994 and 1995 has been restated. Additionally, all share and per share
data has been restated as a result of the stock split.
YEAR ENDED DECEMBER 31, 1995, COMPARED
TO YEAR ENDED DECEMBER 31, 1994
Consolidated gross sales -- which consist of gross premiums written, RLI Vision
sales, net investment income and realized investment gains (losses) -- totaled
$328.4 million, a 0.7% decline from 1994. Consolidated revenue for 1995 was
$190.5 million, down 0.1% from 1994. These decreases were due to the
discontinuation of lines of business and a re-underwriting of the property book
of business resulting in a temporary decline in premiums. The specific declines
from discontinued business were $4.1 million from contact lens and $11.3 million
from Aviation. These decreases were partially offset by increases in investment
income and capital gains.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Year Ended December 31,
- --------------------------------------------------------------------------------
Gross sales (in thousands) 1993 1994 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Gross premiums written $249,369 $279,428 $271,436
RLI Vision Corp. sales 29,195 34,930 34,519
Net investment income 16,857 20,132 22,029
Realized investment gains (losses) 254 (3,595) 457
- --------------------------------------------------------------------------------
Total gross sales $295,675 $330,895 $328,441
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
Net after-tax earnings for the Company were $8.0 million ($1.01 per share) in
1995 compared to a net after-tax loss in 1994 of $4.8 million ($.61 per share).
The net after-tax impact of the Northridge Earthquake was a loss of $18.6
million ($2.37 per share) in 1995. The effect of the earthquake in 1994 was an
after-tax loss of $25.0 million ($3.21 per share). The following table compares
the Company's operating results for 1995 and 1994. Results are shown as actually
reported as well as adjusted for the Northridge Earthquake. All amounts are
shown in thousands, except per share data.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Without Earthquake
- --------------------------------------------------------------------------------
1994 1995 1994 1995
<S> <C> <C> <C> <C>
Premiums earned $140,184 $133,468 $158,197 $134,695
Other revenue 50,512 57,081 50,512 57,081
- --------------------------------------------------------------------------------
Consolidated revenue 190,696 190,549 208,709 191,776
- --------------------------------------------------------------------------------
Loss and settlement expenses 101,642 85,890 80,466 58,552
Policy acquisition costs 47,106 43,042 48,416 43,042
All other expenses 53,534 53,348 53,534 53,348
- --------------------------------------------------------------------------------
Total expenses 202,282 182,280 182,416 154,942
- --------------------------------------------------------------------------------
Earnings (loss) before income taxes (11,586) 8,269 26,293 36,834
Net earnings (loss) (4,775) 7,950 20,246 26,517
Primary net earnings (loss) per share (0.61) 1.01 2.60 3.38
Operating earnings (loss) per share $ (0.31) $0.97 $2.90 $3.34
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
In 1994, the Company's Board of Directors did not authorize a contribution to
the RLI Corp. Employee Stock Ownership Plan and Trust (ESOP). This decision
reduced expenses and thereby enhanced 1994 after-tax earnings by $1.6 million
($.21 per share). Realized capital losses recognized in 1994 reduced after-tax
earnings by $2.4 million ($.30 per share). Realized capital gains in 1995
increased after-tax earnings by $297,000 ($.04 per share).
RLI INSURANCE GROUP
While the effects of the Northridge Earthquake were still being felt in 1995,
they were offset to a large extent by the outstanding results from ongoing
operations of the Group. Including results from the earthquake, the Group's
pretax loss was $9.9 million, which was an improvement of $13.8 million over the
same period in 1994. The Group's overall property loss ratio, including
Northridge, improved 23 points to 75 in 1995 compared to 1994, largely due to
the elimination of unprofitable fire risks.
<PAGE>
Gross written premiums of $271.4 million were down 2.9%, off slightly from 1994
results. This was due to the Group's re-underwriting efforts designed to reduce
Difference In Conditions (DIC) exposure through reduced limits, fewer heavily
exposed policies and attachment at higher levels on large risks. As this
re-underwriting phase was completed toward the end of 1995, property premiums
began to increase accordingly. The Group also reduced its fire book of business
in selected areas by focusing on more profitable risks. Net premiums earned also
declined 4.8% to $133.5 million. The discontinued Aviation and contact lens
lines contributed to this decline.
Excluding the impact of the earthquake, the Group's pretax earnings increased
31.5% to $18.6 million from $14.2 million a year ago. This
25
<PAGE>
improvement was also reflected in the pre-quake combined ratio, calculated
according to GAAP, which was 86.2 in 1995 compared to 91.1 in 1994. Favorable
property loss experience contributed to this trend. While the pre-quake expense
ratio increased slightly in 1995 due to the decline in earned premiums, actual
operating expenses for the Group declined $6.0 million in 1995 compared to 1994.
Of this amount, $5.3 million was attributable to policy acquisition costs where
gross commission dropped $3.0 million due to the decline in gross written
premiums for 1995. Other insurance expenses were lower due mostly to the sale of
AUS, which resulted in 1995 expense savings of $2.1 million.
As described in note 6 of the consolidated financial statements, prior-year loss
reserves developed unfavorably by $23.3 million. This reflects $27.3 million of
development on the Northridge Earthquake claims alone. After adjusting for the
earthquake, favorable development of $4.0 million would have occurred, compared
to unfavorable development of $1.1 million in 1994. The 1995 pre-quake
development constitutes 2.0% of the total reserves for net loss and settlement
expenses.
RLI VISION CORP.
RLI Vision's 1995 revenue of $34.6 million was 1.8% higher than the $34.0
million attained in 1994. Revenue from ophthalmic products increased $892,000,
or 3.5%. This includes contact lenses and other distribution products, which
increased $754,000, or 3.5%, and the manufacturing of spectacle and RGP lenses,
which increased $137,000, or 3.8%. License fees from RLISYS practice management
software increased $370,000, or 36.3%, over 1994. Revenue for Vision Care
Advantage (VCA), RLI Vision's managed care product, increased $109,000, or
457.9%, due to a heavy marketing emphasis during the latter half of 1995.
Revenue from third party administration products, including Total Lens Care
(TLC) and Clear Advantage, decreased $609,000, or 8.5%, from 1994. This decrease
was due to the downward trend of these services throughout the ophthalmic
industry.
RLI Vision's pretax earnings for 1995 decreased 37.7% to $1.2 million from $1.9
million in 1994. Operating expenses increased by $1.3 million, or 4.1%, during
1995. This increase was largely attributable to the increase in cost of goods
sold of $876,000, or 4.7%, related to the increase in sales of ophthalmic
products. The operating expense increase was partially due to an increase of
$214,000 in collection costs; and increase of $107,000 due to the increased
marketing of VCA; and an increase of $221,000 in employee benefits from the
participation in the subsidiary's newly formed 401(k). No comparable employee
benefit contribution was made in 1994. Partially offsetting these increases was
a reduction of $176,000 in marketing expenses, primarily due to TLC.
INVESTMENT INCOME
Net dividend and interest income increased 9.4% during 1995. The increase was
due to the growth of assets throughout 1995 and from the reallocation of shorter
term securities into higher yielding, longer term fixed-income securities. The
Company realized $457,000 in capital gains in 1995 compared to $3.6 million in
realized losses in 1994. During 1994, certain equity securities were sold at a
net loss in order to recover $1.3 million in taxes paid on prior-year capital
gains. The opportunity to recover a portion of these tax dollars would have
expired at the end of 1994. Operating cash flows were down slightly for 1995,
declining to $24.3 million from $27.3 million in 1994. All cash flows in excess
of current needs were used to acquire fixed-income instruments, composed of
intermediate term, high grade tax-exempt securities and U.S. government and
agency securities.
The yields on the Company's fixed-income investments for the years ended
December 31, 1994 and 1995, respectively, were as follows:
<TABLE>
<CAPTION>
1994 1995
- -----------------------------------
<S> <C> <C>
Taxable 6.82% 6.84%
Tax-exempt 5.25% 5.06%
</TABLE>
Yields for 1995 declined as the bond market saw yields tumble nearly 200 basis
points. As a result, cash flows invested in tax-exempt securities were invested
at lower yields. The taxable segment of the portfolio saw a slight increase in
yield through the inclusion of callable agencies in the portfolio.
The investment results of the Company for the last five years are shown in the
following table. All amounts are shown in thousands.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
Tax Equivalent
Change in Annualized Annualized
Unrealized Return on Return on
Average Realized Appreciation Average Average
Invested Investment Gains (Depreciation) Invested Invested
Year Assets(1) Income(2)(3) (Losses)(3) (3)(4) Assets Assets
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1991 $225,546 $12,742 $1,234 $ 8,528 10.0% 11.0%
1992 260,616 13,483 921 3,546 6.9% 8.0%
1993 343,441 16,857 254 7,945 7.3% 8.3%
1994 410,058 20,133 (3,595) (5,749) 2.6% 3.6%
1995 445,562 22,029 457 36,037 13.1% 14.0%
5-yr. $338,133 $17,049 $ (146) $10,061 8.0% 9.0%
</TABLE>
(1) Average of amounts at beginning and end of year.
(2) Investment income, net of investment expenses, including non-debt interest
expense.
(3) Before income taxes.
(4) Relates to available-for-sale fixed maturities and equity securities.
- --------------------------------------------------------------------------------
26
<PAGE>
The annualized return for 1995 was greatly enhanced by the strong performance of
our equity portfolio. During 1995, the equity portfolio had unrealized
appreciation of $34.4 million.
INTEREST AND GENERAL CORPORATE EXPENSE
Interest expense on debt for 1995 was $3.3 million, down slightly from 1994.
General corporate expenses dropped $753,000 in 1995 due primarily to the 1994
contribution of $1.0 million to Bradley University to establish an insurance
chair as part of its curriculum.
INCOME TAXES
The Company's effective tax rate in 1995 was 3.9% on pretax earnings of $8.3
million. These earnings include $7.4 million of investment income which is
wholly or partially exempt from federal income tax. In 1994, the loss before
taxes was $11.6 million, with a tax benefit of $6.8 million, producing an
effective rate of 58%. Non-taxable investment income for 1994 was $7.8 million.
The Company had a net operating loss for tax purposes in 1994. The loss was
carried back to 1991 to recover federal and state income taxes paid. In
addition, the Company realized capital losses to be carried back as an offset to
capital gains in previous years. As a result, the Company carried back $3.6
million in capital losses realized in 1994 and recovered $1.3 million of taxes
paid in 1991, 1992, and 1993.
OUTLOOK FOR 1996
Aside from the recognition of additional earthquake development, the Company
demonstrated strong ongoing earnings potential which bodes well for the coming
year.
PROPERTY INSURANCE
The property line is projected to continue to represent about half of the total
gross premium written by the Group. The Group anticipates that rates will remain
steady throughout 1996. During 1995, exposure reduction and improvements in the
overall reinsurance program were emphasized. Reinsurance rate reductions of 15%
were achieved late in the year as the 1996 reinsurance placements were made.
These savings were utilized to increase protection above existing layers,
purchase a reinstatement cover, and buy lower level per risk coverage. These
strategies are designed to reduce earnings volatility and better control the
impact of earthquake and wind events in total. To illustrate, the total pretax
loss from Northridge for 1994 and 1995 combined was $66.4 million. With the
reduced exposure and improved reinsurance structure, the same event today would
produce a total pretax loss of only $12.5 million.
CASUALTY AND OTHER LINES
The Commercial Umbrella, Directors and Officers Liability, and Personal Umbrella
products are all expected to show continued increases in gross premium writings
during 1996, before consideration of acquisition or addition of new product
lines. Intense competition in the casualty market will likely discourage much
rate improvement.
General Liability business is expected to show modest growth on current branch
office products. However, new product development is expected to foster the bulk
of overall growth in this line.
Although the Group's Surety business has, to date, comprised a small amount of
the overall premium volume, the reported loss experience has been excellent. In
1996, to complement the existing distribution system, new ventures will be
pursued to significantly increase the written premiums on this program.
RLI VISION CORP.
During 1996, RLI Vision expects to see revenue grow through the distribution of
all ophthalmic products, including soft contact lenses, Rx spectacles, frames,
sunglasses, RGP lenses and license fees from the RLISYS practice management
software. Also, a recent increase in the marketing of the Vision Care Advantage
(VCA) product should produce an increase in revenue beginning in 1996.
The division continues to seek out possible acquisitions to enhance its current
product line and overall profitability.
YEAR ENDED DECEMBER 31, 1994, COMPARED
TO YEAR ENDED DECEMBER 31, 1993
RLI INSURANCE GROUP
The effects of the Northridge Earthquake overshadowed what was otherwise an
exceptional year for the Group. Gross premiums written surged to $279.4 million
in 1994, a 12.1% increase over 1993. Net premiums earned in 1994 increased to
$140.2 million, an 11.3% jump, despite the recognition of $18.0 million in ceded
reinsurance reinstatement premiums as a result of the earthquake. The Group
recorded a pretax loss of $23.7 million in 1994 compared to pretax earnings of
$3.5 million in 1993. Losses and expenses caused by the earthquake reduced
pretax earnings by $37.9 million. As a result of the earthquake, the combined
ratio, calculated according to GAAP, hit 116.9, making 1994 the only year of the
prior nine in which the ratio exceeded 100.
