<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, 1996
------------------------------------------
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
incorporation or organization) Identification No.)
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:
Name of each exchange
Title of each class 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
28, 1997 as reported on the New York Stock Exchange, was $263,068,745. 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 28, 1997 was 7,625,181.
DOCUMENTS INCORPORATED BY REFERENCES.
Portions of the Annual Report to Shareholders for the past year ended December
31, 1996, are incorporated by reference into Parts I and II of this document.
Portions of the Registrant's definitive Proxy Statement for the 1997 annual
meeting of security holders to be held May 1, 1997, are incorporated herein by
reference into Part III of this document.
Exhibit index is located on pages 34-35 of this document.
Page 1 of 35
<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 selected property
and casualty insurance.
SIGNIFICANT DEVELOPMENT
OPHTHALMIC MERGER
In November 1996, the Company announced the merger of its ophthalmic
services subsidiary, RLI Vision Corp., with Hester Enterprises, Inc. The
resulting organization operates under the name Maui Jim, Inc. This transaction
brings together the infrastructure of RLI Vision to support the recent sales
growth of Maui Jim sunglasses. The Company has a 44% (34% at December 31, 1996)
minority interest in Maui Jim, Inc., which is reflected in the Company's
financial statements as an equity-based investment. Fourth quarter 1996 results
included a one-time charge to the Company of $733,000, or $.06 per share, for
the effect of the change from pooling to purchase accounting stemming from a
1995 RLI Vision Corp. business combination. This change was required because of
the aforementioned merger.
For further discussion of this transaction, refer to Note 1B of Notes to
Consolidated Financial Statements 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., RLI Aviation, Inc., License Express
Services, 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.
2
<PAGE>
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.
Significant rate increases resulted when the insurance market hardened in
late 1984. The Company responded by expanding its premium volume in targeted
lines. Since 1987, the industry has experienced generally 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
entrenched soft market condition. 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 secured rate
increases of over 30% on the commercial property book of business, while the
casualty book of business incurred flat to moderate decreases. During 1995,
rates for catastrophic driven property business, especially in California,
continued to remain hard. In 1996, as expected, some softening began for this
type of business. The Company's casualty book has continued to incur flat to
moderate rate decreases.
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. The Company produced business under agreements with three
underwriting agents in 1996. 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; Overland Park, Kansas;
Glastonbury, Connecticut; Atlanta, Georgia; and Chicago, Illinois. In 1995,
the Company established an underwriting facility in Columbus, Ohio to underwrite
Lenders' Single Interest inland marine property insurance.
The following table provides for the year ended December 31, 1996 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, 1996, no
other state accounted for more than 2% of total direct premiums earned for all
product lines.
Direct Premiums
STATE EARNED PERCENT OF TOTAL
----- ------------- ----------------
California $106,222,590 39.1%
Texas 38,767,328 14.3
Florida 20,731,370 7.6
New York 18,377,973 6.8
Michigan 6,554,086 2.4
Pennsylvania 5,754,042 2.1
Illinois 5,647,419 2.1
All other 69,496,900 25.6
---------- -----
Total direct premiums $271,551,708 100.00%
============ =======
3
<PAGE>
The Company presently underwrites selected 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, Glastonbury, Overland Park, San Francisco, Chicago, Columbus
and Atlanta branch offices are responsible for underwriting this coverage. In
1994, 1995, and 1996, net earned premiums totaled $42,646,000, $49,430,000, and
$47,822,000 or 27%, 32%, and 31% respectively, of the Company's consolidated
revenues.
GENERAL LIABILITY. The Company writes general liability coverages through
its St. Paul, Glastonbury, 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 $35,160,000, $36,499,000, and $34,834,000, or 22%, 23% and 22%
of the Company's consolidated revenues for the years 1994, 1995, and 1996,
respectively.
COMMERCIAL AND PERSONAL UMBRELLA LIABILITY. The Company's commercial
umbrella coverage is produced through its Overland Park, St. Paul, Atlanta, and
Glastonbury 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 $17,638,000, $18,092,000, and
$21,282,000 or 11%, 12%, and 14% of the Company's consolidated revenues for the
years 1994, 1995, and 1996, respectively.
DIRECTORS' AND OFFICERS' LIABILITY/MISCELLANEOUS PROFESSIONAL LIABILITY.
In December, 1990, the Company established a new Directors' and Officers'
Liability underwriting facility in San Diego, California. In 1996, the facility
expanded to offer Miscellaneous Professional Liability for a variety of low to
moderate classes of risks. Net earned premiums totaled $5,680,000, $6,025,000,
and $5,000,000, or 4%, 4% and 3% of the Company's consolidated revenues for the
years 1994, 1995, and 1996, 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 Overland Park branch office. Net earned premiums totaled $7,953,000,
$8,257,000, and $6,566,000 or 5%, and 5%, and 4% of the Company's consolidated
revenues for 1994, 1995, and 1996, respectively.
SURETY. In 1993, the Company began writing surety business. This product
line is underwritten from the Home Office in Peoria and through an underwriting
facility in Dallas, Texas. The initial target market of the Surety Division was
a wide range of commercial surety bonds written primarily through the
independent agency system. In 1996, the Company expanded their product offering
to include contract bonds for small size contractors. Net earned premiums
totaled $2,300,000, $2,956,000, and $4,408,000, or 1%, 2%, and 3% of the
Company's consolidated revenues for 1994, 1995, and 1996, respectively.
OTHER. Smaller programs offered by the Company include: primary employer's
indemnity, excess medical, contact lens (discontinued in 1995), commercial
multi-peril and accident and health insurance. Net earned premiums from these
lines totaled $28,807,000, $12,209,000, and $10,744,000 or 18%, 8% and 7% of the
Company's consolidated revenues for the years 1994, 1995, and 1996,
respectively.
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.
4
<PAGE>
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 increases experienced in the property lines in California,
Florida and the wind belt from 1993 through 1995. 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 1996, 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 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 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.
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.
5
<PAGE>
REINSURANCE
The Company reinsures a significant portion of its 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
$125,458,000, $131,772,000, and $140,928,000 in 1994, 1995, and 1996,
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 1994 through 1996, 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 1994 through 1996 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 1994, 1995, and 1996, the
Company provided $1,000,000, $613,296, and $1,006,140 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, 1996, 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) that amounted to $59,492,246. 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, 1996 and the amounts of written premium ceded by
the Company to such reinsurers during 1996.
<TABLE>
<CAPTION>
GROSS REINSURER CEDED
EXPOSURE AS OF PERCENT PREMIUMS PERCENT
DECEMBER 31, 1996 OF TOTAL WRITTEN OF TOTAL
<S> <C> <C> <C> <C>
American Re-Insurance Co. $59,492,246 26.20% $19,393,486 13.43%
General Reins Corp. 13,776,840 6.07 7,932,445 5.49
Transatlantic Reinsurance 12,347,185 5.44 16,718,104 11.57
Lloyd's of London 10,687,256 4.71 14,615,153 10.12
NAC Reinsurance Corporation 9,339,787 4.11 4,379,530 3.03
Employer's Re 8,102,927 3.57 8,530,215 5.91
TIG Insurance Co 6,505,160 2.86 708,688 0.49
St. Paul Fire & Marine 5,414,767 2.38 1,927,657 1.33
Security Ins. Co. of Hartford 5,214,385 2.30 1,441,772 1.00
Everest Re 5,064,106 2.23 6,384,821 4.42
All other reinsurers 91,151,134 40.13 62,411,792 43.21
---------- ----- ---------- -----
Total ceded exposure $227,095,793 100.00% $144,443,663 100.00%
============ ======= ============ =======
</TABLE>
As of December 31, 1996, the Company held $18,566,380 in irrevocable
letters of credit, $4,570,492 under trust agreements and $1,684,154 in cash to
collateralize a portion of the total amount recoverable.
6
<PAGE>
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 seeks to limit its net
aggregate exposure to a single catastrophic event to less than 10% of
shareholders' equity by purchasing various types of reinsurance.
The Company maintained its commercial property reinsurance protection in
1996, but decreased net exposure by reducing its retention in the fourth
catastrophe layer. Through implementation of this change, the Company
reaffirmed its ability to maintain its net aggregate exposure on a single
catastrophic event to less than 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.
In 1996, the Company entered into an innovative catastrophe reinsurance and
loss financing program with Centre Reinsurance (Centre Re). The program, called
Catastrophe Equity Puts (CatEPuts)SM, augments the Company's traditional
reinsurance by integrating its loss financing needs with a pre-negotiated sale
of securities linked to exchange-traded shares. CatEPuts allows the Company to
put up to $50.0 million of its convertible preferred shares to Centre Re at a
pre-negotiated rate in the event of a catastrophic loss provided the loss does
not reduce GAAP equity to less than $55.0 million. CatEPuts is intended to be a
three-year program and is designed to enable the Company to continue operating
after a loss of such magnitude that its reinsurance capacity is exhausted. If
the Company exercises its option to put preferred shares to Centre Re, then
Centre Re, in turn, has the option to reinsure certain business written by the
Company on a prospective basis.
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
1993 through 1995, the industry experienced some improvement in underwriting
losses. The trends experienced during the late 1980s, however, have continued,
and companies continue to post underwriting losses but remain profitable through
investment income gains. During 1996 the industry's statutory combined ratio is
estimated to be 106.1. 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 Surety Division offers its business
through a variety of independent agents. Additionally, the Specialty Marketing
Division writes program business, such as Personal Umbrella and the In-Home
Business Policy, through independent agents. 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. As well, the Surety
Division has authorized an underwriting agency to underwrite and bind contract
surety business on behalf of RLI, primarily in the East and Southeast.
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 insurance operating expenses
as a percent of gross written premiums for the years 1994, 1995, and 1996 were
5%, 5%, and 6%, respectively.