Net premiums earned, before the effects of the earthquake (pre-quake), increased
25.6%. The Company's property coverages saw rate increases of over 30% during
1994, with Difference In Conditions coverage regis-
27
<PAGE>
tering a rise of over 45% and Fire, a gain of approximately 10%. Also
contributing to the growth in premiums earned was EEI, a new line of business in
1993, that made excellent progress during 1994. Lastly, the Company revised its
property reinsurance program in 1994 and did not renew its multiple-year,
retrospectively-rated reinsurance contracts. This essentially reduced both ceded
premiums and ceded contingent commissions by $13.0 million.
The Group's pre-quake, pretax earnings increased to $14.2 million, more than
four times the level reported in 1993. Earned premium growth and favorable loss
experience were the primary reasons for the vast improvement. As a result, the
pre-quake GAAP combined ratio declined to 91.1 in 1994 from 97.2 in 1993, the
pre-quake loss ratio dropped to 50.9 in 1994 from 63.3 in 1993, and the
pre-quake expense ratio increased to 40.2 in 1994 compared to 33.9 in 1993. The
shift in the loss and expense ratios was caused by the revision of the property
reinsurance program noted above. Had the same reinsurance program been in place
during 1993, the 1993 loss and expense ratios would have approximated 57.4 and
40.1, respectively.
Pre-quake policy acquisition costs increased 75.2%, primarily because of the
$13.0 million reduction in ceding contingent commissions. Excluding the impact
from the change in the reinsurance program, pre-quake policy acquisition costs
would have increased 19.2% in 1994. This increase was largely due to the
increase in premiums earned along with changes in other ceding commissions. See
note 3 of the consolidated financial statements for additional details on policy
acquisition costs. Other insurance expenses were virtually unchanged from 1993.
The reserves for loss and settlement expenses held strong, minimizing the impact
of reserve development on current operations. As described in note 6 of the
consolidated financial statements, prior-year loss reserves developed
unfavorably by $1.1 million in 1994, and favorably by $1.9 million in 1993. The
1994 development represents approximately half of one percent of the reserves
for net loss and settlement expenses.
The Company has been successful in minimizing loss and settlement expense
reserve development by writing predominantly short-to-medium-tail liability
business, limiting its exposure to environmental liability, and constantly
reviewing and monitoring loss reserve levels.
RLI VISION CORP.
RLI Vision's 1994 revenue of $34.0 million was 16.4% higher than the $29.2
million attained in 1993. A significant part of the increase was due to growth
in TLC revenue. During 1994, TLC revenue increased by approximately $4.0 million
as RLI Vision converted customers from the contact lens insurance product to
TLC. Revenue from all ophthalmic distribution products and RLISYS licensing fees
increased 10.0% in 1994, while revenue from other RLISYS products and extended
services decreased 35.3% from 1993. This decrease was due primarily to the
discontinuation of the unprofitable computer hardware product.
RLI Vision's pretax earnings for 1994 increased 54.1% to $1.9 million from $1.2
million in 1993. Operating expenses increased by $4.1 million, or 14.8%, during
1994. This increase was largely due to expenses related to the TLC product.
Partially offsetting the increase in TLC expenses were decreased expenses on
other products. Cost-control measures and the restructuring of the sales force
during the third quarter of 1993 contributed significantly to these decreases.
Realignment and reduction of the sales territories decreased the number of sales
representatives and regional managers by 28.6%. While revenue generated by
products marketed through the sales force remained level in 1994, travel costs
declined by $180,000. Commissions and other direct selling expenses incurred on
the sale of computer hardware products decreased $610,000 during 1994. This
decrease coincided with the reduction in revenue generated by this discontinued
product. Also, since no ESOP contribution was made for 1994, RLI Vision's
employee benefits were reduced by approximately $360,000.
INVESTMENT INCOME
Net dividend and interest income increased 19.4% during 1994. The increase was
partly due to growth in invested assets during the second half of 1993 and
throughout 1994. Proceeds from a $46.0 million convertible debt offering in July
1993, along with increased premium writings during 1993 and 1994, were the key
contributors to this growth. The Company also recognized $3.6 million of
realized capital losses in 1994 compared to $254,000 of realized gains in 1993.
In the fourth quarter of 1994, the Company sold certain equity securities at a
net loss in order to recover $1.3 million in taxes paid on prior-year capital
gains. The opportunity to recover a portion of these tax dollars expired on
December 31, 1994.
Operating cash flows were $27.3 million for 1994, even though the Company paid
over $100 million to insureds for earthquake claims. Although cash flow was
positive, it decreased by $45.0 million from 1993, thereby diminishing the
potential growth of the Company's investment portfolio. Reinsurance recoveries
on earthquake losses were being collected on a timely basis. These
recoveries--coupled with increased premium production and short-term
investments--provided adequate funding for all current obligations, thus
eliminating any need to sell long-term securities to cover claim payments. All
operating cash flows in excess of current needs were used to acquire
fixed-income instruments, composed almost entirely of intermediate-term U.S.
government and agency securities.
28
<PAGE>
The yields on the Company's fixed-income investments for the years ended
December 31, 1993 and 1994, were as follows:
<TABLE>
<CAPTION>
1993 1994
- ----------------------------------------------------------
<S> <C> <C>
Taxable 6.94% 6.82%
Nontaxable 5.46% 5.25%
</TABLE>
Yields for 1994 decreased due to several factors. Fourth quarter 1993 cash flows
were invested in fixed-income securities prior to February 1994, when interest
rates started increasing. Short-term investments and practically all operating
cash flows generated during the first nine months of 1994 were used to pay
losses and expenses from the Northridge Earthquake. As a result, purchases of
higher-rate, fixed-income securities were reduced. In addition, the fixed-income
securities which matured during 1994 carried higher interest rates;
consequently, the portfolio had a lower effective yield.
INTEREST AND GENERAL CORPORATE EXPENSE
Interest expense on debt for 1994 totaled $3.4 million, up $1.6 million from
1993. The increase was caused by the Company's issuance of convertible
debentures on July 28, 1993. Interest expense on these debentures totaled $2.8
million in 1994 compared to $1.2 million in 1993.
General corporate expenses rose $1.2 million in 1994. The redefinition of
general corporate expenses and a $1.0 million contribution to Bradley University
were the primary contributors to the increase.
INCOME TAXES
During 1994, the Company had a loss before taxes of $11.9 million and a tax
benefit of $6.9 million, or a 58.0% effective rate. This loss was net of
investment income of $20.1 million. For federal income tax purposes, municipal
bond interest and dividend income from equity securities are wholly or partially
exempt. In 1994, $7.8 million of the investment income was exempt from federal
income tax. In 1993, nontaxable investment income totaled $6.4 million, which
reduced the taxable 1993 earnings to approximately $11.7 million. This resulted
in $4.0 million in tax expense, a 22.1% effective tax rate on the 1993 book
earnings.
The Company had a net operating loss for tax purposes in 1994. This loss was
carried back to 1991 to recover federal and state income taxes paid. In
addition, the Company realized capital losses to be carried back as an offset to
capital gains in previous years. As a result, the Company carried back $3.6
million in capital losses realized in 1994 and recover $1.3 million of taxes
paid in 1991, 1992 and 1993.
The Company adopted SFAS 109 on a prospective basis during the first quarter of
1993. As a result, in 1993 the Company recognized income of $1.7 million, or
$.22 per share, through a cumulative "catch-up" adjustment. There was no
material impact on federal income taxes as a result of the implementation of
SFAS 109.
ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board (FASB) issued Statement
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." The Statement provides guidance for the recognition
of impairment losses related to long-lived assets and certain intangibles and
related goodwill for (1) assets to be held and used and (2) assets to be
disposed of. The Statement excludes financial instruments, deferred policy
acquisition costs and deferred tax assets. For assets to be held and used,
assets are to be reviewed when events or change in circumstances indicate the
carrying amount of an asset may not be recoverable. If estimated future cash
flows from the use and disposition of an asset are less than the carrying amount
of the asset, recognition of an impairment loss is required. An impairment loss
is determined by reducing the carrying amount of an asset to its fair value.
This statement is effective for fiscal years beginning after December 15, 1995.
The Company believes that the adoption of this statement in 1996 will not have a
material impact on its financial statements.
In October 1995, the FASB issued Statement 123, "Accounting for Stock-Based
Compensation." The Statement applies to all transactions in which an entity
acquired goods or services by issuing equity instruments or by incurring
liabilities where the payment amounts are based on the entity's common stock
price, except for employee stock ownership plans (ESOPs). The Statement covers
transactions with employees and nonemployees. A new method of accounting for
stock-based compensation arrangements with employees is established by the
Statement based on fair value rather than intrinsic value that is contained in
APB Opinion No. 25 (Opinion 25). The Statement does not, however, require an
entity to adopt the new fair value method for preparing its basic financial
statements. Entities are allowed (1) to continue to use the Opinion 25 method
or (2) to adopt the Statement's fair value based method. Entities not adopting
the fair valued method are required to determine and disclose pro forma net
income as if the fair value based method had been adopted.
The Statement's fair value based method measures the fair value of the stock
compensation award, based on the stock price at the grant date, to which
employees become entitled when they have rendered the requisite service or
satisfied any other conditions necessary to earn the award (i.e. the award is
vested). Total compensation is determined by multiplying the fair value of an
award times the awards that ultimately vest.
29
<PAGE>
The disclosure requirements of the Statement, including the pro forma
information, are effective for financial statements for fiscal years beginning
after December 15, 1995 (calendar 1996). The Company intends to continue to
follow the intrinsic value based method according to Opinion 25 and disclose the
fair value based method on a pro forma basis, beginning with the Company's
December 31, 1996 financial statements.
LEGISLATION
NATURAL DISASTER ACT--Recent natural disasters such as Hurricane Andrew, the
Midwestern floods and the Northridge Earthquake have sparked debate on the best
way to provide affordable insurance coverage for such events. At this time, the
Company supports the proposed Natural Disaster Act as the most desirable
alternative.
CALIFORNIA EARTHQUAKE AUTHORITY--The California Insurance Commissioner has been
authorized to establish a state residential earthquake program. The most recent
proposals for the program include industry participation, investment of private
capital and reinsurance commitments. As the Company writes an insignificant
amount of residential homeowner's insurance, it does not appear that the
legislation will impact the Company in any significant manner.
MCCARRAN-FERGUSON ACT--The repeal of the McCarran-Ferguson Act has long been a
topic of considerable debate. Congress has conducted numerous hearings on the
issue, but has taken no action. The current legislation is inclined to drop the
proposal.
SUPERFUND REFORM (ENVIRONMENTAL LIABILITY)--Environmental liability and the
methods of funding the cleanup of polluted sites received considerable attention
in Congress during 1995. The Superfund Reform '95 Coalition lobbied for reform
of the original law including full repeal of the retroactive liability standard.
In the past, insurance industry supporters have suggested a general tax on all
insurers to pay for the cleanup rather than requiring retroactive liability. The
Company would not be significantly affected by any retroactive tax assessments
since the Company did not write a large volume of liability insurance prior to
1984. However, if a tax is levied against current liability writers for prior
pollution losses, the Company could have some tax exposure.
PROPOSITION 103 (RATE ROLLBACK INITIATIVE)--In November 1988, California voters
approved Proposition 103, which requires insurance premium rates for certain
lines of business to be rolled back twenty percent (20%) from the rates in
effect in November 1987. As a result, in 1994 and 1993, the Company reduced
pretax earnings by $71,280 and $416,400, respectively. No additional provision
was made during 1995. The above amounts include interest for 1994 and 1993 in
the amount of $71,280 and $259,200, respectively. The total amount of deferred
premiums and interest accrued as of December 31, 1995, was $2.5 million.
The state of California maintains that the Company is not in compliance with
Proposition 103 and that the required amount of premiums to be returned is $6.5
million plus accrued interest. The Company maintains it had reduced rates by 20%
or more on its most significant lines of business. This reduction is at issue
with the California Department of Insurance. While it is impossible to predict
the outcome, Management believes that the amount accrued is adequate to cover
the ultimate rollback, if any. The matter has been set for hearing in March of
1996.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the primary sources of the Company's liquidity have been funds
generated from insurance premiums (operating activities) and investment income
and maturing investments (investment activities). In addition, the Company has
occasionally received funds from financing activities, such as the sale of
Company treasury stock to the Employee Stock Ownership Plan; issuance of common
stock or convertible debentures; and small, short term borrowings.
The Company maintains three sources of credit from two financial institutions:
one $10.0 million secured and committed line of credit that cannot be canceled
during its annual term; one $30.0 million secured line of credit that cannot be
canceled during its annual term and one $3.0 million secured line of credit for
obtaining letters of credit. At December 31, 1995, $2.8 million of the $10.0
million line of credit was outstanding which was used to fund the repayment of
the 9.75% Industrial Development Bond that was called in December, 1995.
Management believes that cash generated by operations, cash generated by
investments and cash available from financing activities will provide sufficient
liquidity to meet the Company's anticipated needs over the next 12-24 months.
During 1995, the Company generated net operating cash flows of $24.3 million,
down slightly from 1994's $27.3. Financing activities included net use of $3.5
million of funds to retire $6.3 million of long term debt. The majority of
operating cash flows were added to the Company's investment portfolio.
The Company's fixed-income portfolio continues to be biased in favor of U.S.
government and agency securities due to their high liquidity and
30
<PAGE>
almost risk-free nature. As part of its investment strategy, the Company
attempts to avoid exposure to default risk by holding, almost exclusively,
securities ranked in the top two grades of investment quality by Standard &
Poor's and Moody's (i.e. AAA or AA). The Company's fixed-income portfolio
consists of securities rated A or better, with 99% rated AA or better.
Currently, 80.5% of the Company's fixed-income portfolio is non-callable. Those
securities containing call features have been factored into the overall duration
objectives of the portfolio and will not affect efforts to match assets with
anticipated liabilities.
The Company follows a program of matching assets to anticipated liabilities to
ensure its ability to hold securities until maturity. The Company's known debt
and long-term accounts payable are added to the estimate of its unpaid losses
and settlement expenses, by line of business. These anticipated liabilities are
then factored against ultimate payout patterns and the resulting payout streams
are fully funded with the purchase of fixed-income securities of like maturity.
Management believes that interest rate risk can best be minimized by such
asset/liability matching.
During 1995, the Company chose to reclassify $29.8 million of held-to-maturity
debt securities to available-for-sale under the one-time exemption permitted by
FASB without jeopardizing the status of the entire portfolio. Although it is
likely the Company will hold these securities to maturity, they will provide an
additional source of liquidity and can be used to react to future changes in the
Company's asset/liability structure. The Company intends to hold 85% of the
securities in the Company's fixed-income portfolio until their contractual
maturity. These securities are classified as held-to-maturity and are carried at
amortized cost. The remaining 15% are classified as available-for-sale and are
carried at fair value; unrealized capital gains and losses on these securities
are excluded from earnings and are recorded as a separate component of
shareholders' equity, net of deferred income taxes.
Equity portfolios increased $49.9 million during 1995. The Company had net
purchases of $15.0 million of common stock, while generating $472,000 in capital
gains through the disposal of fully appreciated stocks. Portfolio appreciation
during the year amounted to $34.4 million. The securities within the equity
portfolio remain almost equally divided between conservative, blue-chip stocks
growing with market indices, and fundamentally solid equities generating
substantial dividend income.
The National Association of Insurance Commissioners (NAIC) has been working for
several years on developing a model investment law. This law, which is expected
to be passed in 1996, would regulate insurance company investments. The
Company's current investment portfolio appears to be in compliance with the
proposed model investment law. Management does not feel the proposed model law
will affect its current strategies.
The NAIC has developed Property-Casualty Risk-Based Capital (RBC) standards that
relate an insurer's reported statutory surplus to the risks inherent in its
overall operations. The RBC formula uses the statutory annual statement to
calculate the minimum indicated capital level to support asset (investment and
credit) risk and underwriting (loss reserves, premiums written and unearned
premium) risk. The NAIC model law calls for various levels of regulatory action
based on the magnitude of an indicated RBC capital deficiency, if any. The RBC
standards became effective for 1994 annual statement filings. The Company
continues to monitor its subsidiaries' internal capital requirements and the
NAIC's RBC developments. The Company has determined that its capital levels are
well in excess of the minimum capital requirements for all RBC action levels.
Management believes that the Company's capital levels are sufficient to support
the level of risk inherent in its operations.
31
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
December 31, 1994 1995
(restated)
- ------------------------------------------------------------------------------------------------------------------------
Assets
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Investments:
Fixed maturities:
Held-to-maturity, at amortized cost
(fair value--$234,986,609 in 1994 and $260,957,796 in 1995) $246,796,658 $251,637,536
Available-for-sale, at fair value
(amortized cost--$13,814,266 in 1994 and $43,990,338 in 1995) 13,338,669 45,119,811
Equity securities available-for-sale, at fair value
(cost--$87,123,071 in 1994 and $102,580,834 in 1995) 104,067,362 153,957,535
Short-term investments, at cost which approximates fair value 52,329,819 23,874,732
- ------------------------------------------------------------------------------------------------------------------------
Total investments 416,532,508 474,589,614
Cash 8,185,806 1,196,926
Accrued investment income 5,166,083 5,854,731
Premiums and reinsurance balances receivable, net of allowances for
insolvent reinsurers of $15,547,400 in 1994 and $16,336,146 in 1995 26,082,932 36,447,284
Ceded unearned premiums 40,978,088 50,189,740
Reinsurance balances recoverable on unpaid losses and settlement expenses 199,736,796 197,337,466
Deferred policy acquisition costs 19,208,212 15,806,911
Property and equipment, at cost, net of accumulated depreciation
of $19,076,703 in 1994 and $21,565,315 in 1995 15,788,526 13,950,559
Income taxes--current 3,315,467 2,619,811
Income taxes--deferred 6,801,829
Other assets 16,006,822 16,654,099
- ------------------------------------------------------------------------------------------------------------------------
Total assets $757,803,069 $814,647,141
========================================================================================================================
Liabilities and Shareholders' Equity
- ------------------------------------------------------------------------------------------------------------------------
Liabilities:
Unpaid losses and settlement expenses $394,966,040 $418,985,960
Unearned premiums 119,817,542 126,013,957
Reinsurance balances payable 39,859,746 37,744,456
Income taxes--deferred 4,904,394
Notes payable, short-term 2,800,000
Long-term debt:
Convertible debentures 46,000,000 46,000,000
Industrial development bonds 6,255,000
Other liabilities 19,734,780 19,590,658
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities 626,633,108 656,039,425
- ------------------------------------------------------------------------------------------------------------------------
Commitments and contingent liabilities
- ------------------------------------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock ($1 par value, authorized 12,000,000 shares,
issued 6,762,905 shares in 1994 and 8,453,449 shares in 1995) 6,762,905 8,453,449
Paid-in capital 25,503,282 23,831,969
Net unrealized appreciation of securities, net of tax 10,910,294 34,334,524
Retained earnings 91,394,229 95,378,097
Treasury stock at cost (604,015 shares in 1994 and 602,567 shares in 1995) (3,400,749) (3,390,323)
- ------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 131,169,961 158,607,716
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $757,803,069 $814,647,141
========================================================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
32
<PAGE>
CONSOLIDATED STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
Years ended December 31, 1993 1994 1995
(restated) (restated)
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net premiums earned $125,989,278 $140,184,488 $133,468,133
RLI Vision Corp. revenue 29,194,823 33,973,592 34,595,388
Net investment income 16,857,117 20,132,585 22,029,081
Net realized investment gains (losses) 253,945 (3,595,101) 456,510
- ------------------------------------------------------------------------------------------------------------------------------------
172,295,163 190,695,564 190,549,112
- ------------------------------------------------------------------------------------------------------------------------------------
Losses and settlement expenses 79,737,403 101,641,666 85,889,995
Policy acquisition costs 27,640,459 47,106,098 43,042,045
Insurance operating expenses 15,062,838 15,142,384 14,470,053
RLI Vision Corp. operating expenses 27,989,084 32,115,483 33,438,154
Interest expense on debt 1,855,697 3,431,464 3,347,378
General corporate expenses 1,680,536 2,845,289 2,093,034
- ------------------------------------------------------------------------------------------------------------------------------------
153,966,017 202,282,384 182,280,659
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes and cumulative
effect of change in accounting principle 18,329,146 (11,586,820) 8,268,453
- ------------------------------------------------------------------------------------------------------------------------------------
Income tax expense (benefit):
Current 10,435,263 (3,862,397) 1,225,889
Deferred (6,388,744) (2,948,552) (906,977)
- ------------------------------------------------------------------------------------------------------------------------------------
4,046,519 (6,810,949) 318,912
- ------------------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) before cumulative effect
of change in accounting principle 14,282,627 (4,775,871) 7,949,541
Cumulative effect to January 1, 1993 of initial application
of SFAS 109 "Accounting for Income Taxes" 1,665,000
- ------------------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ 15,947,627 $ (4,775,871) $ 7,949,541
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings per share:
Primary
Net earnings (loss) per share before cumulative
effect of change in accounting principle $1.88 $(0.61) $1.01
Cumulative effect to January 1, 1993 of initial application
of SFAS 109 "Accounting for Income Taxes" .22
- ------------------------------------------------------------------------------------------------------------------------------------
Primary net earnings (loss) per share $2.10 $(0.61) $1.01
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Fully diluted
Net earnings (loss) per share before cumulative
effect of change in accounting principle $1.80 $(0.61) $1.01
Cumulative effect to January 1, 1993 of initial application
of SFAS 109 "Accounting for Income Taxes" .20
- ------------------------------------------------------------------------------------------------------------------------------------
Fully diluted net earnings (loss) per share $2.00 $(0.61) $1.01
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted average number of common shares outstanding:
Primary 7,599,563 7,786,004 7,849,799
Fully diluted 8,360,575 7,786,004 7,849,799
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
33
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Net
Unrealized Treasury
Common Paid-in Appreciation Retained Stock
Years ended December 31, Stock Capital of Securities Earnings at Cost Total
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1993 (restated) $ 6,762,905 $21,409,616 $ 9,419,726 $86,971,422 $(5,864,428) $118,699,241
Net earnings 15,947,627 15,947,627
Treasury shares
reissued
(196,405 shares) 2,576,537 1,467,433 4,043,970
Net change in unrealized
appreciation of
securities 5,227,481 5,227,481
Dividends declared
($.42 per share) (3,211,947) (3,211,947)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1993 (restated) 6,762,905 23,986,153 14,647,207 99,707,102 (4,396,995) 140,706,372
Net loss (4,775,871) (4,775,871)
Treasury shares
reissued
(138,368 shares) 1,517,129 996,246 2,513,375
Unrealized appreciation of
securities from adoption
of SFAS 115 327,707 327,707
Net change in unrealized
appreciation of available-
for-sale securities (4,064,620) (4,064,620)
Dividends declared
($.45 per share) (3,537,002) (3,537,002)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1994 (restated) 6,762,905 25,503,282 10,910,294 91,394,229 (3,400,749) 131,169,961
Net earnings 7,949,541 7,949,541
Treasury shares
reissued
(1,448 shares) 23,241 10,426 33,667
5-for-4 stock split 1,690,544 (1,694,554) (4,010)
Net change in unrealized
appreciation of available-
for-sale securities 23,424,230 23,424,230
Dividends declared
($.51 per share) (3,965,673) (3,965,673)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 $ 8,453,449 $23,831,969 $34,334,524 $95,378,097 $(3,390,323) $158,607,716
- ----------------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
34
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years ended December 31, 1993 (restated) 1994 (restated) 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net earnings (loss) $15,947,627 $ (4,775,871) $ 7,949,541
Adjustments to reconcile net earnings (loss) to net cash
provided by operating activities:
Provision for insolvencies 1,163,278 1,000,000 613,296
Net realized investment losses (gains) (253,945) 3,595,101 (456,510)
Depreciation 3,182,808 3,397,241 3,499,295
Other items, net 889,238 (5,646,076) (119,261)
Change in:
Accrued investment income (1,208,707) (761,455) (688,648)
Premiums and reinsurance balances receivable
(net of direct write-offs and commutations) 3,398,291 145,383 (10,977,648)
Reinsurance balances payable 4,821,929 9,090,049 (2,115,290)
Ceded unearned premium 2,434,129 (7,308,036) (9,211,652)
Reinsurance balances recoverable on unpaid losses (7,616,802) (54,528,764) 2,399,330
Deferred policy acquisition costs (7,639,187) (485,817) 3,401,301
Unpaid losses and settlement expenses 42,724,265 84,199,014 24,019,920
Unearned premiums 15,289,456 13,785,231 6,196,415
Income taxes:
Current 7,267,637 (11,479,595) 695,656
Deferred (8,109,511) (2,948,552) (906,977)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 72,290,506 27,277,853 24,298,768
- ------------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchase of:
Fixed maturities, held-to-maturity (110,827,936) (64,032,621) (59,029,702)
Fixed maturities, available-for-sale (4,793,980) (9,091,447)
Equity securities, available-for-sale (35,344,941) (18,979,331) (32,221,842)
Short-term investments, net (10,527,372) (7,267,683)
Property and equipment (2,443,332) (4,045,374) (2,186,892)
Proceeds from sale of:
Fixed maturities, held-to-maturity 5,211,541
Fixed maturities, available-for-sale 1,260,031 3,383,745
Equity securities, available-for-sale 2,879,335 22,481,402 17,187,726
Short-term investments, net 28,455,087
Property and equipment 164,333 73,462 525,564
Proceeds from call or maturity of:
Fixed maturities, held-to-maturity 36,339,029 46,181,373 25,234,977
Fixed maturities, available-for-sale 2,335,000 3,730,000
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (114,549,343) (26,787,721) (24,012,784)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Proceeds from issuance of debt 46,000,000 2,800,000
Payments on debt (745,000) (6,255,000)
Fractional shares paid 4,010
Treasury shares reissued 4,043,970 2,513,375 33,667
Cash dividends paid (3,132,338) (3,461,217) (3,849,521)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 46,911,632 (1,692,842) (7,274,864)
- ------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 4,652,795 (1,202,710) (6,988,880)
Cash at beginning of year 4,735,722 9,388,516 8,185,806
- ------------------------------------------------------------------------------------------------------------------------------------
Cash at end of year $ 9,388,516 $ 8,185,806 $ 1,196,926
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
35
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. DESCRIPTION OF BUSINESS: RLI Corp. is a holding company which, through its
subsidiaries, underwrites specialty property and casualty insurance products and
provides a wide range of products and services to the ophthalmic industry.