ENVIRONMENTAL EXPOSURES. The Company is subject to environmental claims
and exposures through its commercial umbrella, general liability, and
discontinued 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, 1995 and 1996:
- -------------------------------------------------------------------------------
Inception-to-date December 31
(in thousands) 1994 1995 1996
- -------------------------------------------------------------------------------
Loss and Loss Adjustment
Expense (LAE) payments
Gross $ 3,549 $ 5,117 $ 8,267
Ceded ( 2,933) ( 3,842) ($ 5,761)
- -------------------------------------------------------------------------------
Net $ 616 $ 1,275 $ 2,506
===============================================================================
Unpaid losses and LAE at end of year
Gross $ 15,519 $20,154 $17,596
Ceded ( 9,875) (13,398) ($11,150)
- -------------------------------------------------------------------------------
Net $ 5,644 $ 6,756 $ 6,446
===============================================================================
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 adjusts 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, 1996 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 1994, 1995, and 1996.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------
(Dollars in thousands) 1994 1995 1996
---- ---- ----
<S> <C> <C> <C>
Unpaid losses and settlement
expenses at beginning of year:
Gross $310,767 $394,966 $418,986
Ceded (145,208) (199,737) (197,338)
------- ------- -------
Net 165,559 195,229 221,648
------- ------- -------
Increase (decrease) in incurred losses and
settlement expenses:
Current accident year 100,535 62,619 69,724
Prior accident years 1,107 23,271 (1,463)
----- ------ ------
Total incurred 101,642 85,890 68,261
------- ------ ------
Loss and settlement expense payments for
claims incurred:
Current accident year (36,501) (10,586) (11,026)
Prior accident years (36,026) (48,023) (37,505)
------ ------ ------
Total paid (72,527) (58,609) (48,531)
------ ------ ------
Insolvent reinsurer charge off 643 514 607
Loss reserves commuted (88) (1,376) (1,201)
------ ----- ------
Unpaid losses and settlement
expenses at end of year $195,229 $221,648 $240,784
======== ======== ========
Unpaid losses and settlement
expenses at end of year:
Gross $394,966 $418,986 $405,801
Ceded (199,737) (197,338) (165,017)
-------- -------- --------
Net $195,229 $221,648 $240,784
======== ======== ========
</TABLE>
Explanation of significant components of reserve development by calendar
year are as follows:
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.
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.
11
<PAGE>
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.
1996 During 1996, the Company experienced approximately $1,463,000 of
favorable development on loss reserves. This development resulted
from approximately $1,519,000 of favorable development in the property
lines of business. Various property claims closed during the year were
settled below recorded reserves. The remaining $56,000 of adverse
development relates to the net effect of changes made to casualty loss
reserves. This development is a result of reserve strengthening of
$3,557,000 made in the General Liability and Miscellaneous Professional
business on accident years 1987 through 1995. This increase was offset
by favorable development and reserve decreases of $3,501,000 in the
Umbrella and Excess Employer's Indemnity programs on accident years
1986 and 1993 through 1995.
The table on the following page presents the development under generally
accepted accounting principles of the Company's balance sheet reserves for
1987 through 1996. 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) 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net Liability for unpaid
losses and settlement
expenses at end of year $66,169 $89,197 $95,953 $103,302 $110,844 $130,452 $165,559 $195,229 $221,648 $240,784
Paid (cumulative) as of:
One year later 10,170 17,312 14,302 19,297 23,561 24,725 36,026 48,023 37,505
Two years later 21,860 26,093 26,685 35,963 37,763 46,342 63,675 73,972
Three years later 28,052 37,137 40,341 44,088 49,462 64,364 84,614
Four years later 35,459 47,617 44,714 52,322 57,085 78,994
Five years later 42,010 48,937 51,153 56,413 65,318
Six years later 41,698 53,670 54,546 62,989
Seven years later 44,995 56,254 59,444
Eight years later 46,113 60,499
Nine years later 49,551
Liability re-estimated
as of:
One year later 67,033 86,230 91,646 101,251 108,249 128,600 166,666 218,499 220,185
Two years later 67,939 85,120 89,112 98,505 105,747 132,850 164,218 214,352
Three years later 68,697 84,426 87,981 95,690 107,777 132,377 157,286
Four years later 69,904 84,931 87,403 97,041 106,326 127,426
Five years later 69,670 84,217 90,030 96,490 100,968
Six years later 70,486 87,585 88,982 93,159
Seven years later 72,074 86,593 85,381
Eight years later 72,540 83,306
Nine years later 69,601
Net cumulative redundancy
(deficiency) $(3,432) $ 5,891 $10,572 $10,143 $ 9,876 $ 3,026 $ 8,273 $(19,123) $ 1,463
Gross liability $394,966 $418,986 $405,801
Reinsurance recoverable (199,737) (197,338) (165,017)
-------- -------- --------
Net liability $195,229 $221,648 $240,784
Gross re-estimated liability $427,830 $413,669
Re-estimated recoverable (213,478) (193,484)
-------- --------
Net re-estimated liability $214,352 $220,185
Gross cumulative redundancy
(deficiency) $(32,864) $5,227
</TABLE>
13
<PAGE>
OPERATING RATIO
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) 1992 1993 1994 1995 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Statutory net premiums written $110,895 $136,728 $131,164 $130,453 $130,908
Policyholders' surplus $100,585 $152,262 $136,125 $172,313 $207,787
Ratio 1.1 to 1 .9 to 1 1.0 to 1 .8 to 1 .6 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 1992 1993 1994 1995 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Loss ratio 60.3 63.3 72.5 64.4 52.2
Expense ratio 31.1 33.9 44.4 43.1 35.2
---- ---- ---- ---- ----
Combined ratio 91.4 97.2 116.9 107.5 87.4
==== ==== ===== ===== ====
</TABLE>
(1) Excluding the effects of the Northridge Earthquake, the GAAP combined ratio
for the years ended 1994 and 1995 would have been 91.1 and 86.2,
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 1992 1993 1994 1995 1996
---- ---- ---- ---- ----
Loss ratio 58.9 65.8 73.4 63.6 52.3
Expense ratio 36.9 22.1 (3) 43.5 42.9 36.8
---- ---- ---- ---- ----
Combined ratio 95.8 87.9 (3) 116.9 (4) 106.5 (4) 89.1
==== ==== ===== ===== ====
Industry combined ratio 115.7 (2) 106.9 (2) 108.4 (2) 106.4 (2) 106.1 (1)
===== ===== ===== ===== =====
</TABLE>
14
<PAGE>
(1) Source: Insurance Information Institute. Estimated for the year ended
December 31, 1996.
(2) Source: A.M. Best Aggregate & Averages -- Property-Casualty (1996
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 1994 and 1995 would have been 89.7 and 85.3,
respectively.
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.
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 rated or better 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 1996, operating cash flows were used to acquire fixed income
instruments composed mainly of intermediate-term U.S. Government and Agency
securities and municipal securities. Additionally, a small portion of the funds
were allocated to an investment grade convertible debenture portfolio designed
to provide diversification and yield enhancement to the portfolio. The
tax-exempt component of the fixed maturity portfolio increased $7.9 million, to
$114.7 million; and comprises 37.2% of the Company's total fixed maturity
portfolio, up 1.1% from year end 1995. The taxable U.S. Government, Agency and
Municipal portion of the fixed income portfolio declined slightly by $0.4
million to $185.8 million, or 60.3% of the total versus 63.0% at year end 1995.
Investment grade corporate securities totaled $3.7 million compared to $2.7
million at year end 1995, while convertible debenture securities totaling $4.0
million were added to the portfolio in 1996.
Equity securities increased $34.9 million from $154.0 million at the end of
last year to $188.9 million at the end of 1996. During 1996, net common equity
investments totaling $9.2 million were purchased and pretax unrealized
appreciation of equity securities totaled $25.8 million. Equity securities as a
percentage of cash and invested assets increased to 35.1% at the end of 1996
from 32.4% at year end 1995. Combined cash and short-term investments totaling
$40.8 million at year end 1996 represented 7.6% of cash and invested assets
versus 4.4% in 1995. 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. The
majority of 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 limited by restricting and managing acceptable call provisions among new
security purchases.
15
<PAGE>
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.
Aggregate maturities for the fixed maturity securities are as follows:
<TABLE>
<CAPTION>
MATURITY PAR AMORTIZED FAIR CARRYING
YEAR VALUE VALUE VALUE VALUE
- ---- ----- ----- ----- -----
<S> <C> <C> <C> <C>
1997 $16,745,000 $16,719,228 $16,829,890 $16,721,759
1998 27,995,000 28,260,289 28,717,798 28,287,175
1999 39,270,000 39,626,036 40,901,976 39,943,462
2000 32,910,000 33,687,738 34,601,360 33,876,334
2001 20,640,000 21,371,646 21,649,472 21,305,084
2002 23,380,000 24,390,589 24,560,773 24,300,451
2003 41,300,000 41,534,757 40,607,493 41,534,757
2004 20,295,000 20,433,996 20,474,843 20,433,996
2005 29,040,000 29,446,145 29,833,274 29,446,145
2006 14,350,000 14,343,596 14,532,125 14,343,596
2007 7,100,000 7,114,873 7,218,453 7,114,873
2008 8,275,000 8,029,518 8,206,127 8,029,518
2009 10,310,000 10,384,245 10,416,465 10,384,245
2010 9,750,000 10,132,696 9,968,673 10,132,696
2011 2,000,000 812,348 787,500 812,348
2012 0 0 0 0
2013 1,400,000 999,354 1,088,500 999,354
2014 0 0 0 0
2015 500,000 520,940 535,000 520,940
------- ------- ------- -------
$305,260,000 $307,807,994 $310,929,722 $308,186,733
============ ============ ============ ============
</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, 1996, the Company's equity
securities valued at $188.9 million, accounted for 35.1% of total cash and
invested assets and 90.9% of the combined statutory surplus of its insurance
subsidiaries. At December 31, 1996, net pretax unrealized capital appreciation
of equity securities was $77.2 million.
16
<PAGE>
The Company's investment results are summarized in the following table:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
(Dollars in thousands) 1992 1993 1994 1995 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Average invested
assets (1) $259,522 $341,361 $407,722 $442,717 $504,773
Investment
income (2)(3) 13,483 16,857 20,133 22,029 23,681
Realized gains
(losses) (3) 921 254 (3,595) 457 1,018
Change in unreal-
ized appreciation/
depreciation (3)(4) 3,546 7,945 (5,749) 36,037 25,033
Annualized return
on average
invested assets 6.9% 7.3% 2.7% 13.2% 9.9%
</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.
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. Currently, the National Association of Insurance
Commissioners (NAIC) has a project to codify statutory accounting practices, the
result of which is expected to constitute the only source of "prescribed"
statutory accounting practices. Accordingly, the project may result in changes
to the accounting policies that insurance enterprises use to prepare their
statutory financial statements.
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.
17
<PAGE>
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.
PROPOSITION 103 (RATE ROLLBACK INITIATIVE)--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. Beginning in 1989 and ending in 1994, the Company deferred premium
revenue of $1,449,200 and accrued interest in the amount of $1,050,480 to cover
the proposed rollback. No additional provision was made during 1995 and the
total funds accrued for rollback remained $2,449,680 at December 31, 1995.
During 1996, the Company reached a settlement with the California Department of
Insurance resolving its total liability for refunds and interest under
Proposition 103. The settlement requires the Company to pay $2,987,050 in
refunds and interest. In the second quarter of 1996, the Company recorded a
pretax charge of $487,370 to record the difference between the actual settlement
and the amount previously accrued. The Company is currently in the process of
issuing refund checks to policyholders.