The property and casualty insurance segment, RLI Insurance Group (the Group), is
composed primarily of two main insurance companies. RLI Insurance Company, the
principal subsidiary, writes multiple lines of insurance on an admitted basis in
all 50 states, the District of Columbia and Puerto Rico. Mt. Hawley Insurance
Company, a subsidiary of RLI Insurance Company, writes multiple lines of
insurance on an admitted basis in Kansas and surplus lines insurance in the
remaining 49 states, the District of Columbia, Puerto Rico, the Virgin Islands
and Guam.
The ophthalmic segment includes the operations of RLI Vision Corp. (RLI Vision)
and its Canadian subsidiaries: RLI Planned Services Ltd. and RLI Insurance
Agency Ltd. These companies offer a wide variety of products and services to the
ophthalmic industry, including: wholesale distribution of soft contact lenses,
spectacle frames and sunglasses; third party administration of extended service
programs; manufacturing rigid gas permeable (RGP) contact lenses and spectacle
lenses; and RLISYS practice management software.
B. PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION: The accompanying
consolidated financial statements were prepared in conformity with generally
accepted accounting principles (GAAP), which differ in some respects from those
followed in reports to insurance regulatory authorities.
The consolidated financial statements include the accounts of RLI Corp. and its
subsidiaries (the Company). All significant intercompany balances and
transactions have been eliminated.
On May 4, 1995, RLI Vision Corp. (formerly known as RLI Professional
Technologies, Inc.), a wholly owned subsidiary of RLI Corp., acquired through
merger, Target Industries, Inc., a wholesale optical goods distributor of
contact lenses, Rx spectacles, frames and sunglasses, located in Cohasset,
Massachusetts. As consideration, RLI Corp. issued 313,500 shares of its common
stock. The combined enterprise is now doing business under the name of RLI
Vision Corp. This business combination has been accounted for as a
pooling-of-interests. The consolidated financial statements and related
financial information for periods prior to the combination have been restated to
include the accounts and results of operations of Target Industries, Inc.
Prior to the combination, the Target Industries, Inc. fiscal year ended June 30.
In recording the pooling-of-interests combination, Target Industries, Inc. June
30 financial statements for the fiscal years 1993, 1994, and 1995, were adjusted
to reflect a fiscal period ending December 31 for combination with RLI Corp.'s
1993 and 1994 financial statements.
The results of operations previously reported by the separate enterprises and
the combined amounts presented in the accompanying consolidated financial
statements are summarized as follows.
<TABLE>
<CAPTION>
- ------------------------------------------------------
1993 1994
<S> <C> <C>
Net Sales Revenue:
RLI Corp. $155,124,621 $171,902,369
Target Industries, Inc. 17,170,542 18,793,195
- ------------------------------------------------------
Combined $172,295,163 $190,695,564
======================================================
1993 1994
Net income (loss):
- ------------------------------------------------------
RLI Corp. $ 15,797,075 ($5,001,317)
Target Industries, Inc. 150,552 225,446
- ------------------------------------------------------
Combined $ 15,947,627 ($4,775,871)
=======================================================
</TABLE>
Additionally, the accompanying consolidated balance sheet for the year ended
December 31, 1994, has been restated to include the assets, liabilities, and
equity of Target Industries, Inc. The net increase to RLI Corp.'s December 31,
1994 assets, liabilities, and equity was $5,501,935, $3,929,447, and $1,572,488,
respectively, as a result of this merger.
Prior years' share and per share data have additionally been restated to reflect
the 5-for-4 stock split that occurred on June 21, 1995.
C. SIGNIFICANT EVENT: On January 17, 1994, an earthquake occurred in the
Northridge, California area. Losses incurred as a result of this earthquake
represent the largest single loss event in the Company's history. The combined
effects of the earthquake-- including losses, expenses and the reduction of
revenue due to reinstatement of reinsurance coverages--reduced 1994 after-tax
earnings by $25.0 million or $3.21 per share.
In September 1995, the Company strengthened loss reserves related to the
Northridge Earthquake. While relatively minor development had occurred
throughout the first six months of 1995, the third quarter claim-by-claim review
indicated that greater future development was likely. The overall impact in 1995
of the Northridge Earthquake was a reduction to after-tax earnings by $18.6
million or $2.37 per share.
This additional development resulted in part from hidden damage and increased
business interruption losses on the Company's excess policies which, in 1994,
were estimated by adjusters to be well within the coverage limits of the primary
and underlying excess layers. Also contributing to the increased development
were unanticipated building code enactments, escalating construction costs, and
the impact of reopened claims as a result of the involvement of public
adjusters.
36
<PAGE>
Following is a summary of the effects of the Northridge Earthquake. All amounts
are shown in thousands, except per share data.
<TABLE>
<CAPTION>
<S> <C> <C>
- -------------------------------------------------------------------
Earthquake Impact 1994 1995
- -------------------------------------------------------------------
Premiums earned decrease $(18,013) $ (1,227)
- -------------------------------------------------------------------
Consolidated revenue decrease (18,013) (1,227)
- -------------------------------------------------------------------
Losses and settlement expense increase (21,176) (27,338)
Policy acquisition costs decrease 1,310
- -------------------------------------------------------------------
Total expense increase (19,866) (27,338)
- -------------------------------------------------------------------
Loss before income taxes (37,879) (28,565)
Net loss (25,021) (18,567)
Primary net loss per share $(3.21) $(2.37)
===================================================================
</TABLE>
D. INVESTMENTS: Effective January 1, 1994, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." This statement requires that
investments in all debt securities and those equity securities with readily
determinable fair values be classified into one of three categories:
held-to-maturity, trading, or available-for-sale.
HELD-TO-MATURITY SECURITIES
Debt securities that the Company has the positive intent and ability to hold to
maturity are classified as held-to-maturity and carried at amortized cost.
Except for declines that are other than temporary, changes in the fair value of
these securities are not reflected in the financial statements. The Company has
classified approximately 85% of its portfolio of debt securities as
held-to-maturity.
TRADING SECURITIES
Debt and equity securities purchased for short-term resale are classified as
trading securities. The Company holds no debt or equity securities in this
category.
AVAILABLE-FOR-SALE SECURITIES
All other debt and equity securities not included in the above categories are
classified as available-for-sale and reported at fair value. Unrealized gains
and losses on these securities are excluded from earnings and reported as a
separate component of shareholders' equity net of deferred income taxes. All of
the Company's equity securities and approximately 15% of debt securities are
classified as available-for-sale.
In December 1995, the Company reclassified $29.8 million of held-to-maturity
debt securities to available-for-sale under the "one time exemption" permitted
by the Financial Accounting Standards Board. This reclassification resulted in
recording unrealized gains of $0.5 million, net of deferred income taxes.
Short-term investments are carried at cost, which approximates fair value.
The Company reviews the values of its investments in fixed maturities and equity
securities on an ongoing basis. If this review shows that a decline in fair
value is other than temporary, the Company's carrying value in the investment is
reduced to its estimated realizable value through an adjustment to earnings.
Realized gains and losses on disposition of investments are based on specific
identification of the investments sold.
Interest on fixed maturities and short-term investments is credited to earnings
as it accrues. Dividends on equity securities are credited to earnings on the
ex-dividend date.
E. REINSURANCE: Ceded unearned premiums and reinsurance balances recoverable on
unpaid losses and settlement expenses are reported separately as assets, instead
of being netted with the appropriate liabilities, since the Company is not
relieved of its legal liability to its policyholders.
The Company evaluates its reinsurance contracts for significant risk transfer.
If a reinsurance contract is deemed to not transfer significant risk to the
reinsurer, the contract is recorded using the deposit method of accounting. The
Company has reviewed its reinsurance contracts for significant risk transfer and
believes all contracts have been properly recorded in accordance with GAAP.
The Company continuously reviews and monitors the financial condition of its
reinsurers. The Company's policy is to charge to current earnings an estimate of
unrecoverable amounts from troubled or insolvent reinsurers. During 1993, 1994,
and 1995, the Company provided $1,163,278, $1,000,000, and $613,296,
respectively, for uncollectible reinsurance balances.
F. UNPAID LOSSES AND SETTLEMENT EXPENSES: The liability for unpaid losses and
settlement expenses represents estimates of amounts needed to pay reported and
unreported claims and related settlement expenses. The estimates are based on
certain actuarial and other assumptions related to the ultimate cost to settle
such claims. Such assumptions are subject to occasional changes due to evolving
economic, social and political conditions. All estimates are periodically
reviewed and, as experience develops and new information becomes known, the
reserves are adjusted as necessary. Such adjustments are reflected in the
results of operations in the period in which they are determined. Due to the
inherent uncertainty in estimating reserves for losses and settlement expenses,
there can be no assurance that the ultimate liability will not exceed recorded
amounts, with a resulting adverse effect on the Company. Based on the current
assumptions used in calculating reserves, Management believes that the Company's
overall reserve levels at December 31, 1995, are adequate to meet its future
obligations.
G. REVENUE RECOGNITION: Insurance premiums are recognized ratably over the term
of the contracts, net of ceded reinsurance. Unearned
premiums are calculated on the monthly pro rata basis.
H. POLICY ACQUISITION COSTS: The costs of acquiring insurance premiums
(principally commissions and brokerage, sales compensation, premium taxes, and
other direct underwriting expenses), net of reinsurance com-
37
<PAGE>
missions received, are amortized over the life of the policies in order to
properly match policy acquisition costs to the related premium revenue. The
method followed in computing deferred policy acquisition costs limits the amount
of such deferred costs to their estimated realizable value, which gives effect
to the premium to be earned, related investment income, losses and settlement
expenses and certain other costs expected to be incurred as the premium is
earned.
I. PROPERTY AND EQUIPMENT: Property and equipment are depreciated on a
straight-line basis for financial statement purposes over periods ranging from
three to 10 years for equipment and up to 40 years for buildings and
improvements.
J. INCOME TAXES: The Company files a consolidated income tax return. Tax
provisions are computed and apportioned to the subsidiaries on the basis of
their taxable income.
Effective January 1, 1993, the Company adopted SFAS No. 109, "Accounting for
Income Taxes." This statement requires a change from the deferred method of
accounting for income taxes of APB Opinion 11 to the asset and liability method
of accounting for income taxes. Under the asset and liability method of SFAS
109, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in years in which those temporary
differences are expected to be recovered or settled. Under SFAS 109, the effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. The Company has reported
the cumulative effect of the change in the method of accounting for income taxes
in the 1993 consolidated statement of earnings.
K. EARNINGS PER SHARE: Primary earnings per share are computed based on the
weighted average number of shares of common stock and common stock equivalents
outstanding during the period.
Fully diluted earnings per share calculations are based on the weighted average
number of shares of common stock and common stock equivalents outstanding for
the period, assuming full conversion of all convertible debentures into common
stock. Net earnings are adjusted for purposes of this calculation to eliminate
interest and amortization of debt issuance costs on the convertible debentures,
net of related income taxes. When the conversion of convertible debentures
increases the earnings per share or reduces the loss per share, the effect on
earnings is antidilutive. Under these circumstances the fully diluted net
earnings or net loss per share is computed assuming no conversion of the
convertible debentures.
L. FAIR VALUE DISCLOSURES: The following methods were used to estimate the fair
value of each class of financial instruments for which it was practicable to
estimate that value. Fixed maturities and equity securities are valued using
quoted market prices, if available. If a quoted market price is not available,
fair value is estimated using quoted market prices of similar securities. Fair
value disclosures for investments are included in note 2. Due to the relatively
short-term nature of cash, short-term investments, accounts receivable, accounts
payable and short-term debt, their carrying amounts are reasonable estimates of
fair value. Fair value of long-term debt is based on quoted market prices if
available or quoted market prices of similar issues. Fair value disclosures for
long-term debt are included in note 4.
M. RISKS AND UNCERTAINTIES: Certain risks and uncertainties are inherent to the
Company's day-to-day operations and to the process of preparing its financial
statements. The more significant of those risks and uncertainties, as well as
the Company's methods for mitigating, quantifying, and minimizing such, are
presented below and throughout the notes to consolidated financial statements.
CATASTROPHE EXPOSURES
The Company's past and present insurance coverages include exposure to
catastrophic events. Catastrophic events such as earthquakes, floods, and
windstorms are covered by certain of the Company's property policies. The
Company has a concentration of such coverages in California (75.1% of gross
property premiums written during 1995). Using computer-assisted modeling
techniques, the Company quantifies and monitors its exposure to catastrophic
events. The Company limits its risk to such catastrophes through the purchase of
reinsurance. Utilizing the above, the Company attempts to limit its net
aggregate exposure to a single catastrophic event to less than 10% of
shareholders' equity.
ENVIRONMENTAL EXPOSURES
The Company is subject to environmental claims and exposures through its
commercial umbrella, general liability and assumed reinsurance lines of
business. Although exposure to environmental claims exists in these lines of
business, Management has sought to mitigate or control the extent of this
exposure through the following methods: 1) the Company's policies include
pollution exclusions that have been continually updated to further strengthen
the exclusion; 2) the Company's policies primarily cover moderate hazard risks;
and 3) the Company began writing this business after the industry became aware
of the potential pollution liability exposure.