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. Previously
the Company supported the proposed Natural Disaster Act as the most desirable
alternative. That Act was never passed and the Company is considering other
proposed alternatives.
SUPERFUND REFORM (ENVIRONMENTAL LIABILITY)--In 1996, the president asked
congress to reinstate the corporate levies that provide funds for Superfund
cleanup. Congressional representatives indicate they would not support a
reinstatement but are considering comprehensive reform of this bill, that if
passed, could impose some tax liability on the Company.
18
<PAGE>
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.
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 357 associates. Of the 357 total
associates, 40 are part-time and 317 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.
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 23.0 acre campus is a 12,800 square foot 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 Maui Jim,
Inc., as a part of its contact lens distribution center.
19
<PAGE>
Additionally, the Company owns two other buildings located near the
headquarter building. One, a 19,000 square foot building, is leased to Maui
Jim, Inc. and is used as their headquarters. The other, a 20,000 square foot
building, was purchased in December of 1996. Currently, used for warehousing
and record storage, this building will provide space for future office
expansion.
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 49 of the Annual Report to Shareholders
for the year ended December 31, 1996 attached in Exhibit 13.
Item 6. SELECTED FINANCIAL DATA
Refer to the Selected Financial Data on pages 18 through 19 of the Annual
Report to Shareholders for the year ended December 31, 1996 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 20 through 25 of the Annual Report to
Shareholders for the year ended December 31, 1996 attached in Exhibit 13.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Refer to the consolidated financial statements and supplementary data
included on pages 26 through 43 of the Annual Report to Shareholders for the
year ended December 31, 1996 attached in Exhibit 13. (See Index to Financial
Statements and Schedules attached on page 24.)
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.
20
<PAGE>
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 pages 34-35.
(b) No reports on Form 8-K were filed during the last quarter of 1996.
(c) Exhibits. See Exhibit Index on pages 34-35.
(d) Financial Statement Schedules. The schedules included on attached pages 25
through 33 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 24. There is no other financial information required by
Regulation S-X which is excluded from the Company's Annual Report to
Shareholders.
21
<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 5, 1997
--------------------------------------------------
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 5, 1997
------------------------------------------------
* * * * *
By: /S/Joseph E. Dondanville
----------------------------------------------------
J. E. Dondanville, Vice President,
Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: March 5, 1997
----------------------------------------------------
* * * * *
By: /S/Gerald D. Stephens
------------------------------------------------
G. D. Stephens, Director
Date: March 5, 1997
------------------------------------------------
* * * * *
By: /S/Bernard J. Daenzer
------------------------------------------------
B. J. Daenzer, Director
Date: March 5, 1997
------------------------------------------------
* * * * *
By: /S/Richard J. Haayen
------------------------------------------------
R. J. Haayen, Director
Date: March 5, 1997
------------------------------------------------
* * * * *
By: /S/William R. Keane
------------------------------------------------
W. R. Keane, Director
Date: March 5, 1997
------------------------------------------------
* * * * *
22
<PAGE>
By: /S/Gerald I. Lenrow
------------------------------------------------
G. I. Lenrow, Director
Date: March 5, 1997
------------------------------------------------
* * * * *
By: /S/John S. McGuinness
------------------------------------------------
J. S. McGuinness, Director
Date: March 5, 1997
------------------------------------------------
* * * * *
By: /S/Edwin S. Overman
-------------------------------------------------
E. S. Overman, Director
Date: March 5, 1997
------------------------------------------------
* * * * *
By: /S/Edward F. Sutkowski
------------------------------------------------
E. F. Sutkowski, Director
Date: March 5, 1997
------------------------------------------------
* * * * *
By: /S/Robert O. Viets
------------------------------------------------
R. O. Viets, Director
Date: March 5, 1997
------------------------------------------------
* * * * *
23
<PAGE>
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
REFERENCE (PAGE)
DATA SUBMITTED HEREWITH:
Report of Independent Auditors 25
Schedules:
I. Summary of Investments - Other than Investments in
Related Parties at December 31, 1996. 26
II. Condensed Financial Information of Registrant
for the three years ended December 31, 1996. 27 - 29
III.Supplementary Insurance Information
for the three years ended December 31, 1996. 30 - 31
IV. Reinsurance for the three years ended December 31, 1996. 32
V. Valuation and Qualifying Accounts 33
VI. Supplemental Information Concerning Property-Casualty Insurance
Operations for the three years ended December 31, 1996. 30 - 31
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.
24
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
RLI Corp.:
Under date of January 21, 1997, we reported on the consolidated balance sheets
of RLI Corp. and subsidiaries as of December 31, 1996 and 1995, 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, 1996, as contained
in the 1996 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 1996. 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.
KPMG Peat Marwick LLP
Chicago, Illinois
January 21, 1997
25
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE I--SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS
IN RELATED PARTIES
DECEMBER 31, 1996
<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 $152,612,589 $154,134,493 $152,612,589
States, political subdivisions, and revenues 110,669,841 111,890,926 110,669,841
- --------------------------------------------------------------------------------------------------------------
Total held-to-maturity 263,282,430 266,025,419 263,282,430
- --------------------------------------------------------------------------------------------------------------
Available-for-sale
United States government and government
agencies and authorities 29,461,455 29,681,299 29,681,299
Foreign governments 443,198 435,094 435,094
Corporates 7,585,492 7,736,658 7,736,658
States, political subdivisions, and revenues 7,035,419 7,051,252 7,051,252
- --------------------------------------------------------------------------------------------------------------
Total available-for-sale 44,525,564 44,904,303 44,904,303
- --------------------------------------------------------------------------------------------------------------
Total fixed maturities 307,807,994 310,929,722 308,186,733
- --------------------------------------------------------------------------------------------------------------
Equity securities, available-for-sale:
Common stock:
Public utilities 36,340,454 51,075,525 51,075,525
Banks, trusts and insurance companies 9,872,511 22,279,317 22,279,317
Industrial, miscellaneous and all other 65,558,288 115,578,210 115,578,210
Preferred stock 1,950 2,308 2,308
- --------------------------------------------------------------------------------------------------------------
Total equity securities 111,773,203 188,935,360 188,935,360
- --------------------------------------------------------------------------------------------------------------
Short-term investments 40,823,967 40,823,967 40,823,967
- --------------------------------------------------------------------------------------------------------------
Total investments $460,405,164 $540,689,049 $537,946,060
- --------------------------------------------------------------------------------------------------------------
</TABLE>
Note: See notes 1D and 2 of Notes to Consolidated Financial Statements, as
attached in Exhibit 13.
(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.
26
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY)
CONDENSED BALANCE SHEETS
DECEMBER 31, 1995 AND 1996
1995 1996
- -------------------------------------------------------------------------------
ASSETS
Cash $ 236,902 $ 9,597,834
Investments in subsidiaries, at equity 199,299,589 228,205,464
Equity securities available-for-sale,
at fair value
(Cost--$6,667,195 in 1995 and
$6,800,912 in 1996) 8,138,847 9,676,285
Investment in Rabbi Trust 2,817,965 4,062,723
Deferred debt costs 928,865 805,701
Income taxes recoverable 537,838
Property and equipment 1,090,713 1,051,637
Other assets 238,615 898,113
- -------------------------------------------------------------------------------
Total assets $213,289,334 $254,297,757
===============================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable, current $ 1,163,723 $ 1,283,960
Notes payable, short-term 2,800,000
Deferred compensation--Rabbi Trust 2,817,965 4,062,723
Interest payable--Convertible debentures 1,265,000 1,265,000
Income taxes payables 815,999
Long-term debt--Convertible debentures 46,000,000 46,000,000
Other liabilities 634,930 830,714
- -------------------------------------------------------------------------------
Total liabilities 54,681,618 54,258,396
- -------------------------------------------------------------------------------
Shareholders' equity:
Common stock ($1 par value, authorized
12,000,000 shares, in 1995 and 50,000,000
shares in 1996, issued 8,453,449
shares in 1995 and 1996) 8,453,449 8,453,449
Other shareholders' equity 153,544,590 197,464,904
Treasury shares at cost (602,567 shares
in 1995 and 631,719 shares in 1996) (3,390,323) (5,878,992)
- -------------------------------------------------------------------------------
Total shareholders' equity 158,607,716 200,039,361
- -------------------------------------------------------------------------------
Total liabilities and shareholders' equity $213,289,334 $254,297,757
===============================================================================
See Notes to Consolidated Financial Statements, as attached in Exhibit 13.
27
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY)--(CONTINUED)
CONDENSED STATEMENTS OF EARNINGS
YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1994 1995 1996
<S> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------
Net investment income (expense) $ 146,815 $ ( 100,881) $ 164,181
Selling, general, and administrative expenses 2,845,289 2,093,019 3,559,113
Interest expense on debt 3,431,464 3,347,378 2,808,470
- ----------------------------------------------------------------------------------------------------
(6,129,938) (5,541,278) (6,203,402)
Income tax benefit (2,312,907) (2,147,995) (2,186,013)
- ----------------------------------------------------------------------------------------------------
Net loss before equity in net earnings
of subsidiaries (3,817,031) (3,393,283) (4,017,389)
Equity in net earnings (loss) of subsidiaries (958,840) 11,342,824 29,713,110
- ----------------------------------------------------------------------------------------------------
Net earnings (loss) $(4,775,871) $7,949,541 $25,695,721
====================================================================================================
</TABLE>
See Notes to Consolidated Financial Statements, as attached in Exhibit 13.
28
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY)--(CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1994 1995 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Losses before equity in net earnings
of subsidiaries $(3,817,031) $(3,393,283) $(4,017,389)
Adjustments to reconcile net losses to net
cash provided by operating activities:
Write-down of investments 9,597
Other items, net 445,597 (399,566) (55,262)
Change in:
Affiliate balances payable (10,058) 135,916 (207,668)
Federal income taxes (1,034,695) 1,658,597 437,303
Deferred debt costs 135,908 123,165 123,164
- ------------------------------------------------------------------------------------------
Net cash used in operating activities (4,270,682) (1,875,171) (3,719,852)
- ------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchase of:
Equity securities, available-for-sale (1,995,106) (857,883) (387,395)
Property and equipment (1,054,894) (9,600)
Sale of:
Equity securities, available-for-sale 433,263 1,004,380 236,986
Cash dividends received-subsidiaries 6,340,282 7,823,965 21,125,783
- ------------------------------------------------------------------------------------------
Net cash provided by investing activities 3,723,545 7,960,862 20,975,374
- ------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Payments on debt (745,000) (6,255,000) (2,800,000)
Proceeds from issuance of debt 2,800,000
Fractional share paid (4,010)
Treasury shares reissued 2,513,375 33,667 2,207,526
Treasury shares purchased (3,040,671)
Cash dividends paid (3,461,217) (3,849,521) (4,261,445)
- ------------------------------------------------------------------------------------------
Net cash used in financing activities (1,692,842) (7,274,864) (7,894,590)
- ------------------------------------------------------------------------------------------
Net increase (decrease) in cash (2,239,979) (1,189,173) 9,360,932
Cash at beginning of year 3,666,054 1,426,075 236,902
- ------------------------------------------------------------------------------------------
Cash at end of year $ 1,426,075 $ 236,902 $ 9,597,834
</TABLE>
===============================================================================
Interest paid on outstanding debt for 1994, 1995, and 1996 amounted to
$3,345,714, $3,372,479, and $2,834,192, respectively.