The Company has made loss and settlement expense payments on environmental
liability claims and has loss and settlement expense reserves for others. The
Company includes this historical environmental loss experience with the
remaining loss experience in the applicable line of business to project ultimate
incurred losses and settlement expenses and related "incurred but not reported"
loss and settlement expense reserves.
Although historical experience on environmental claims may not accurately
reflect future environmental exposures, the Company has used this
38
<PAGE>
experience to record loss and settlement expense reserves in the exposed lines
of business. See further discussion of environmental exposures in note 6.
REINSURANCE
Reinsurance does not discharge the Company from its primary liability to
policyholders, and to the extent that a reinsurer is unable to meet its
obligations, the Company would be liable. The Company reviews and monitors the
financial condition of prospective and existing reinsurers. As a result, the
Company currently attempts to purchase reinsurance from a limited number of
financially strong reinsurers. The Company provides a reserve for reinsurance
balances deemed uncollectible.
FINANCIAL STATEMENTS
The preparation of the consolidated financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the reported
financial statement balances as well as the disclosure of contingent assets and
liabilities. Actual results could differ from those estimates. The most
significant of these amounts is the liability for unpaid losses and settlement
expenses. Management continually updates its estimates as additional data
becomes available and adjusts the financial statements as deemed necessary.
Other estimates such as the recoverability of reinsurance balances and deferred
policy acquisition costs are constantly monitored, evaluated, and adjusted.
Although recorded estimates are supported by actuarial computations and other
supportive data, the estimates are ultimately based on Management's expectations
of future events.
EXTERNAL FACTORS
The Company's insurance subsidiaries are highly regulated by the states in
which they are incorporated, as well as states in which they do business. Such
regulations, among other things, limit the amount of dividends, impose
restrictions on the amount and types of investments, and regulate rates insurers
may charge for various products. The Company is also subject to insolvency and
guarantee fund assessments for policyholder losses covered by insolvent
insurers. The Company generally accrues the full amount of the assessment upon
notification.
The National Association of Insurance Commissioners (NAIC) has developed
Property-Casualty Risk-Based Capital (RBC) standards that relate an insurer's
reported statutory surplus to the risks inherent in its overall operations. The
RBC formula uses the statutory annual statement to calculate the minimum
indicated capital level to support asset (investment and credit) risk and
underwriting (loss reserves, premiums written, and unearned premium) risk. The
NAIC model law calls for various levels of regulatory action based on the
magnitude of an indicated RBC capital deficiency, if any. The RBC standards
became effective for annual statement filings beginning December 31, 1994. The
Company continues to monitor its subsidiaries' internal capital requirements and
the NAIC's RBC developments. The Company has determined that its capital levels
are well in excess of the minimum capital requirements for all RBC action
levels. Management believes that the Company's capital levels are sufficient to
support the level of risk inherent in its operations.
2. INVESTMENTS
A summary of net investment income is as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
- -------------------------------------------------------------------------------
1993 1994 1995
Interest on fixed maturities $13,029,859 $15,311,817 $17,333,118
- -------------------------------------------------------------------------------
Dividends on equity securities 3,976,593 5,290,715 5,444,146
Interest on short-term investments 2,189,198 1,846,881 1,893,693
Gross investment income 19,195,650 22,449,413 24,670,957
Less investment expenses 2,338,533 2,316,828 2,641,876
- -------------------------------------------------------------------------------
Net investment income $16,857,117 $20,132,585 $22,029,081
================================================================================
</TABLE>
Pretax net realized investment gains (losses) and net changes in unrealized
appreciation/depreciation of investments for the years ended December 31 are
summarized as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1993 1994 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Net realized investment gains (losses)
Fixed maturities
Held-to-maturity $ 46,677 $ 79,124 $(21,428)
Available-for-sale 27,217 6,324
Equity securities 207,268 (3,701,442) 471,614
- --------------------------------------------------------------------------------
253,945 (3,595,101) 456,510
- --------------------------------------------------------------------------------
Net changes in unrealized
appreciation/depreciation on investments
Fixed maturities
Held-to-maturity 3,664,847 (22,112,459) 21,130,309
Available-for-sale (475,597) 1,605,070
Equity securities 7,945,381 (5,273,316) 34,432,410
- --------------------------------------------------------------------------------
11,610,228 (27,861,372) 57,167,789
- --------------------------------------------------------------------------------
Net realized investment gains (losses)
and changes in unrealized
appreciation/depreciation
on investments $11,864,173 $(31,456,473) $57,624,299
================================================================================
</TABLE>
Net unrealized appreciation on fixed maturity securities declined significantly
during 1994, due primarily to climbing interest rates, not the result of issuer
credit concerns. The higher interest rate environment and overall market
pressures forced our interest-sensitive equity securities lower in 1994, thus
reducing net unrealized appreciation. However, with the upturn in the market and
general interest rate declines during 1995, the Company's fixed-income and
equity securities posted substantial increases in unrealized appreciation,
rebounding well beyond pre-1994 levels.
39
<PAGE>
Below is a summary of the disposition of fixed maturities for the years ended
December 31, with separate presentations for sales and calls/maturities.
<TABLE>
<CAPTION>
Sales
- -----------------------------------------------------------------------------------
Proceeds Gross Realized Net Realized
from sales Gains Losses gain (loss)
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1993 $5,211,541 $9,222 $(479) $8,743
1994
Available-for-sale 1,260,031 (603) (603)
1995
Available-for-sale 3,383,745 15,447 (7,875) 7,572
==================================================================================
</TABLE>
<TABLE>
<CAPTION>
Calls/Maturities
- ----------------------------------------------------------------------------------
Proceeds from Gross Realized Net Realized
calls/maturities Gains Losses gain (loss)
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1993 $36,339,029 $ 41,848 $(3,914) $ 37,934
1994
Held-to-maturity 46,181,373 107,106 (27,982) 79,124
Available-for-sale 2,335,000 28,773 (953) 27,820
1995
Held-to-maturity 25,234,977 11,567 (32,997) (21,428)
Available-for-sale 3,730,000 (1,248) (1,248)
===================================================================================
</TABLE>
The following is a schedule of amortized costs and estimated fair values of
investments in fixed maturities and equity securities as of December 31, 1994
and 1995. Estimated fair values for fixed maturity and equity securities are
based on quoted market prices where available, or on values obtained from
independent pricing services.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
Amortized Estimated Gross Unrealized
Cost Fair Value Gains Losses
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1994
Held-to-maturity
U.S. governments $152,481,172 $143,898,057 $ 638,161 $ (9,221,276)
Foreign governments 496,511 493,875 (2,636)
States, political subdivisions & revenues 93,818,975 90,594,677 248,202 (3,472,500)
- ----------------------------------------------------------------------------------------------------
Total held-to-maturity $246,796,658 $234,986,609 $ 886,363 $(12,696,412)
- ----------------------------------------------------------------------------------------------------
Available-for-sale
U.S. governments $ 11,161,851 $ 10,847,456 $ 242 $ (314,637)
States, political subdivisions & revenues 2,652,415 2,491,213 (161,202)
- ----------------------------------------------------------------------------------------------------
Fixed maturities 13,814,266 13,338,669 242 (475,839)
Equity securities 87,123,071 104,067,362 19,603,431 (2,659,140)
- ----------------------------------------------------------------------------------------------------
Total available-for-sale 100,937,337 117,406,031 19,603,673 (3,134,979)
- ----------------------------------------------------------------------------------------------------
Total $347,733,995 $352,392,640 $20,490,036 $(15,831,391)
====================================================================================================
- ----------------------------------------------------------------------------------------------------
Amortized Estimated Gross Unrealized
Cost Fair Value Gains Losses
- ----------------------------------------------------------------------------------------------------
1995
Held-to-maturity
U.S. governments $148,846,846 $156,517,125 $ 7,767,238 $ (96,959)
Foreign governments 498,208 509,260 11,052
States, political subdivisions & revenues 102,292,482 103,931,411 1,735,159 (96,230)
- ----------------------------------------------------------------------------------------------------
Total held-to-maturity $251,637,536 $260,957,796 $ 9,513,449 $ (193,189)
- ----------------------------------------------------------------------------------------------------
Available-for-sale
U.S. governments $ 33,730,335 $ 34,767,197 $ 1,126,476 $ (89,614)
States, political subdivisions & revenues 10,260,003 10,352,614 108,283 (15,672)
- ----------------------------------------------------------------------------------------------------
Fixed maturities 43,990,338 45,119,811 1,234,759 (105,286)
Equity securities 102,580,834 153,957,535 51,700,372 (323,671)
- ----------------------------------------------------------------------------------------------------
Total available-for-sale 146,571,172 199,077,346 52,935,131 (428,957)
- ----------------------------------------------------------------------------------------------------
Total $398,208,708 $460,035,142 $62,448,580 $ (622,146)
====================================================================================================
</TABLE>
The amortized cost and estimated fair value of fixed maturity securities at
December 31, 1995, by contractual maturity, are shown as follows. Expected
maturities may differ from contractual maturities due to call provisions present
on some existing securities. Management believes the impact of any calls should
be slight and intends to follow its policy of matching assets against
anticipated liabilities.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
Amortized Cost Estimated Fair Value
- ------------------------------------------------------------------------------
<S> <C> <C>
Held-to-maturity
Due in one year or less $ 14,622,708 $ 14,772,295
Due after one year through five years 99,177,271 103,642,779
Due after five years through ten years 116,413,697 120,054,838
Due after ten years 21,423,860 22,487,884
- ------------------------------------------------------------------------------
$251,637,536 $260,957,796
- ------------------------------------------------------------------------------
Available-for-sale
Due in one year or less $ 3,007,431 $ 3,015,964
Due after one year through five years 22,479,070 23,575,952
Due after five years through ten years 18,503,837 18,527,895
- ------------------------------------------------------------------------------
$ 43,990,338 $ 45,119,811
- ------------------------------------------------------------------------------
</TABLE>
At December 31, 1994, the net unrealized appreciation of available-for-sale
fixed maturities and equity securities totaled $10,910,294. This amount was net
of deferred taxes of $5,558,400. At December 31, 1995, the net unrealized
appreciation of available-for-sale fixed maturities and equity securities
totaled $34,334,524. This amount is net of deferred taxes of $18,171,600.
The Company is party to a securities lending program whereby fixed-income and
equity securities are loaned to third parties, primarily major brokerage firms.
As of December 31, 1994 and 1995, fixed maturities with a fair value of
$69,995,135 and $59,511,640, respectively, were loaned. Addi-
40
<PAGE>
tionally, at December 31, 1994, the Company had loaned $1,726,601 of equity
securities. Agreements with custodian banks facilitating such lending require a
minimum of 102% of the value of the loaned securities to be separately
maintained as collateral for each loan. To further minimize the credit risks
related to this lending program, the Company monitors the financial condition of
counter parties to these agreements.
As required by law, certain fixed maturities and short-term investments
amounting to $21,699,946 at December 31, 1995, were on deposit with either
regulatory authorities or banks. Additionally, the Company has certain fixed
maturities held in trust amounting to $10,927,015 at December 31, 1995. These
funds cover net premiums, losses, and expenses related to a property and
casualty insurance program.
The Company does not invest in derivative securities or collateralized mortgage
obligations (CMOs).
3. POLICY ACQUISITION COSTS
Policy acquisition costs deferred and amortized to income for the years ended
December 31 are summarized as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
1993 1994 1995
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Deferred policy acquisition costs, beginning of year $11,083,208 $18,722,395 $19,208,212
- ------------------------------------------------------------------------------------------------
Deferred:
Direct commissions 41,633,710 47,187,978 44,232,003
Premium taxes 4,323,682 4,135,567 4,185,861
Other direct underwriting expenses 14,729,245 12,088,813 12,122,153
Ceding commissions (14,262,107) (16,939,817) (24,666,527)
- ------------------------------------------------------------------------------------------------
Net deferred 46,424,530 46,472,541 35,873,490
- ------------------------------------------------------------------------------------------------
Amortized 38,785,343 45,986,724 39,274,791
- ------------------------------------------------------------------------------------------------
Deferred policy acquisition costs, end of year $18,722,395 $19,208,212 $15,806,911
================================================================================================
Policy acquisition costs:
Amortized to expense 38,785,343 45,986,724 39,274,791
Period costs:
Ceding commission--contingent(1) (12,967,381) 60,227 (456,527)
Other 1,822,497 1,059,147 4,223,781
- ------------------------------------------------------------------------------------------------
Total policy acquisition costs $27,640,459 $47,106,098 $43,042,045
================================================================================================
</TABLE>
(1) During 1993 the Company participated in various reinsurance contracts that
included contingent commissions. The Company did not renew these contracts in
1994, resulting in an increase in net policy acquisition costs and a decrease in
ceded earned premiums.