See Notes to Consolidated Financial Statements, as attached in Exhibit 13.
29
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION
SCHEDULE VI--SUPPLEMENTARY INFORMATION CONCERNING
PROPERTY-CASUALTY INSURANCE OPERATIONS
YEARS ENDED DECEMBER 31, 1994, 1995, AND 1996
<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, 1994
<S> <C> <C> <C> <C> <C>
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
==================================================================================================
Year ended
December 31, 1996
RLI Insurance Group $16,663,603 $240,784,071 $76,076,561 $130,656,095 $ 69,724,730
==================================================================================================
</TABLE>
NOTE 1: Investment income is not allocated to the segments, therefore net
investment income (column G) has not been provided.
30
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION
SCHEDULE VI--SUPPLEMENTARY INFORMATION CONCERNING
PROPERTY-CASUALTY INSURANCE OPERATIONS
(CONTINUED)
YEARS ENDED DECEMBER 31, 1994, 1995, AND 1996
<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
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
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
============================================================================================
Year ended
December 31, 1996
RLI Insurance Group $( 1,463,423) $29,556,390 $16,441,332 $132,357,640
============================================================================================
</TABLE>
31
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE IV--REINSURANCE
FOR THE YEARS 1994, 1995, AND 1996
<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
- ----------------------------------------------------------------------------------------------------
1994
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
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%
====================================================================================================
1996
- ----------------------------------------------------------------------------------------------------
RLI Insurance Group
premiums earned $271,551,708 $140,928,326 $ 32,713 $130,656,095 .02%
====================================================================================================
</TABLE>
NOTES: Column B, "Gross Amount" includes only direct premiums earned.
32
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE V--VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1994, 1995, AND 1996
<TABLE>
<CAPTION>
Column A Column B Column C Column D Column E
Balance at Amounts Amounts Balance
beginning of charged to recovered Amounts at end
period expense (written-off) commuted of period
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
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
1996 Allowance for
insolvent reinsurers $16,336,146 $1,006,140 $ (444,488) -- $16,897,798
</TABLE>
33
<PAGE>
EXHIBIT INDEX
Exhibit No. Description of Document Reference (page)
- ----------- ----------------------- ----------------
2.1 Plan of Reorganization Incorporated by reference to the
and Agreement Company's Quarterly
of Merger 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 Attached Exhibit 3.1.
incorporation
3.2 By-Laws Attached Exhibit 3.2.
4.1 Indenture dated Incorporated by reference to the
July 28, 1993 between Company's Registration Statement on
the Company and Form S-3 filed on July 21, 1993.
Norwest Bank
Minnesota, National
Association as Trustee
10.1 Executive Achievement Incorporated by reference to the
Target Salary Company's Registration
Plan Statement on Form S-2 filed on
August 22, 1985, File No. 0-6612.
10.2 RLI Corp. Director Incorporated by reference to the
Deferred Company's Registration Statement on
Compensation Plan Form 10-Q for the Second Quarter ended
June 30, 1993.
10.3 The RLI Corp. Incorporated by reference to the
Directors' Irrevocable Company's Registration Statement on
Trust Agreement Form 10-Q for the Second Quarter ended
June 30, 1993.
10.4 Key Employee Excess Incorporated by reference to the
Benefit Plan Company's Annual Form 10-K/A
for the 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 Annual
between the Company Form 10-K/A for the year ended
and American December 31, 1992.
Re-Insurance Company
10.10 Reinsurance Agreements Incorporated by reference to the
between the Company Company's Annual Form 10-K/A
and Lloyds of London for the year ended December 31, 1992.
10.11 Reinsurance Agreements Incorporated by reference to the
between the Company and Company's Annual Form 10-K/A
NAC Reinsurance Corp. for the year ended December 31, 1992.
11.0 Statement re computation Attached page 36.
of per share earnings
13.1 Refer to the Annual Attached Exhibit 13.
Report to Shareholders
for the year ended
December 31, 1996,
pages 18-43 and 49.
34
<PAGE>
Exhibit No. Description of Document Reference (page)
- ----------- ----------------------- ----------------
21.1 Subsidiaries of the Attached page 37.
Registrant
23.1 Consent of KPMG Peat Attached page 38.
Marwick LLP
23.2 Consent of Kirkland Incorporated by reference to the
& Ellis 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 Attached page 39.
reports furnished to
state insurance
regulatory authorities
35
<PAGE>
Articles of Incorporation
1. Corporate Name: RLI Corp.
2. Initial Registered Agent: Camille J. Hensey
Initial Registered Office: 9025 North Lindbergh Drive
Peoria, Illinois 61615
Peoria County
3. Purpose or purposes for which the corporation is organized:
To do any and all acts and things for which corporations
may be incorporated under The Business Corporation Act of
1983 of the State of Illinois.
4. Paragraph 1: Authorized Shares, Issued Shares and Consideration Received:
# of Shares
Par Value # of Shares Proposed to Consideration to be
Class per Share Authorized be Issued Received Therefore
Common $1.00 50,000,000 1,000 $1,000.00
Paragraph 2: The preferences, qualifications, limitations, restrictions
and special or relative rights in respect of the shares of each class are:
Denial of Cumulative Voting Rights
No holder of any class or series of shares of this corporation shall have
cumulative voting rights with respect to any matter voted upon by the holders of
such shares.
5. Optional
6. Optional:
(a) It is estimated that the value of all property
to be owned by the corporation for the following
year wherever located will be: $116,778,993.
(b) It is estimated that the value of the property
to be located within the State of Illinois
during the following year will be: $444,870.
(c) It is estimated that the gross amount of
business that will be transacted by the
corporation during the following year
will be: $7,554,638.
(d) It is estimated that the gross amount of
business that will be transacted from places
of business in the State of Illinois during
the following year will be: $14,723.
7. Optional: Other Provisions
<PAGE>
Staggered Director Terms
In accordance with the provisions of Section 8.10(e) Number, election and
resignation of directors, of the Business Corporation Act of 1983, the Board of
Directors of the Corporation shall consist of nine members. The members of the
Board of Directors shall be divided into three equal classes. The term of
office of directors of the first class shall expire at the first annual meeting
of shareholders after their election, that of the second class shall expire at
the second annual meeting of shareholders after their election, and that of the
third class shall expire at the third annual meeting of the shareholders after
their election. At each annual meeting, the number of directors equal to the
number of the class whose terms expire at the time of such meeting shall be
elected to hold office until the third succeeding annual meeting of the
shareholders.
Removal of Directors
In accordance with the provisions of Section 8.35(4) Removal of Directors of the
Business Corporation Act of 1983, a director of this Corporation may be removed
only for cause.
Merger: Majority Shareholder Vote Required
In accordance with the provisions of Section 11.20 Approval by Shareholders, of
the Business Corporation Act of 1983, any plan of merger, consolidation or
exchange shall be approved upon receiving the affirmative vote of the holders of
at least a majority of the outstanding shares entitled to vote on the issue.
Indemnification of officers, directors, employees and agents; insurance.
(a) This corporation shall indemnify any person who was or is a party, or is
threatened to be made a party to any threatened, pending or completed action,
suit or proceeding, whether civil, criminal, administrative or investigative
(other than an action by or in the right of the corporation) by reason of the
fact that he or she is or was a director, officer, employee or agent of the
corporation, or who is or was serving at the request of the corporation as a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust or other enterprise, against expenses (including attorneys'
fees), judgments, fines and amounts paid in settlement actually and reasonably
incurred by such person in connection with such action, suit or proceeding, if
such person acted in good faith and in a manner he or she
<PAGE>
reasonably believed to be in, or not opposed to the best interests of the
corporation, and with respect to any criminal action or proceeding, had no
reasonable cause to believe his or her conduct was unlawful. The termination of
any action, suit or proceeding by judgment, order, settlement, conviction or
upon a plea of nolo contendere or its equivalent, shall not, of itself, create a
presumption that the person did not act in good faith and in a manner which he
or she reasonably believed to be in or not opposed to the best interests of the
corporation or with respect to any criminal action or proceeding, that the
person had reasonable cause to believe that his or her conduct was unlawful.
(b) This corporation shall indemnify any person who was or is a party, or is
threatened to be made a party to any threatened, pending or completed action or
suit by or in the right of the corporation to procure a judgment in its favor by
reason of the fact that such person is or was a director, officer, employee or
agent of the corporation, or is or was serving at the request of the corporation
as a director, officer, employee or agent of another corporation, partnership,
joint venture, trust or other enterprise, against expenses (including attorneys'
fees) actually and reasonably incurred by such person in connection with the
defense or settlement of such action or suit, if such person acted in good faith
and in a manner he or she reasonably believed to be in, or not opposed to the
best interests of the corporation, provided that no indemnification shall be
made in respect of any claim, issue or matter as to which such person shall have
been adjudged to be liable for negligence or misconduct in the performance of
his or her duty to the corporation, unless and only to the extent that the court
in which such action or suit was brought shall determine upon application that,
despite the adjudication of liability, but in view of all the circumstances of
the case, such person is fairly and reasonably entitled to indemnity for such
expenses as the court shall deem proper.
(c) To the extent that a director, officer, employee or agent of this
corporation has been successful, on the merits or otherwise, in the defense of
any action, suit or proceeding referred to in subsections (a) and (b), or in
defense of any claim, issue or matter therein, such person shall be indemnified
against expenses, including attorneys' fees, actually and reasonably incurred by
such person in connection therewith.
(d) Any indemnification under subsections (a) and (b), unless ordered by a
court, shall be made by the corporation only as authorized in the specific case,
upon a determination that indemnification of the director, officer, employee or
agent is proper in the circumstances because he or she has met the applicable
standard of conduct set forth in subsections (a) or (b). Such determination
shall be made (1) by the board of directors by a majority vote of a quorum
consisting of directors who were not parties to such action, suit or proceeding,
or (2) if such quorum is not obtainable or, even if obtainable, if a quorum of
disinterested directors so directs, by independent legal counsel in a written
opinion, or (3) by the shareholders.
(e) Expenses incurred in defending a civil or criminal action, suit or
proceeding may be paid by the corporation in advance of the final disposition of
such action, suit or proceeding, as authorized by the board of directors in the
specific case, upon receipt of an undertaking by or on behalf of the director,
officer, employee or
<PAGE>
agent to repay such amount, unless it shall ultimately be determined that he or
she is entitled to be indemnified by the corporation as authorized in this
section.
(f) The indemnification provided by this section shall not be deemed exclusive
of any other rights to which those seeking indemnification may be entitled under
any by-law, agreement, vote of shareholders or disinterested directors or
otherwise, both as to action in his or her official capacity and as to action in
another capacity while holding such office, and shall continue as to a person
who has ceased to be a director, officer, employee or agent, and shall inure to
the benefit of the heirs, executors and administrators of such a person.
(g) This corporation may purchase and maintain insurance on behalf of any
person who is or was a director, officer, employee or agent of the corporation
or who is or was serving at the request of the corporation as a director,
officer, employee or agent of another corporation, partnership, joint venture,
trust or other enterprise, against any liability asserted against such person
and incurred by such person in any such capacity, or arising out of his or her
status as such, whether or not the corporation would have the power to indemnify
such person against such liability under the provisions of this section.
(h) If the corporation has paid indemnity or has advanced expenses to a
director, officer, employee or agent, the corporation shall report the
indemnification or advance in writing to the shareholders with or before the
notice of the next shareholders meeting.
(i) For purposes of this section, references to "the corporation" or "this
corporation" shall include, in addition to the surviving corporation, any
merging corporation (including any corporation having merged with a merging
corporation) absorbed in a merger which, if its separate existence had
continued, would have had the power and authority to indemnify its directors,
officers and employees or agents, so that any person who was a director,
officer, employee or agent of such merging corporation, or was serving at the
request of such merging corporation as a director, officer, employee or agent of
another corporation, partnership, joint venture, trust or other enterprises,
shall stand in the same position under the provisions of this section with
respect to the surviving corporation as such person would have with respect to
such merging corporation if its separate existence had continued.
(j) For purposes of this section, references to "other enterprises" shall
include employee benefit plans; references to "fines" shall include any excise
taxes assessed on a person with respect to an employee benefit plan; and
references to "serving at the request of the corporation" shall include any
service as a director, officer, employee or agent of the corporation which
imposes duties on, or involves services by such director, officer, employee or
agent with respect to an employee benefit plan, its
<PAGE>
participants or beneficiaries. A person who acted in good faith and in a manner
he or she reasonably believed to be in the best interests of the participants
and beneficiaries of an employee benefit plan shall be deemed to have acted in a
manner "not opposed to the best interest of the corporation" as referred to in
this section.
<PAGE>
________________________________________________________________________________
BY-LAWS OF RLI CORP.
________________________________________________________________________________
<PAGE>
TABLE OF CONTENTS
ARTICLE I: OFFICES . . . . . . . . . . . . . 1
1.1 REGISTERED OFFICE. . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.2 OTHER OFFICES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
ARTICLE II: MEETINGS OF SHAREHOLDERS. . . . . . . . . 1
2.1 ANNUAL MEETING.. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
2.2 SPECIAL MEETINGS.. . . . . . . . . . . . . . . . . . . . . . . . . . . 1
2.3 PLACE OF MEETINGS. . . . . . . . . . . . . . . . . . . . . . . . . . . 1
2.4 NOTICE OF MEETINGS.. . . . . . . . . . . . . . . . . . . . . . . . . . 1
2.5 SHAREHOLDER LIST.. . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2.6 QUORUM.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2.7 PROXIES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2.8 VOTING.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
2.9 VOTING OF CERTAIN SHARES.. . . . . . . . . . . . . . . . . . . . . . . 4
2.10 ACTION WITHOUT MEETING.. . . . . . . . . . . . . . . . . . . . . . . . 4
ARTICLE III: DIRECTORS . . . . . . . . . . . . 5
3.1 NUMBER AND ELECTION. . . . . . . . . . . . . . . . . . . . . . . . . . 5
3.2 RESIGNATIONS.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
3.3 REMOVAL. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
3.4 VACANCIES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
3.5 MANAGEMENT OF AFFAIRS OF CORPORATION.. . . . . . . . . . . . . . . . . 6
3.6 DIVIDENDS AND RESERVES.. . . . . . . . . . . . . . . . . . . . . . . . 6
3.7 REGULAR MEETINGS.. . . . . . . . . . . . . . . . . . . . . . . . . . . 6
3.8 SPECIAL MEETINGS.. . . . . . . . . . . . . . . . . . . . . . . . . . . 7
3.9 NOTICE OF SPECIAL MEETINGS.. . . . . . . . . . . . . . . . . . . . . . 7
3.10 QUORUM.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
3.11 PRESUMPTION OF ASSENT. . . . . . . . . . . . . . . . . . . . . . . . . 7
3.12 ACTION WITHOUT MEETING.. . . . . . . . . . . . . . . . . . . . . . . . 8
3.13 PRESIDING OFFICER. . . . . . . . . . . . . . . . . . . . . . . . . . . 8
3.14 EXECUTIVE COMMITTEE. . . . . . . . . . . . . . . . . . . . . . . . . . 8
3.15 OTHER COMMITTEES.. . . . . . . . . . . . . . . . . . . . . . . . . . . 8
3.16 QUORUM AND MANNER OF ACTING - COMMITTEES.. . . . . . . . . . . . . . . 9
3.17 COMMITTEE CHAIRMAN, BOOKS AND RECORDS. . . . . . . . . . . . . . . . . 9
3.18 FEES AND COMPENSATION OF DIRECTORS.. . . . . . . . . . . . . . . . . . 9
3.19 RELIANCE UPON RECORDS. . . . . . . . . . . . . . . . . . . . . . . . . 9
ARTICLE IV: NOTICES . . . . . . . . . . . . . 10
4.1 MANNER OF NOTICE.. . . . . . . . . . . . . . . . . . . . . . . . . . . 10
4.2 WAIVER OF NOTICE.. . . . . . . . . . . . . . . . . . . . . . . . . . . 10
ARTICLE V: OFFICERS . . . . . . . . . . . . . 10
5.1 OFFICE AND OFFICIAL POSITIONS. . . . . . . . . . . . . . . . . . . . . 11
5.2 ELECTION AND TERM OF OFFICE. . . . . . . . . . . . . . . . . . . . . . 11
5.3 REMOVAL AND RESIGNATION. . . . . . . . . . . . . . . . . . . . . . . . 11
5.4 VACANCIES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
<PAGE>
5.5 PRESIDENT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
5.6 VICE PRESIDENTS. . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
5.7 SECRETARY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
5.8 TREASURER. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
5.9 ASSISTANT TREASURERS AND ASSISTANT SECRETARIES.. . . . . . . . . . . . 14
5.10 SALARIES.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
ARTICLE VI: DIVISIONS. . . . . . . . . . . . . 15
6.1 DIVISIONS OF THE CORPORATION.. . . . . . . . . . . . . . . . . . . . . 15
6.2 OFFICIAL POSITIONS WITHIN A DIVISION.. . . . . . . . . . . . . . . . . 15
ARTICLE VII: CONTRACTS, LOANS, CHECKS AND DEPOSITS . . . . . 15
7.1 CONTRACTS AND OTHER INSTRUMENTS. . . . . . . . . . . . . . . . . . . . 15
7.2 LOANS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
7.3 CHECKS, DRAFTS.. . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
7.4 DEPOSITS.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
ARTICLE VIII: CERTIFICATES OF SHARES AND THEIR TRANSFER . . . . 15
8.1 CERTIFICATES OF SHARES.. . . . . . . . . . . . . . . . . . . . . . . . 16
8.2 LOST, STOLEN OR DESTROYED CERTIFICATE. . . . . . . . . . . . . . . . . 16
8.3 TRANSFERS OF SHARES. . . . . . . . . . . . . . . . . . . . . . . . . . 16
8.4 RESTRICTIONS ON TRANSFER.. . . . . . . . . . . . . . . . . . . . . . . 16
8.5 NO FRACTIONAL SHARE CERTIFICATES.. . . . . . . . . . . . . . . . . . . 17
8.6 FIXING RECORD DATE.. . . . . . . . . . . . . . . . . . . . . . . . . . 17
8.7 SHAREHOLDERS OF RECORD.. . . . . . . . . . . . . . . . . . . . . . . . 17
ARTICLE IX: GENERAL PROVISIONS . . . . . . . . . . 17
9.1 FISCAL YEAR. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
9.2 SEAL.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
ARTICLE X: INDEMNIFICATION . . . . . . . . . . . 18
10.1 THIRD PARTY ACTION.. . . . . . . . . . . . . . . . . . . . . . . . . . 18
10.2 CORPORATION ACTION.. . . . . . . . . . . . . . . . . . . . . . . . . . 18
10.3 FEES.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
10.4 CONDITIONS PRECEDENT.. . . . . . . . . . . . . . . . . . . . . . . . . 19
10.5 EXPENSES.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
10.6 NON-EXCLUSIVITY. . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
10.7 INSURANCE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
10.8 REPORTING. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
10.9 DEFINITIONS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
ARTICLE XI: AMENDMENTS . . . . . . . . . . . . 21
<PAGE>
ARTICLE I: OFFICES
1.1 REGISTERED OFFICE. The registered office of RLI Corp. ("Corporation") in
the State of Illinois shall be located at 9025 North Lindbergh Drive, Peoria,
Illinois 61615. The name of its registered agent is Camille J. Hensey. The
registered office and agent may be periodically changed by the Board of
Directors.
1.2 OTHER OFFICES. The Corporation may also have offices at such other places
both within or without the State of Illinois as the Board of Directors may
periodically determine or the business of the Corporation may require.
ARTICLE II: MEETINGS OF SHAREHOLDERS
2.1 ANNUAL MEETING. The annual meeting of the shareholders shall be held at
2:00 P.M. on the first Thursday in May of each year, if not a legal holiday, or,
if a legal holiday, then on the next succeeding business day, for the purpose of
electing directors and for the transaction of such other business as may come
before the meeting. If the election of directors shall not be held on the day
designated for the annual meeting, or at any adjournment thereof, the Board of
Directors shall cause such election to be held at a special meeting of
shareholders.