4. LONG-TERM DEBT
On July 28, 1993, the Company issued $46 million of 6.0% convertible debentures
which mature July 15, 2003, and pay interest semi-annually. The Company received
$45,080,000 in net proceeds from the issue ($46,000,000 principal less $920,000
of underwriting costs incurred) of which $30,500,000 has been contributed to the
insurance subsidiaries to increase underwriting capacity and facilitate
expansion of their business. The balance was retained for general corporate
purposes, including debt service and the payment of dividends. All convertible
debentures, unless previously redeemed, are convertible at the option of the
holder at any time prior to maturity, into RLI Corp. common stock at an adjusted
conversion price of $26.00 per share, subject to further adjustment in certain
events. The Company has the option to redeem the convertible debentures, in
whole or in part, on or after July 15, 1997, at specified redemption prices,
plus accrued interest to redemption date. The convertible debentures are general
unsecured obligations of the Company and rank on a parity with all other
unsecured and unsubordinated indebtedness of the Company. The convertible
debentures include various covenants with which the Company has complied. These
covenants are basic in nature and include maintenance of properties, payment of
taxes, limitations on issuance or disposition of RLI Corp. stock or the stock of
material subsidiaries, and limitations on liens. The fair value of the
convertible debentures at December 31, 1995, was $47,840,000.
On December 1, 1995, the Company retired its entire 9.75% Industrial Development
Bond of $6,255,000. This tax-exempt issue was obtained by the Company on
December 27, 1985, and proceeds were used by the Company to finance a portion of
the acquisition, construction and equipping of an addition to the home office
building and related facilities located in Peoria. The retirement of the debt
included a scheduled principal payment of $815,000, along with the execution by
the Company of its first available call provision, to call the remaining debt of
$5,440,000 at a 102 call premium. The call was financed in part with available
cash, along with short term borrowings totaling $2,800,000.
Interest paid on outstanding debt for 1993, 1994, and 1995 amounted to $682,500,
$3,345,714, and $3,372,479, respectively.
The Company maintains three sources of credit from two financial institutions:
one $10.0 million secured and committed line of credit that cannot be canceled
during its annual term; a $30 million secured line of credit that cannot be
canceled during its annual term; and a $3.0 million secured line of credit
available for the issuance of letters of credit. As of December 31, 1995, $2.8
million of the $10.0 million line of credit was outstanding at a variable rate
of 6.48%. It is anticipated that these short-term borrowings will be repaid
during the first quarter 1996.
5. REINSURANCE
In the ordinary course of business, the insurance subsidiaries assume and cede
premiums with other insurance companies and various pools and associations of
which they are members. A large portion of the reinsurance
41
<PAGE>
is effected under reinsurance contracts known as treaties and, in some
instances, by negotiation on each individual risk. In addition, there are excess
of loss and catastrophe reinsurance contracts which protect against losses over
stipulated amounts arising from any one occurrence or event. The arrangements
provide greater diversification of business and serve to limit the maximum net
loss on catastrophes
<PAGE>
and large and unusually hazardous risks.
Through the purchase of reinsurance, the Company generally limits the loss on
any individual risk to $1.0 million. Additionally, through extensive use of
computer-assisted modeling techniques, the Company monitors the concentration of
risks exposed to catastrophic events (predominantly earthquakes). The Company
seeks to limit its estimated net aggregate exposure to a single catastrophic
event to less than 10% of shareholders' equity.
Premiums written and earned along with losses and settlement expenses incurred
for the years ended December 31 are summarized as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
Written 1993 1994 1995
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Direct $248,944,184 $279,410,212 $270,887,545
Reinsurance assumed 425,168 17,905 548,601
Reinsurance ceded (105,838,301) (132,766,433) (140,983,251)
- -----------------------------------------------------------------------------------------
Net $143,531,051 $146,661,684 $130,452,895
- -----------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------
Earned 1993 1994 1995
- -----------------------------------------------------------------------------------------
Direct $233,757,304 $265,453,514 $264,651,370
Reinsurance assumed 504,463 189,371 588,362
Reinsurance ceded (108,272,489) (125,458,397) (131,771,599)
- -----------------------------------------------------------------------------------------
Net $125,989,278 $140,184,488 $133,468,133
- -----------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------
Losses and settlement expenses incurred 1993 1994 1995
- -----------------------------------------------------------------------------------------
Direct $131,276,131 $280,126,708 $160,294,644
Reinsurance assumed 348,478 (349,972) 809,657
Reinsurance ceded (51,887,206) (178,135,070) (75,214,306)
- -----------------------------------------------------------------------------------------
Net $ 79,737,403 $101,641,666 $ 85,889,995
- -----------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------
</TABLE>
The Company was party to multiple-year, retrospectively-rated reinsurance
contracts through 1993. These contracts included provisions for additional
premiums to be paid to the reinsurer, or amounts to be returned to the Company
in the form of contingent commissions based on cumulative loss experience. In
1993, the Financial Accounting Standards Board's Emerging Issues Task Force
(EITF) issued Consensus No. 93-6, "Accounting and Reporting for Multiple-Year,
Retrospectively-Rated Reinsurance Contracts by Ceding and Assuming Enterprises"
(EITF 93-6). According to EITF 93-6 an asset should be recognized by the ceding
enterprise for amounts due from the reinsurer relating to experience to date
under those contracts. Accordingly, the Company recognized an asset for
contingent commissions due from reinsurers based on experience under these
contracts. During December 1993, the Company cancelled its multiple-year,
retrospectively-rated reinsurance contracts.
At December 31, 1995, the Company had prepaid reinsurance premiums and
reinsurance recoverables on paid and unpaid losses and settlement expenses with
American Re-Insurance Company (rated A+ "superior" by A.M. Best Company) and
Lloyds of London that amounted to $50,886,661 and $19,593,757, respectively. All
other reinsurance balances recoverable, when considered by individual reinsurer,
are less than 10% of shareholders' equity.
6. UNPAID LOSSES AND SETTLEMENT EXPENSES
The following table is a reconciliation of the Company's liability for unpaid
losses and settlement expenses (LAE) for the three years ended December 31,
1995. Since reserves are based on estimates, the ultimate net cost may vary from
the original estimate. As adjustments to these estimates become necessary, they
are reflected in current operations. As part of the reserving process,
historical data is reviewed and consideration is given to the anticipated impact
of various factors such as legal developments and economic conditions, including
the effects of inflation. Changes in reserves from the prior years' estimates
are calculated based on experience as of the end of each succeeding year (loss
and LAE development).
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------
Year Ended December 31,
(In thousands) 1993 1994 1995
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Unpaid losses and LAE at beginning of year:
Gross $268,043 $310,767 $394,966
Ceded (137,591) (145,208) (199,737)
- ---------------------------------------------------------------------------------------------
Net 130,452 165,559 195,229
- ---------------------------------------------------------------------------------------------
Increase (decrease) in incurred losses and LAE:
Current accident year 81,589 100,535 62,619
Prior accident years (1,852) 1,107 23,271
- ---------------------------------------------------------------------------------------------
Total incurred 79,737 101,642 85,890
- ---------------------------------------------------------------------------------------------
Loss and LAE payments for claims incurred:
Current accident year (18,743) (36,501) (10,600)
Prior accident years (24,726) (36,026) (48,023)
- ---------------------------------------------------------------------------------------------
Total paid (43,469) (72,527) (58,623)
- ---------------------------------------------------------------------------------------------
Insolvent reinsurer charge off (221) 643 514
Loss reserves commuted (940) (88) (1,376)
- ---------------------------------------------------------------------------------------------
Net unpaid losses and LAE at end of year 165,559 195,229 221,648
- ---------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------
Unpaid losses and LAE at end of year:
Gross 310,767 394,966 418,986
Ceded (145,208) (199,737) (197,338)
- ---------------------------------------------------------------------------------------------
Net $165,559 $195,229 $221,648
- ---------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------
</TABLE>
During 1993 and 1994, overall development on prior accident-year loss and
settlement expense reserves was insignificant to operating results and recorded
loss and settlement expense reserves. For 1995, however, prior accident-year
development has been significantly impacted by the effects of
42
<PAGE>
the 1994 Northridge Earthquake. As previously discussed in note 1, the Company
experienced $27.3 million of loss development from this event during calendar
year 1995.
The Company is subject to environmental claims and exposures through its
commercial umbrella, general liability, and assumed reinsurance lines of
business. Within these lines, the Company's environmental exposures include
environmental site cleanup, asbestos removal, and mass tort liability. The
majority of the exposure is in the excess layers of the Company's commercial
umbrella and assumed reinsurance books of business.
The following table represents inception-to-date paid and unpaid data (including
incurred but not reported losses) for the periods ended 1994 and 1995:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Inception-to-date December 31,
(In thousands) 1994 1995
- -------------------------------------------------------------------------------
<S> <C> <C>
Loss and LAE payments for claims incurred
Gross $ 3,549 $ 5,117
Ceded (2,933) (3,842)
- -------------------------------------------------------------------------------
Net $ 616 $ 1,275
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Unpaid losses and LAE at end of year
Gross $15,519 $20,154
Ceded (9,875) (13,398)
- -------------------------------------------------------------------------------
Net $ 5,644 $ 6,756
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
</TABLE>
Although the Company's environmental exposure is limited as a result of entering
the liability lines after the industry had already recognized it as a problem,
Management cannot determine the Company's ultimate liability within any
reasonable degree of certainty. This ultimate liability is difficult to assess
due to evolving legislation on such issues as joint and several liability,
retroactive liability, and standards of cleanup. Additionally, the Company
participates primarily in the excess layers, making it even more difficult to
assess the ultimate impact.
7. INCOME TAXES
As discussed in note 1J, the Company adopted SFAS 109 as of January 1, 1993. The
cumulative effect of this change in accounting for income taxes of $1,665,000
was determined as of January 1, 1993, and is reported separately in the
consolidated statement of earnings for the year ended December 31, 1993.
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are presented below.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
1993 1994 1995
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Deferred tax assets:
Tax discounting of claim reserves $13,589,724 $15,402,122 $15,635,860
Unearned premium offset 5,065,358 5,419,657 5,307,695
Other, net 1,498,805 2,060,970 2,365,467
- ----------------------------------------------------------------------------------------------
20,153,887 22,882,749 23,309,022
Less valuation allowance (300,000) (300,000) (300,000)
- ----------------------------------------------------------------------------------------------
Total deferred tax assets $19,853,887 $22,582,749 $23,009,022
- ----------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------
Deferred tax liabilities:
Net unrealized appreciation of securities $ 7,776,109 $ 5,764,109 $18,171,600
Deferred policy acquisition costs 6,552,838 6,722,874 5,532,419
Book/tax depreciation 1,717,133 1,720,598 1,535,324
Other, net 1,966,530 1,573,339 2,674,073
- ----------------------------------------------------------------------------------------------
Total deferred tax liabilities 18,012,610 15,780,920 27,913,416
- ----------------------------------------------------------------------------------------------
Net deferred tax asset (liability) $ 1,841,277 $ 6,801,829 $ (4,904,394)
- ----------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------
</TABLE>
Management feels it is more likely than not that a portion of the Company's
deferred tax assets will not be realized. Therefore, an allowance has been
established for certain deferred tax assets which have an indefinite reversal
pattern. Management also believes the Company's remaining deferred tax assets
will be fully realized through deductions against future taxable income.
Income tax expense attributable to income from operations for the years ended
December 31, 1993, 1994, and 1995, differed from the amounts computed by
applying the U.S. federal tax rate of 35% to pretax income from continuing
operations as a result of the following:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
1993 1994 1995
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Provision for income taxes at
the statutory federal tax rates $ 6,415,201 $(4,055,387) $2,893,959
Increase (reduction) in taxes
resulting from:
Dividends received deduction (844,496) (1,126,519) (1,170,146)
Dividends paid deduction (248,163) (258,474) (265,754)
Tax exempt interest income (1,385,440) (1,607,296) (1,428,846)
State income tax provision 152,620 67,683 144,405
Other items, net (43,203) 169,044 145,294
- -------------------------------------------------------------------------------
$ 4,046,519 $(6,810,949) $318,912
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
</TABLE>
The Company has recorded its deferred tax assets and liabilities using the
statutory federal tax rate of 35%. Management believes when these deferred items
reverse in future years, the Company's taxable income will be taxed at an
effective rate of 35%.
Federal and state income taxes paid in 1993, 1994, and 1995, amounted to
$2,962,003, $7,617,198, and $530,230, respectively.
The IRS has examined the Company's income tax returns through the tax year ended
December 31, 1990. In 1993 and 1994, the Company received tax refunds from
certain of these tax years, the majority of which was
43
<PAGE>
previously accrued. As a result, the Company recorded tax benefits of $129,411
in 1993 and $73,893 in 1994. Additionally, the Company received interest from
the IRS in 1993 and 1994 of $941,731 and $56,590, respectively, which was
recorded as investment income. The IRS is currently examining the Company's
income tax returns for the years ended December 31, 1991 through 1994.
Management believes any tax implications from examinations of these years should
not materially impact the Company's consolidated financial position or results
of operations.
8. EMPLOYEE BENEFITS
The Company has a non-contributory defined benefit pension plan covering
substantially all employees meeting age and service eligibilities, except those
of RLI Vision Corp. The plan provides a benefit based on service and the highest
five consecutive years' average compensation out of the last 10 years of service
of a participant. The Company funds pension costs as accrued, except that in no
case will the Company contribute amounts less than the minimum contribution
required under the Employee Retirement Income Security Act of 1974 or more than
the maximum tax deductible contribution for the year. The plan reached the full
funding limitation in 1986 and remained fully funded through 1993. Therefore no
contribution was made in 1993. During 1994 and 1995, the Company made the
maximum tax deductible contribution allowed, totaling $312,740 and $397,158,
respectively, to adequately meet the funding requirements of the plan.