2.2 SPECIAL MEETINGS. Any special meeting of the shareholders may be called
by the President, by the Board of Directors, or by the holders of not less than
one-fifth of the outstanding shares entitled to vote on the matter for which the
meeting is called.
2.3 PLACE OF MEETINGS. Any meeting of the shareholders for the election of
directors shall be held at the office of the Corporation in Peoria, Illinois,
unless the Board of Directors shall, by resolution, designate any other
location, within or without the State of Illinois, as the place of such meeting.
Any meeting of shareholders for any other purpose may be held at such place,
within or without the State of Illinois, and at such time as shall be determined
pursuant to Section 2.2 SPECIAL MEETINGS.
2.4 NOTICE OF MEETINGS. Written notice stating the place, day and hour of the
meeting and, in the case of a special meeting, the purpose for which the meeting
is called, shall be delivered not less than ten (10) nor more than sixty (60)
days before the date of
<PAGE>
the meeting, or in the case of a merger, consolidation, share exchange,
dissolution or sale, lease or exchange of assets not less than twenty (20) nor
more than sixty (60) days before the date of the meeting, either personally or
by mail, by or at the direction of the President, the Secretary or the officer
or persons calling the meeting, to each shareholder of record entitled to vote
at such meeting. If mailed, such notice shall be deemed to be delivered when
deposited in the United States mail addressed to the shareholder at such
shareholder's address as it appears on the records of the Corporation, with
postage thereon prepaid.
When a meeting is adjourned to another time or place, no notice of the adjourned
meeting, other than an announcement at the meeting, need be given unless the
adjournment is for more than thirty (30) days or a new record date is fixed for
the adjourned meeting after such adjournment.
2.5 SHAREHOLDER LIST. At least ten (10) days before every meeting of
shareholders, a complete list of the shareholders entitled to vote at such
meeting, arranged in alphabetical order, and showing the address of each such
shareholder and the number of shares registered in the name of each such
shareholder, shall be prepared by the Secretary.
The list shall be open to examination of any shareholder of the Corporation, and
to copying at the shareholder's expense, during ordinary business hours, for any
purpose germane to the meeting during the ten (10) day period ending on the date
of the meeting, at the office of the Corporation in Peoria, Illinois. The list
shall be produced and kept at the time and place of meeting during the meeting
and be subject to inspection by any shareholder for any purpose germane to the
meeting.
2.6 QUORUM. Except as otherwise provided by statute, the articles of
incorporation or By-Laws, the holders of shares of the Corporation having a
majority of the voting power thereof, present in person or represented by proxy,
shall be requisite for, and shall constitute, a quorum at all meetings of the
shareholders of the Corporation for the transaction of business. If such quorum
shall not be present or represented at any meeting of the shareholders, the
shareholders entitled to vote, present in person or represented by proxy, shall
have power to adjourn the meeting from time to time until a quorum shall be
present or represented. At such adjourned meeting at which a quorum shall be
present or represented, any business may be transacted which might have been
transacted at the meeting as originally notified.
2.7 PROXIES. A shareholder may vote such shareholder's shares in person or may
appoint a proxy to vote or otherwise act for such shareholder by signing an
appointment form and delivering it to the person so appointed.
<PAGE>
No proxy shall be valid after the expiration of eleven (11) months from the date
thereof unless otherwise provided in the proxy. Every proxy continues in full
force and effect until revoked by the person executing it prior to the vote
pursuant thereto, except as otherwise provided in this section. Such revocation
may be effected by a writing delivered to the Corporation stating that the proxy
is revoked or by a subsequent proxy executed by, or by attendance at the meeting
and voting in person by, the person executing the proxy. The dates contained on
the forms of proxy presumptively determine the order of execution, regardless of
the postmark dates on the envelopes in which they are mailed.
An appointment of a proxy is revocable by the shareholder unless the appointment
form conspicuously states that it is revocable and the appointment is coupled
with an interest, as such term is defined by applicable law. A transferee for
value of shares subject to an irrevocable appointment may revoke the appointment
if the transferee was ignorant of its existence when the shares were acquired
and both the existence of the appointment and its irrevocability were not noted
conspicuously on the certificate, or information statement for shares without
certificates, representing the shares.
The death or incapacity of the shareholder appointing a proxy does not revoke
the proxy's authority unless notice of the death or incapacity is received by
the officer or agent who maintains the Corporation's share transfer book before
the proxy exercises such shareholder's authority under the appointment.
Unless the appointment of a proxy contains an express limitation on the proxy's
authority, the Corporation may accept the proxy's vote or other action as that
of the shareholder making the appointment. If the proxy appointed fails to vote
or otherwise act in accordance with the appointment, the shareholder is entitled
to such legal or equitable relief as is appropriate in the circumstances.
2.8 VOTING. Except as otherwise provided by the articles of incorporation,
each shareholder shall be entitled to one (1) vote for each share of the
Corporation entitled to vote thereat and registered in the name of such
shareholder on the books of the Corporation on the referent record date. No
holder of any class or series of shares of this Corporation shall have
cumulative voting rights with respect to any matter voted upon by the holders of
such shares.
<PAGE>
When a quorum is present at any meeting of the shareholders, the vote of the
holders of a majority of the shares having voting power which is present in
person or represented by proxy shall, except as otherwise required by applicable
law, the articles of incorporation, or these By-Laws, decide any question
brought before such meeting.
2.9 VOTING OF CERTAIN SHARES. Shares standing in the name of another
corporation, and entitled to vote may be voted by such officer, agent, or proxy
as the by-laws of such corporation may prescribe or, in the absence of such
provision, as the board of directors of such corporation may determine. Shares
standing in the name of a deceased person, a minor or an incompetent and
entitled to vote may be voted by such person's administrator, executor, guardian
or conservator, as the case may be, either in person or by proxy. Shares
standing in the name of a trustee, receiver or pledgee and entitled to vote may
be voted by such trustee, receiver or pledgee either in person or by proxy as
provided by applicable law.
2.10 ACTION WITHOUT MEETING. Unless otherwise provided in the articles of
incorporation, any action required to be taken at any annual or special meeting
of the shareholders, or any action which may be taken at a meeting of the
shareholders, may be taken without a meeting and without a vote if a consent in
writing, expressing the action so taken, shall be signed: if five (5) days
prior notice of the proposed action is given in writing to all of the
shareholders entitled to vote with respect to the subject matter thereof, by the
holders of outstanding shares having not less than the minimum number of votes
that would be necessary to authorize or take such action at a meeting at which
all shares entitled to vote thereon were present and voting; or, by all of the
shareholders entitled to vote with respect to the subject matter thereof.
Prompt notice of the taking of Corporation action without a meeting by less than
unanimous written consent shall be given in writing to those shareholders who
have not consented in writing. If the action which is consented to is such as
would have required the filing of a certificate under applicable law if such
action had been voted on by the shareholders at a meeting thereof, the
certificate filed shall state, in lieu of any statement required by applicable
law, concerning any vote of shareholders, that written consent has been given in
accordance with the provisions of this
<PAGE>
section and that written notice has been given as provided in this section.
ARTICLE III: DIRECTORS
3.1 NUMBER AND ELECTION. The number of directors of this Corporation shall be
nine. The members of the Board of Directors shall be divided into three equal
classes.
The term of office of directors of the first class shall expire at the first
annual meeting of shareholders after their election, that of the second class
shall expire at the second annual meeting of shareholders after their election,
and that of the third class shall expire at the third annual meeting of the
shareholders after their election. At each annual meeting, the number of
directors equal to the number of the class whose terms expire at the time of
such meeting shall be elected to hold office until the third succeeding annual
meeting of the shareholders.
Except for vacancies filled pursuant to Section 3.4 VACANCIES, the directors
shall be elected by the shareholders of the Corporation, and at each election
the persons receiving the greatest number of votes, up to the number of
directors then to be elected, shall be the persons then elected. The election
of directors is subject to any provisions contained in the articles of
incorporation relating thereto.
3.2 RESIGNATIONS. Any director may resign at any time by giving written
notice to the Board of Directors or to the President, provided that the party to
whom such notice is given is other than the individual director giving the
notice. Any such resignation shall take effect at the date of the receipt of
such notice or at any later time specified therein. Unless otherwise specified
in such resignation, the acceptance of such resignation shall not be necessary
to make it effective.
3.3 REMOVAL. Except as otherwise provided in the following sentence, a
director of the Corporation may be removed only for cause by the affirmative
vote of a majority of the outstanding shares then entitled to vote at an
election of directors. No director shall be removed at a meeting of
shareholders unless the notice of such meeting shall state that a purpose of
such meeting is to vote upon the removal of the director named in the notice,
and only the named director may be removed at such meeting.
<PAGE>
3.4 VACANCIES. Except as otherwise provided in the articles of incorporation,
any vacancy in the Board, whether because of death, resignation,
disqualification, an increase in the number of directors or any other cause, may
be filled by the vote of the majority of the remaining directors, although less
than a quorum. Each director so chosen to fill a vacancy shall hold office
until such director's successor shall have been elected and shall qualify or
until such director shall resign or shall have been removed. No decrease in the
number of directors constituting the Board of Directors shall shorten the term
of any incumbent director.
3.5 MANAGEMENT OF AFFAIRS OF CORPORATION. The property and business of the
Corporation shall be managed by its Board of Directors, which may exercise any
such power of the Corporation and do any such lawful act as are not by
applicable law, the articles of incorporation or these By-Laws directed or
required to be exercised or done by shareholders.
If the Corporation shall transact any business or enter into any contract with a
director, or with any firm of which one or more of its directors are members, or
with any trust, firm, corporation or association in which any director is a
shareholder, director or officer or otherwise interested, the officers of the
Corporation and directors in question shall be severally under the duty of
disclosing all material facts as to their interest to the remaining directors
promptly if and when such interested officers or such interested directors in
question shall become advised of the circumstances. In the case of continuing
relationships in the normal course of business such disclosure shall be deemed
effective, when once given, as to all transactions and contracts subsequently
entered into.
3.6 DIVIDENDS AND RESERVES. Dividends upon shares may be declared by the
Board of Directors at any regular or special meeting. Dividends may be paid in
cash, in property, in shares or otherwise in the form, and to the extent,
permitted by applicable law. The Board of Directors may set apart, out of any
funds of the Corporation available for dividends, a reserve or reserves for
working capital or for any other lawful purpose, and also may abolish any such
reserve in the manner in which it was created.
3.7 REGULAR MEETINGS. An annual meeting of the Board of Directors shall be
held, without notice other than as provided in these By-Laws, immediately after,
and at the same place as, the annual
<PAGE>
meeting of the shareholders. The Board of Directors may provide, by resolution,
the time and place, either within or without the State of Illinois, for the
holding of additional regular meetings without notice other than such
resolution.