The Company has made various amendments to the plan in order to comply with
certain Internal Revenue Code changes.
The components of net periodic pension costs for each of the three years ended
December 31, are as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
1993 1994 1995
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost $356,478 $405,796 $277,870
Interest cost 185,686 234,127 239,607
Actual return on assets (346,070) 190,316 (796,106)
Net amortization and deferral (25,101) (534,183) 486,482
- -------------------------------------------------------------------------------
Net pension expense $170,993 $296,056 $207,853
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
</TABLE>
The following table sets forth the plan's funded status at December 31, 1994 and
1995:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
1994 1995
- -------------------------------------------------------------------------------
<S> <C> <C>
Actuarial present value of benefit obligation:
Accumulated benefit obligation:
Vested $2,236,955 $3,055,535
Nonvested 69,754 90,201
- -------------------------------------------------------------------------------
$2,306,709 $3,145,736
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Projected benefit obligation $2,751,264 $3,835,535
Plan assets at fair market value 2,684,511 3,253,386
- -------------------------------------------------------------------------------
Plan assets under
projected benefit obligation $ (66,753) $ (582,149)
Unrecognized net asset at January 1,
being amortized over 17.2 years (299,611) (267,045)
Unrecognized prior service cost 23,477 12,367
Unrecognized net loss (gain) (480,582) 307,666
- -------------------------------------------------------------------------------
Accrued pension costs $ (823,469) $ (529,161)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
</TABLE>
At December 31, 1995, plan assets at fair value are comprised of approximately
5% fixed maturities, 94% equity securities and 1% invested cash.
In 1994, the Company used a settlement rate of approximately 8.75%, an increase
in salary levels of 6%, and an expected long-term return on plan assets of 10%
in determining the projected benefit obligation. During 1995, the Company used
the following rates to determine its projected benefit obligation: 7.25%
settlement rate, 6% increase in salary, and 10% expected long-term return on
plan assets.
In December 1994, the Board passed a resolution to exclude all employees of RLI
Vision from the defined benefit pension plan effective January 1, 1995, for
benefit accrual purposes. This curtailment had an immaterial impact on the
consolidated financial statements.
The Company has a non-leveraged Employee Stock Ownership Plan (ESOP) which
covers substantially all employees meeting eligibility requirements, except
those of RLI Vision Corp. ESOP contributions are determined annually by the
Company's Board of Directors and are expensed in the year earned and funded in
the following year. During 1993, 1994, and 1995, the Company recognized expense
of $2,645,973, $160,154, and $2,046,474, respectively, related to the ESOP.
During 1993, the ESOP purchased 114,688 shares of the Company's treasury stock
at an average price of $20.62 ($2,365,388). During 1994, the ESOP purchased
124,500 shares of the Company's treasury stock at an average price of $18.03
($2,245,050) and 5,000 shares of the Company's common stock on the open market
at an average price of $16.46 ($82,320). During 1995, no ESOP shares were
purchased. All shares held by the ESOP are treated as outstanding in computing
the Company's earnings per share. Dividends on ESOP shares are passed through to
the participants.
44
<PAGE>
At its December 1995 meeting, the Board voted in favor of making a contribution
to the ESOP for 1995 based on the projected net income for the year. In 1994,
the Board did not authorize a contribution based on that year's projected net
loss. Additionally, in 1994, the Board resolved to exclude all employees of RLI
Vision Corp. from the ESOP starting January 1, 1995, for benefit accrual
purposes.
During 1995, RLI Vision adopted a 401(k) retirement and savings plan to replace
the ESOP and pension plans. This plan covers all employees who meet service and
eligibility requirements. Employee 401(k) contributions are matched by RLI
Vision at 50% of up to 6% of eligible compensation. A profit sharing
contribution, determined annually by the Board, is expensed in the year earned
and funded to the plan in the following year. During 1995, the Company
recognized $92,197 for the matching contribution and $128,428 for the profit
sharing contribution. All contributions are allocated among six mutual funds and
RLI Corp. stock.
The Company has a management and executive incentive plan for key employees of
the Company. The plan is subject to limitations and is based on minimum profit
levels and varying percentages of the managers' and executives' salaries
determined annually by Management and the Board of Directors. The amounts earned
under this plan for 1993, 1994, and 1995, were $988,900, $433,911, and $516,298,
respectively.
The Company has a directors deferred compensation plan and an excess ESOP for
key employees through which Company shares are purchased for the directors and
key employees. The Company funded the plans by establishing Rabbi Trusts and by
purchasing Company treasury shares. Since the assets of the Rabbi Trusts are
subject to claims of the Company's general creditors, such assets are recorded
as other assets in the accompanying balance sheets. A corresponding liability
for the same amount, which represents the Company's liability to its directors
and key employees, is reflected as a component of other liabilities. During
1993, 1994, and 1995, the Company recognized expenses of $375,628, $81,850, and
$145,550, respectively, under these plans. In 1995, the Rabbi Trusts purchased
1,448 shares of the Company's treasury stock, at an average price of $23.25
($33,667). At December 31, 1995, the Trusts' assets were valued at $2,817,965.
During 1995, the Company adopted and the shareholders approved a non-qualified
Incentive Stock Option Plan (The Plan). Under The Plan, an officer may be
granted an option to purchase shares at 100% of the grant date fair market value
(110% if the optionee and affiliates own 10% or more of the shares), payable in
cash. Options may be granted only during the ten-year period ending in May,
2005. An optionee must exercise an option within the first to occur of ten years
(five years if the optionee and affiliates own 10% or more of the shares) from
the grant date, or three months after the optionee ceases to be an employee.
During the year, the Company granted 65,625 options at a grant price of $20.60.
Since no options were exercisable at year end, all 65,625 options remained
outstanding at December 31, 1995.
The Company does not provide post-retirement or post-employment benefits to
employees and therefore does not have any liability under SFAS No. 106,
"Employer's Accounting for Post-retirement Benefits Other Than Pensions" or SFAS
No. 112, "Employers' Accounting for Post-employment Benefits."
9. STATUTORY INFORMATION AND DIVIDEND RESTRICTIONS
The Company's insurance subsidiaries maintain their accounts in conformity with
accounting practices prescribed or permitted by state insurance regulatory
authorities which vary in certain respects from GAAP. Reconciliations of net
income and shareholders' equity (statutory surplus), as reported in conformity
with statutory reporting practices to that reported in the accompanying
financial statements on the basis of GAAP, are shown as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------
Year ended December 31,
Net Income (Loss) 1993 1994 1995
- ------------------------------------------------------------------------------------
<S> <C> <C> <C>
Consolidated net income (loss),
statutory basis
$18,609,617 $(4,057,703) $12,638,658
Proposition 103 liability (416,400) (71,280)
Deferred policy acquisition costs 7,639,187 485,817 (3,401,296)
Reinsurance contingent
commissions (15,116,908)
Deferred income tax benefit 6,388,744 2,948,552 906,977
Net income of non-insurance
operations, interest expense
on debt and general corporate
expense
(1,328,938) (3,181,152) (2,153,744)
Implementation of SFAS 109 1,665,000
Other (1,492,675) (900,105) (41,054)
- ------------------------------------------------------------------------------------
As reported in accompanying
financial statements $15,947,627 $(4,775,871) $ 7,949,541
- ------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------
December 31,
Shareholders' Equity 1994 1995
- ------------------------------------------------------------------------------------
<S> <C> <C>
Consolidated surplus, statutory basis $136,124,530 $172,312,961
Deferred policy acquisition costs 19,208,212 15,806,911
Non-admitted assets 2,328,527 2,237,739
Proposition 103 liability (2,499,680) (2,499,680)
Deferred tax asset (liability) 6,801,829 (4,904,394)
Statutory liability for reinsurance 450,800 2,045,800
Proceeds from RLI Corp. debt
contributed to RLI Insurance Co. (37,500,000) (30,500,000)
Equity of non-insurance companies 6,251,835 2,855,246
Other 3,908 1,253,133
- ------------------------------------------------------------------------------------
As reported in accompanying financial statements $131,169,961 $158,607,716
- ------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------
</TABLE>
45
<PAGE>
Dividend payments to the Company from its principal insurance subsidiary are
restricted by state insurance laws as to the amount that may be paid without
prior notice or approval of the regulatory authorities of Illinois and
California. The maximum dividend distribution is limited by Illinois and
California law to the greater of: 10% of RLI Insurance Company's policyholder
surplus as of December 31 of the preceding year, or the net income of RLI
Insurance Company for the 12-month period ending December 31 of the preceding
year. Therefore, the maximum dividend distribution that can be paid by RLI
Insurance Company during 1996 without prior notice or approval is $17,231,297.
The actual amount paid to the Company during 1995 was $7,373,877.
10. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is involved in certain legal proceedings and disputes considered by
Management to be ordinary and incidental to the business, or which have no
foundation in fact. Management believes that valid defenses exist as to all such
litigation and disputes and is of the opinion that these will not have a
material effect on the Company's financial statements.
The Company has one standby letter of credit for $2,070,000, outstanding at
December 31, 1995, to secure amounts sought in litigation involving an insurance
claim. The letter of credit has not been drawn on. The Company maintains a
liability which Management believes adequately covers estimated losses and
related expenses that will be incurred as a result of this claim. Therefore, no
loss is expected to result if draw downs on the letter of credit are required in
the future.
In November 1988, California voters approved Proposition 103, which requires
insurance rates for certain lines of business to be rolled back 20% from the
rates in effect in November 1987. As a result, in 1993 and 1994, the Company
reduced pretax earnings by $416,400 and $71,280, respectively. No additional
provision was made during 1995. The above amounts include interest for 1993 and
1994, in the amount of $259,000 and $71,280, respectively. The total amount of
deferred premiums and interest accrued as of December 31, 1995, was $2,499,680.
The state of California maintains that the Company is not in compliance with
Proposition 103 and that the required amount of premiums to be returned is $6.5
million plus accrued interest. The Company maintains it had reduced rates by 20%
or more on its most significant lines of business. This reduction is at issue
with the California Department of Insurance. While it is impossible to predict
the outcome, Management believes that the amount accrued is adequate to cover
the ultimate rollback, if any. The matter has been set for hearing in March of
1996.
The Company leases regional office facilities and automobiles under operating
leases expiring in various years through 1999. Minimum future rental payments
under noncancellable operating leases are as follows:
<TABLE>
<CAPTION>
<S> <C>
1996 $ 734,861
1997 607,577
1998 314,267
1999 57,699
----------
Total minimum future rental payments $1,714,404
----------
----------
</TABLE>
46
<PAGE>
11. INDUSTRY SEGMENT INFORMATION
Selected information by industry segment for 1993, 1994, and 1995 is summarized
in the chart below.
RLI Insurance Group: Specialty coverages of property and casualty insurance
provided on a direct basis, primarily on commercial risks.
RLI Vision Corp.: The wholesale distribution of soft contact lenses, spectacle
frames and sunglasses; third party administration of extended service programs;
manufacturing rigid gas permeable (RGP) contact lenses and spectacle lenses;
RLISYS practice management software; and income from investments held by RLI
Vision Corp.
Investment Income: Net interest and dividend income from the fixed maturities,
equity securities and short-term investments of RLI Corp. and RLI Insurance
Group.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
Earnings (loss)
before income taxes
Segment Data Revenue and cumulative effect Assets
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1993
RLI Insurance Group $125,989,278 $ 3,548,578 $648,567,132
RLI Vision Corp. 29,194,823 1,205,739 12,337,586
Net investment income 16,857,117 16,857,117
Net realized investment gains 253,945 253,945
General corporate and interest expense (3,536,233) 12,961,586
- ------------------------------------------------------------------------------------------------------------
Consolidated $172,295,163 $ 18,329,146 $673,866,304
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
1994
RLI Insurance Group $140,184,488 $(23,705,660) $730,112,294
RLI Vision Corp. 33,973,592 1,858,109 14,501,655
Net investment income 20,132,585 20,132,585
Net realized investment losses (3,595,101) (3,595,101)
General corporate and interest expense (6,276,753) 13,189,120
- ------------------------------------------------------------------------------------------------------------
Consolidated $190,695,564 $(11,586,820) $757,803,069
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
1995
RLI Insurance Group $133,468,133 $ (9,933,960) $786,243,404
RLI Vision Corp. 34,595,388 1,157,234 13,872,364
Net investment income 22,029,081 22,029,081
Net realized investment gains 456,510 456,510
General corporate and interest expense (5,440,412) 14,531,373
- ------------------------------------------------------------------------------------------------------------
Consolidated $190,549,112 $ 8,268,453 $814,647,141
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
</TABLE>
47
<PAGE>
12. UNAUDITED INTERIM FINANCIAL INFORMATION
Selected quarterly information is as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
First Second Third Fourth Year End
1994 Total
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net premiums earned $21,949,965 $36,470,083 $34,162,868 $47,601,572 $140,184,488
RLI Vision Corp. revenue 7,921,092 8,668,980 8,874,208 8,509,312 33,973,592
Net investment income 4,696,248 4,915,558 5,060,832 5,459,947 20,132,585
Net realized investment gains (losses) 11,634 (19,630) 105,105 (3,692,210) (3,595,101)
Earnings (loss) before income taxes (23,839,629) 5,785,276 (26,068) 6,493,601 (11,586,820)
Net earnings (loss) (14,955,965) 4,536,116 728,620 4,915,358 (4,775,871)
Primary earnings (loss) per share* $(1.94) $0.58 $0.09 $0.63 $(0.61)
Fully diluted earnings (loss) per share* $(1.94) $0.53 $0.09 $0.56 $(0.61)
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
1995
- -----------------------------------------------------------------------------------------------------------------------------
Net premiums earned $35,562,960 $33,226,482 $32,170,742 $32,507,949 $133,468,133
RLI Vision Corp. revenue 8,732,501 9,011,315 8,964,995 7,886,577 34,595,388
Net investment income 5,400,021 5,265,829 5,575,171 5,788,060 22,029,081
Net realized investment gains (losses) (29,391) 136,542 11,297 338,062 456,510
Earnings (loss) before income taxes 7,248,585 7,623,243 (15,762,640) 9,159,265 8,268,453
Net earnings (loss) 5,336,931 5,479,819 (9,560,670) 6,693,461 7,949,541
Primary earnings (loss) per share* $0.68 $0.70 $(1.22) $0.85 $1.01
Fully diluted earnings (loss) per share* $0.60 $0.62 $(1.22) $0.75 $1.01
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
*Since the weighted average shares for the quarters are calculated independent
of the weighted average shares for the year, and due to the exclusion of the
antidilutive effects as discussed in note 1K, quarterly earnings per share may
not total to annual earnings per share.