3.8 SPECIAL MEETINGS. Special meetings of the Board of Directors may be
called by the President and shall be called by the Secretary at the request of
any two directors, to be held at such time and place, either within or without
the State of Illinois, as shall be designated by the call.
3.9 NOTICE OF SPECIAL MEETINGS. Except as otherwise prescribed by statute,
written or actual oral notice of the time and place of each special meeting of
the Board of Directors shall be given at least two (2) day prior to the time of
holding the meeting. Any director may waive notice of any meeting.
3.10 QUORUM. The presence of not less than a majority of the Board of
Directors shall be necessary and sufficient to constitute a quorum for the
transaction of business. Except as otherwise provided by applicable law, the
articles of incorporation or these By-Laws, the act of a majority of the
directors present at any meeting at which there is a quorum shall be the act of
the Board of Directors. If a quorum shall not be present at any meeting of
directors, the directors present thereat may adjourn the meeting from time to
time, without notice other than announcement at the meeting, until a quorum
shall be present.
Unless otherwise provided by the articles of incorporation, any member of the
Board of Directors or of any committee designated by the Board may participate
in a meeting of the directors or committee by means of conference telephone or
similar communications equipment by means of which all persons participating in
the meeting can hear each other, and participation in a meeting by means of such
equipment shall constitute presence in person at such meeting.
3.11 PRESUMPTION OF ASSENT. Unless otherwise provided by applicable law, a
director of the Corporation who is present at a meeting of the Board of
Directors at which action is taken on any corporate matter shall be presumed to
have assented to the action taken unless such director's dissent shall be
entered in the minutes of the meeting or unless such director shall file such
director's written dissent to such action with the person acting as
<PAGE>
secretary of the meeting before the adjournment thereof or shall forward such
dissent by registered mail to the Secretary of the Corporation immediately after
the adjournment of the meeting. Such right to dissent shall not apply to a
director who voted in favor of such action.
3.12 ACTION WITHOUT MEETING. Except as otherwise provided by applicable law,
the articles of incorporation or these By-Laws, any action required or permitted
to be taken at any meeting of the Board of Directors, or of any committee
thereof, may be taken without a meeting, if a written consent thereto, setting
forth the action so taken, is signed by all members of the board or of such
committee entitled to vote, as the case may be, and such written consent is
filed with the minutes of proceedings of the board or committee.
3.13 PRESIDING OFFICER. The presiding officer at any meeting of the Board of
Directors shall be the President or, in such President's absence, any other
director elected chairman by vote of a majority of the directors present at the
meeting.
3.14 EXECUTIVE COMMITTEE. The Board of Directors may, by resolution passed by
a majority of the number of directors fixed by these By-Laws, designate two or
more directors of the Corporation to constitute an executive committee. The
executive committee shall, to the extent provided in the resolution and by
applicable law, have and may exercise any power and authority of the Board of
Directors in the management of the business and affairs of the Corporation.
3.15 OTHER COMMITTEES. The Board of Directors may, by resolution passed by a
majority of the number of directors, designate such other committees as it may
periodically determine. Any committee shall consist of such number of
directors, shall serve for such term and shall have and may exercise, during
intervals between meetings of the Board of Directors, such duties, functions and
powers as the Board of Directors may periodically prescribe, except that a
committee may not authorize distributions; approve or recommend to shareholders
any act required by applicable law to be approved by shareholders; fill
vacancies on the board or on any of its committees; elect or remove officers or
fix the compensation of any member of the committee; adopt, amend or repeal
these By-Laws; approve a plan of merger not requiring shareholder approval;
authorize or approve reacquisition of shares, except according to
<PAGE>
a general formula or method prescribed by the Board of Directors; authorize or
approve the issuance or sale, or contract for sale, of shares or determine the
designation and relative rights, preferences and limitations of a series of
shares, except that the board may direct a committee to fix the specific terms
of the issuance or sale or contract for sale or the number of shares to be
allocated to particular employees under an employee benefit plan; or amend,
alter, repeal or take action inconsistent with any resolution or action of the
Board of Directors when the resolution or action of the Board of Directors
provides by its terms that it shall not be amended, altered or repealed by
action of a committee.
3.16 QUORUM AND MANNER OF ACTING - COMMITTEES. The presence of a majority of
members of any committee shall constitute a quorum for the transaction of
business at any meeting of such committee, and the act of a majority of those
present shall be necessary for the taking of any action.
3.17 COMMITTEE CHAIRMAN, BOOKS AND RECORDS. The Chairman of any committee
shall be selected from among the members of the committee by the Board of
Directors. Any committee shall keep a record of its acts and proceedings, and
any action of each committee shall be reported to the Board of Directors at its
next meeting. Any committee shall fix its own rules of procedure not
inconsistent with applicable law, these By-Laws or the resolution of the Board
of Directors designating such committee and shall meet at such times and places
and upon such call or notice as shall be provided by such designation.
3.18 FEES AND COMPENSATION OF DIRECTORS. The Board of Directors shall, by the
affirmative vote of a majority of directors then in office, and irrespective of
any personal interest of any of its members, have the authority to establish
reasonable compensation of all directors for services to the Corporation as
directors, including expenses incurred.
3.19 RELIANCE UPON RECORDS. Each director of the Corporation, or member of any
committee designated by the Board of Directors shall be fully protected in
relying in good faith upon the books of account or reports made to the
Corporation by any of its officials, by an independent certified public
accountant, by an appraiser selected with reasonable care by the Board of
Directors or by such committee, or in relying in good faith upon other records
of the Corporation, including the records expressing or relating to the
<PAGE>
value and amount of assets, liabilities and profits of the Corporation or any
other facts pertinent to the existence and amount of surplus or other funds from
which dividends may properly be declared or paid or with which shares of the
Corporation might lawfully be purchased or redeemed.
ARTICLE IV: NOTICES
4.1 MANNER OF NOTICE. Whenever notice is required to be given to any
shareholder, director or member of any committee designated by the Board of
Directors, such notice may be given by any commercially acceptable means in
writing or otherwise, including by depositing such notice in a sealed envelope,
in the United States mail, postage prepaid, addressed to such addressee at the
address of such addressee as it appears on the books of the Corporation or, in
the case of a director, at such director's last known address. Notice shall be
deemed to be given at the time when deposited in the United States mails or
otherwise delivered to the commercially acceptable means of communication.
Except in the case of written shareholder notice, any notice requirement shall
be deemed satisfied if actual notice is received by the person entitled thereto
as far in advance of the event with respect to which notice is given as the
minimum notice period required by applicable law or these By-Laws.
4.2 WAIVER OF NOTICE. Any notice requirement may be waived in writing signed
by the person entitled to such notice, whether before, at or after the time
stated therein. Except where a person attends a meeting for the purpose of
objecting to such meeting, or for the purpose of objecting to the transaction of
any business because such notice is not lawfully called or convened, attendance
at a meeting by a person who is the subject of a notice requirement shall
constitute a waiver of notice of such meeting.
Except as otherwise required by applicable law, the articles of incorporation or
these By-Laws, neither the business to be transacted at, nor the purpose of, any
regular or special meeting of the shareholders, directors or committee of
directors need be specified in any written waiver of notice.
ARTICLE V: OFFICERS
<PAGE>
5.1 OFFICE AND OFFICIAL POSITIONS. The officers of the Corporation shall be a
President, one or more Vice Presidents, a Secretary, a Treasurer, and such
Assistant Secretaries, Assistant Treasurer, and other officers as the Board of
Directors shall periodically determine to be appropriate.
Any two or more offices may be held by the same person. None of the officers
need be a director, a shareholder of the Corporation or a resident of the State
of Illinois. The Board of Directors may periodically establish, and abolish,
official positions within the divisions into which the business and operations
of the Corporation are divided and assign titles and duties to such positions.
A person appointed to any official position within any division need not be an
officer of the Corporation.
The Board of Directors may periodically appoint officers to official positions
within a division and remove any person so appointed with or without cause. The
authority incident to an official position within a division shall be limited to
acts and transactions within the scope of the business and operations of such
division.
5.2 ELECTION AND TERM OF OFFICE. The officers of the Corporation shall be
elected annually by the Board of Directors. Any officer shall hold office until
the first to occur of the election of such officer's successor, or such
officer's death, resignation or removal.
5.3 REMOVAL AND RESIGNATION. Any officer may be removed, with or without
cause, by a majority of the directors then in office at any regular or special
meeting of the board.
Any officer may resign upon written notice to the Board of Directors, to the
President or to the Secretary. Except as otherwise specified in such
resignation, any resignation shall be effective on the date received and need
not be accepted by the Corporation.
5.4 VACANCIES. A vacancy in any office because of death , resignation,
removal, or any other cause may be filled for the unexpired portion of the term
by the Board of Directors.
5.5 PRESIDENT. The President shall be the chief executive officer of the
Corporation and shall preside at all meetings of the
<PAGE>
shareholders, the Board of Directors or any committee of the Board if such
President is a member.
The President shall have the overall supervision of the business of the
Corporation and shall direct the affairs and policies of the Corporation,
subject to such policies and directions as may periodically be promulgated by
the Board of Directors. The President shall have authority to designate the
duties and powers of other officers and delegate special powers and duties to
specified officers, so long as such designation shall not be inconsistent with
applicable law, the articles of incorporation, these By-Laws or action of the
Board of Directors. The President may execute any deed, mortgage, bond,
contract or other instrument of the Corporation except where required or
permitted by law to be otherwise signed and executed and except where the
signing and execution thereof shall be expressly delegated by the Board of
Directors or by the President to some other officer or agent of the Corporation.
The President may sign with the Secretary or any Assistant Secretary or the
Treasurer or any Assistant Treasurer, any certificate for shares, the issuance
of which shall have been duly authorized by the Board of Directors, and shall
vote, or give a proxy to any other person to vote, all shares of any other
corporation standing in the name of the Corporation.
Subject to the limitations and satisfaction of the conditions expressed in the
preceding paragraphs, the President shall have all powers and shall perform all
duties which are incident to the chief executive office of a Corporation or as
may periodically be prescribed by the Board of Directors.
5.6 VICE PRESIDENTS. Absent the President, the Vice Presidents in order of
their rank as fixed by the Board of Directors or, if not ranked, the Vice
President designated by the Board of Directors or the President, shall perform
all duties and shall have all powers of the President.