48
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
RLI Corp.
We have audited the accompanying consolidated balance sheets of RLI Corp. and
Subsidiaries as of December 31, 1995 and 1994, and the related consolidated
statements of earnings, shareholders' equity, and cash flows for each of the
years in the three year period ended December 31, 1995. These consolidated
financial statements are the responsibility of the Company's Management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
Management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of RLI Corp. and
Subsidiaries at December 31, 1995 and 1994, and the results of their operations
and their cash flows for each of the years in the three year period ended
December 31, 1995, in conformity with generally accepted accounting principles.
As discussed in note 1 to the consolidated financial statements, in 1994 the
Company adopted the provisions of the Financial Accounting Standards Board's
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," and in 1993, the Company adopted the
provisions of the Financial Accounting Standards Board's Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes."
January 25, 1996
KPMG Peat Marwick LLP
Certified Public Accountants
Peat Marwick Plaza
303 East Wacker Drive
Chicago, Illinois 60601
STATEMENT OF FINANCIAL REPORTING RESPONSIBILITY
The Management of RLI Corp. and Subsidiaries is responsible for the preparation
and for the integrity and objectivity of the accompanying financial statements
and other financial information in this report. The financial statements have
been prepared in accordance with generally accepted accounting principles and
include amounts that are based on Management's estimates and judgments.
The accompanying financial statements have been audited by KPMG Peat Marwick LLP
(KPMG), independent certified public accountants, selected by the Audit
Committee and approved by the shareholders. Management has made available to
KPMG all the Company's financial records and related data, including minutes of
directors' meetings. Furthermore, Management believes that all representations
made by it to KPMG during its audit were valid and appropriate.
Management has established and maintains a system of internal controls
throughout its operations that are designed to provide assurance as to the
integrity and reliability of the financial statements, the protection of assets
from unauthorized use, and the execution and recording of transactions in
accordance with Management's authorization. The system of internal controls
provides for appropriate division of responsibility and is documented by written
policies and procedures that are updated by Management as necessary. Certain
aspects of these systems and controls are tested periodically by the Company's
Internal Auditor. As part of its audit of the financial statements, which is
performed in accordance with generally accepted auditing standards, KPMG
considers certain aspects of the system of internal controls to the extent
necessary to form an opinion on the financial statements and not to provide
assurance on the system of internal controls. Management considers the
recommendations of its Internal Auditor and independent public accountants
concerning the Company's internal controls and takes the necessary actions that
are cost-effective in the circumstances to respond appropriately to the
recommendations presented. Management believes that as of December 31, 1995, the
Company's system of internal controls was adequate to accomplish the objectives
described herein.
The Audit Committee is comprised solely of five non-employee directors and is
charged with general supervision of the audits, examinations and inspections of
the books and accounts of RLI Corp. and Subsidiaries. It also recommends to the
Board of Directors the firm of independent public accountants to be engaged to
audit the annual consolidated financial statements, and it meets regularly with
those independent public accountants and with Management, both separately and
together. The independent public accountants and the Internal Auditor have ready
access to the Audit Committee.
Gerald D. Stephens, CPCU
President, RLI Corp.
Joseph E. Dondanville, CPA
Vice President, Chief Financial Officer, RLI Corp.
49
<PAGE>
CORPORATE DATA
ANNUAL MEETING
The annual meeting of shareholders will be held at 2:00 p.m., local time, on May
2, 1996, at the Company's offices at 9025 North Lindbergh Drive, Peoria, IL.
COMMON STOCK/CONVERTIBLE DEBENTURE SYMBOLS
RLI common stock (NYSE): RLI RLI convertible debenture (NYSE): RLIS
TRADING AND DIVIDEND INFORMATION
The following table sets forth the high and low sale prices, as well as the
closing prices, for the Common Stock for the indicated periods as reported by
the NYSE. The table also indicates cash dividends as declared by the Company.
<TABLE>
<CAPTION>
Stock Price Dividends
High Low Close Declared
- --------------------------------------------------------------------------------
1995
<S> <C> <C> <C> <C>
1st Quarter 19 1/10 16 3/10 18 7/10 $.12
2nd Quarter 23 1/4 18 6/10 22 3/4 .13
3rd Quarter 23 5/8 21 7/8 22 3/8 .13
4th Quarter 25 21 3/4 25 .13
- --------------------------------------------------------------------------------
1994
1st Quarter 22 2/10 18 6/10 19 1/10 $.11
2nd Quarter 19 1/10 17 7/10 17 3/10 .11
3rd Quarter 18 8/10 16 1/2 17 3/10 .12
4th Quarter 17 3/10 15 9/10 16 4/10 .12
- --------------------------------------------------------------------------------
</TABLE>
RLI Corp. normally pays dividends four times a year, usually on January 15,
April 15, July 15 and October 15. The Company has paid and increased dividends
for 19 consecutive years. Since 1989, RLI dividends qualify for the Enterprise
Zone dividend subtraction modification for Illinois state income tax returns.
CORPORATE HEADQUARTERS
9025 North Lindbergh Drive, Peoria, IL 61615-1431, (309) 692-1000, (800)
331-4929, Fax: (309) 692-1068
FINANCIAL INFORMATION
For Management's perspective on specific issues, call RLI Treasurer, Tim
Krueger, direct at (309) 693-5884.
SHAREHOLDER INQUIRIES
Shareholders of record requesting information concerning individual account
balances, stock certificates, dividends, stock transfers or address corrections
should contact the Transfer Agent and Registrar at:
Norwest Bank Minnesota, N.A., 161 North Concord Exchange, P.O. Box 64854
South St. Paul, MN 55164-0854, Phone: (800) 468-9716, Internet:
[email protected]
RLI ON THE INTERNET
For up-to-date financial information, earnings releases, press releases, and a
wide variety of other RLI information, contact us on the Internet at:
http://www.rlicorp.com. RLI Vision maintains a separate Internet site at:
http://www.rlivision.com.
BONDHOLDER INQUIRIES
Inquiries concerning lost bonds, interest payments, changes of address, and
other matters relating to ownership should be directed to RLI's convertible debt
trustee:
Norwest Corporate Trust Services, Sixth & Marquette, Minneapolis, MN 55479-0069,
Phone: (612) 667-9764
ANNUAL REPORT AND FORM 10-K
Additional copies of this report and the Annual Report to the Securities and
Exchange Commission, Form 10-K, will be furnished without charge to any
shareholder. Simply contact the Treasurer at our Corporate Headquarters.
"Street Name" shareholders wishing to have their names placed on a mailing list
to receive copies of annual reports, quarterly reports, and other shareholder
materials, should also indicate their desire to the Treasurer at the Corporate
Headquarters.
DIVIDEND DIRECT DEPOSIT PLAN
Shareholders may have their dividends deposited directly into their checking,
savings or money market accounts. If you wish to sign up for this Plan, send
your request to Shareholder Information at the Transfer Agent and Registrar
address listed at left.
DIVIDEND REINVESTMENT PLAN
An Automatic Dividend Reinvestment and Stock Purchase Plan is offered to
shareholders of RLI on a voluntary basis. As a shareholder, you may add to your
holdings in the following ways: Shares purchased with dividends are purchased as
an open market transaction. Optional cash payments may also be made, in any
amount, from $25 to $2,000 per month to purchase shares also as an open market
transaction. The Company pays the additional costs associated with the open
market purchases, which will have a slight tax impact on participating
shareholders. A summary outlining the provisions of the Plan and an enrollment
form may be obtained by contacting Shareholder Information at the Transfer Agent
and Registrar address listed at left.
STOCK OWNERSHIP
At December 31, 1995, stock ownership was as follows:
<TABLE>
<CAPTION>
Shares %
-------------------------------
<S> <C> <C>
Insiders 706,833 9.00
ESOP 1,410,290 17.96
Institutions 3,286,585 41.86
Other Public 2,447,174 31.18
-------------------------------
7,850,882 100.00%
</TABLE>
53
<PAGE>
Exhibit 21.1
Subsidiaries of the Registrant
The following companies are subsidiaries
of the Registrant as of December 31, 1995.
<TABLE>
<CAPTION>
Jurisdiction of Percentage
Name Incorporation Ownership
- ---- ------------- ---------
<S> <C> <C>
RLI Insurance Company Illinois 100%
RLI Aviation, Inc. Illinois 100%
Replacement Lens Inc. Illinois 100%
RLI Vision Corp. Illinois 100%
Mt. Hawley Insurance Company Kansas 99.5%
License Express Services, Inc. Illinois 100%
RLI Insurance Ltd. Bermuda 100%
RLI Insurance Agency Ltd. Canada 100%
RLI Planned Services Ltd. Canada 100%
</TABLE>
42
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
RLI Corp.:
We consent to incorporation by reference in the registration statement (No. 333-
01637) on Form S-8 of RLI Corp. of our reports dated January 25, 1996, relating
to the consolidated balance sheets of RLI Corp. and subsidiaries as of December
31, 1995 and 1994, and the related consolidated statements of earnings,
shareholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1995, and all related schedules, which reports are
incorporated by reference in, or appear in (with respect to the schedules), the
1995 annual report on Form 10-K of RLI Corp.
As discussed in Note 1 to the consolidated financial statements, in 1994 the
Company adopted the provisions of the Financial Accounting Standards Board's
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," and in 1993 the Company adopted the
provisions of the Financial Accounting Standards Board's Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes."
KPMG Peat Marwick LLP
Chicago, Illinois
March 22, 1996
43
<PAGE>
Exhibit 29.1
Information from reports furnished to state insurance regulatory authorities -
Reconciliation of reserves for unpaid losses and settlement expenses.
The domestic insurance subsidiaries of the Company are required to file annual
statements with state insurance regulatory authorities prepared on an accounting
basis prescribed or permitted by such authorities (statutory basis). The
differences between the net liability reported in the accompanying consolidated
financial statements in accordance with generally accepted accounting principles
(GAAP) and that reported in the annual statutory statements are as follows:
<TABLE>
<CAPTION>
At December 31, 1995
(In thousands)
--------------
<S> <C>
Net liability reported on a statutory basis $221,997
Adjustments:
Interest imputed on commutation settlements (349)
----
Net liability reported on a GAAP basis $221,648
--------
--------
Reconciliation of the GAAP net liability:
Gross unpaid losses and settlement expenses $418,986
Reinsurance balances recoverable on unpaid losses
and settlement expenses (197,338)
-------
Net liability reported on a GAAP basis $221,648
--------
--------
</TABLE>
44
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS IN THE RLI CORP. ANNUAL REPORT TO SHAREHOLDERS
FOR THE PERIOD ENDED DECEMBER 31, 1995, ATTACHED AS EXHIBIT 13 TO RLI CORP.'S
FORM 10K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> DEC-31-1995
<CASH> 1,197
<SECURITIES> 474,590
<RECEIVABLES> 36,447
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 800,696
<PP&E> 35,516
<DEPRECIATION> (21,565)
<TOTAL-ASSETS> 814,647
<CURRENT-LIABILITIES> 605,135
<BONDS> 46,000
0
0
<COMMON> 8,453
<OTHER-SE> 150,155
<TOTAL-LIABILITY-AND-EQUITY> 814,647
<SALES> 0
<TOTAL-REVENUES> 190,549
<CGS> 0
<TOTAL-COSTS> 176,841
<OTHER-EXPENSES> 2,093
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,347
<INCOME-PRETAX> 8,268
<INCOME-TAX> 318
<INCOME-CONTINUING> 7,950
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,950
<EPS-PRIMARY> 1.01
<EPS-DILUTED> 1.01
</TABLE>