The Vice Presidents shall have such other powers and perform such other duties,
not inconsistent with applicable law, the articles of incorporation, these By-
Laws, or action of the Board of Directors, as may periodically be prescribed for
them, respectively, by the Board of Directors or the President. Any Vice
President may sign, with the Secretary or an Assistant Secretary, or the
Treasurer or
<PAGE>
an Assistant Treasurer, certificates for shares of the Corporation, the issuance
of which shall have been duly authorized by the Board of Directors.
5.7 SECRETARY. The Secretary shall:
(a) keep the minutes of the meetings of the shareholders, the Board of
Directors and committees of directors, in one or more books provided for
such purpose;
(b) see that all notices are fully given in accordance with the provisions
of these By-Laws or as required by applicable law;
(c) have charge of the corporate records and of the seal of the
Corporation;
(d) affix the seal of the Corporation or a facsimile thereof, or cause it
to be affixed, to all certificates for shares prior to the issue thereof
and to all documents the execution of which on behalf of the Corporation
under its seal is duly authorized by the Board of Directors or otherwise in
accordance with the provisions of these By-Laws;
(e) keep a register of the post office address of each shareholder,
director and committee member which shall periodically be furnished to the
Secretary by such shareholder, director or member;
(f) sign with the President, or a Vice President, certificates for shares
of the Corporation, the issuance of which shall have been duly authorized
by resolution of the Board of Directors;
(g) have general charge of the stock transfer books of the Corporation; and
(h) perform all duties incident to the office of Secretary and such other
duties as may periodically be assigned to the Secretary by the President or
by the Board of Directors. The Secretary may delegate such details of the
performance of duties of the Secretary's office as may be appropriate in
the exercise of reasonable care to one or more persons, but shall
<PAGE>
not be relieved of responsibility for the performance of such duties.
5.8 TREASURER. The Treasurer shall:
(a) be responsible to the Board of Directors for the receipt, custody and
disbursements of all funds and securities of the Corporation;
(b) receive and give receipts for moneys due and payable to the Corporation
from any source whatsoever and deposit all such moneys in the name of the
Corporation in such banks, trust companies or other depositories as shall
from time to time be selected in accordance with the provisions of these
By-Laws;
(c) disburse the funds of the Corporation as ordered by the Board of
Directors or the President or as otherwise required in the conduct of the
business of the Corporation;
(d) render to the President or Board of Directors, upon request, an account
of all transactions as Treasurer and on the financial condition of the
Corporation;
(e) perform all the duties incident to the office of Treasurer and such
other duties as may periodically be assigned to the Treasurer by the
President, by the Board of Directors or these By-Laws. The Treasurer may
sign, with the President, or a Vice President, certificates for shares of
the Corporation, the issuance of which shall have been duly authorized by
resolution of the Board of Directors. The Treasurer may delegate such
details of the performance of duties of the Treasurer's office as may be
appropriate in the exercise of reasonable care to one or more persons, but
shall not be relieved of responsibility for the performance of such duties.
5.9 ASSISTANT TREASURERS AND ASSISTANT SECRETARIES. The Assistant Treasurers
and Assistant Secretaries shall perform all functions and duties which the
Secretary or Treasurer, as the case may be, may assign or delegate.
5.10 SALARIES. The salaries of the officers shall be periodically determined by
the Board of Directors or as it shall otherwise direct. No officer shall be
prevented from receiving a salary or
<PAGE>
other compensation by reason of the fact that such officer is also a director of
the Corporation.
ARTICLE VI: DIVISIONS
6.1 DIVISIONS OF THE CORPORATION. The Board of Directors may periodically
establish such operating divisions of the Corporation as the Board of Directors
periodically determines to be appropriate.
6.2 OFFICIAL POSITIONS WITHIN A DIVISION. Except as otherwise periodically
provided by the Board of Directors, the President may appoint and remove, with
or without cause, any individual as an officer within a division.
ARTICLE VII: CONTRACTS, LOANS, CHECKS AND DEPOSITS
7.1 CONTRACTS AND OTHER INSTRUMENTS. The Board of Directors may periodically
authorize any person to enter into any contract or execute and deliver any
instrument in the name of and on behalf of the Corporation, or of any division
thereof and such authorization may be general or confined to specific instances.
7.2 LOANS. No loan shall be contracted on behalf of the Corporation, or any
division thereof, and no evidence of indebtedness shall be issued in the name of
the Corporation, or any division thereof, unless authorized by a resolution of
the Board of Directors and such authorization may be general or confined to
specific instances.
7.3 CHECKS, DRAFTS. Any check, demand, draft or other order for the payment of
money, note or other evidence of indebtedness issued in the name of the
Corporation, or any division thereof, shall be signed by such person as the
Board of Directors shall periodically designate.
7.4 DEPOSITS. Any funds of the Corporation, or any division thereof, not
otherwise employed shall be periodically deposited to the credit of the
Corporation in such bank, trust company or other depository as the Board of
Directors may periodically designate.
ARTICLE VIII: CERTIFICATES OF SHARES AND THEIR TRANSFER
<PAGE>
8.1 CERTIFICATES OF SHARES. The certificates of shares shall be in such form
as may be periodically determined by the Board of Directors, shall be numbered
and entered in the books of the Corporation as they are issued, and shall
exhibit the holder's name and number of shares, that the Corporation is
organized under the Illinois Business Corporation Act, and shall be signed by
the President or a Vice President and by the Treasurer or an Assistant Treasurer
or the Secretary or an Assistant Secretary.
If any share certificate is signed by a transfer agent and a registrar, the
signature of any officer of the Corporation may be facsimile. If any officer
whose facsimile signature has been used on any certificate, and such officer
shall cease to act in such capacity before such certificate is delivered by the
Corporation, such certificate may nevertheless be delivered by the Corporation
without regard to the cessation of such officer.
Any certificate surrendered to the Corporation for transfer shall be canceled
and no new certificate shall be issued to evidence transferred shares until the
former certificate shall have been surrendered.
8.2 LOST, STOLEN OR DESTROYED CERTIFICATE. The Board of Directors may
periodically promulgate procedures to be followed in connection with the
issuance of new certificates in replacement of any certificate previously issued
by the Corporation.
8.3 TRANSFERS OF SHARES. Subject to the satisfaction of the conditions
periodically expressed by the Board of Directors, upon the surrender of a
certificate representing shares of the Corporation, the Corporation shall issue
a new certificate to the person entitled thereto, cancel the old certificate and
record the transaction upon its books. Transfers of shares shall be made only
on the books of the Corporation by the registered holder thereof or by its
attorney or successor duly authorized as evidenced by documents filed with the
Secretary or transfer agent of the Corporation. The person in whose name shares
stand on the books of the Corporation shall be deemed the owner thereof for all
purposes.
8.4 RESTRICTIONS ON TRANSFER. Subject to such conditions and limitations as
the Board of Directors may periodically promulgate, and except as otherwise
provided by any applicable law, the articles of incorporation or these By-Laws,
any shareholder or the Corporation may enter into any agreement restricting the
<PAGE>
transferability of any shares of the Corporation, granting put, call, or other
rights or responsibilities with respect to such shares on such terms and
conditions as are equally applicable to any other shareholder of the
Corporation. Any restriction on the transferability of any shares may be
expressed on the certificate representing such shares.
8.5 NO FRACTIONAL SHARE CERTIFICATES. Certificates shall not be issued
representing any fractional share.
8.6 FIXING RECORD DATE. The Board of Directors may fix in advance a date, not
exceeding sixty (60) days, nor less than ten (10) days, preceding the date of
any meeting of shareholders, or the date for the payment of any dividend, or the
date for the allotment of rights, or the date when any change or conversion or
exchange of shares shall be effective, or a date in connection with obtaining
any consent, as a record date for the termination of the shareholders entitled
to notice of, and to vote at, any such meeting, or adjournment thereof, or
entitled to receive payment of any such dividend, or to any such allotment of
rights, or to exercise the rights in respect of any such change, conversion or
exchange of shares, or to give such consent, and in such case such shareholders
and only such shareholders as shall be shareholders of record on the date so
fixed shall be entitled to notice of, and to vote at, such meeting and any
adjournment thereof, or to receive payment of such dividend, or to receive such
allotment of rights, or to exercise such rights, or to give such consent, as the
case may be, notwithstanding any transfer of any shares on the books of the
Corporation after any such record date.
8.7 SHAREHOLDERS OF RECORD. Except as otherwise required by applicable law,
the Corporation may treat the holder of record of any share as the holder in
fact thereof.
ARTICLE IX: GENERAL PROVISIONS
9.1 FISCAL YEAR. The fiscal year of the Corporation shall begin on January 1
and shall end on December 31.
9.2 SEAL. The Board of Directors may provide a corporate seal which shall have
inscribed thereon the name of the Corporation, and the words "CORPORATE SEAL"
and "Illinois;" and it shall otherwise be in the form approved by the Board of
Directors. The seal may be
<PAGE>
used by causing it, or a facsimile thereof, to be impressed or affixed or
otherwise reproduced.
ARTICLE X: INDEMNIFICATION
10.1 THIRD PARTY ACTION. The Corporation shall indemnify any person who was or
is a party, or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding, whether civil, criminal, administrative or
investigative (other than an action by or in the right of the Corporation) by
reason of the fact that such person is or was a director, officer, employee or
agent of the Corporation, or who is or was serving at the request of the
Corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, against expenses
(including attorneys' fees), judgments, fines and amounts paid in settlement
actually and reasonably incurred by such person in connection with such action,
suit or proceeding, if such person acted in good faith and in a manner he or she
reasonably believed to be in, or not opposed to the best interests of the
Corporation, and with respect to any criminal action or proceeding, had no
reasonable cause to believe his or her conduct was unlawful. The termination of
any action, suit or proceeding by judgment, order, settlement, conviction or
upon a plea of nolo contendere or its equivalent, shall not, of itself, create a
presumption that the person did not act in good faith and in a manner which such
person reasonably believed to be in or not opposed to the best interests of the
Corporation or with respect to any criminal action or proceeding, that the
person had reasonable cause to believe that his or her conduct was unlawful.
10.2 CORPORATION ACTION. The Corporation shall indemnify any person who was or
is a party, or is threatened to be made a party to any threatened, pending or
completed action or suit by or in the right of the Corporation to procure a
judgment in its favor by reason of the fact that such person is or was a
director, officer, employee or agent of the Corporation, or is or was serving at
the request of the Corporation as a director, officer, employee or agent of
another corporation, partnership, joint venture, trust or other enterprise,
against expenses (including attorneys' fees) actually and reasonably incurred by
such person in connection with the defense or settlement of such action or suit,
if such person acted in good faith and in a manner he or she reasonably believed
to be in, or not opposed to the best interests of the Corporation, provided that
no indemnification shall be made in respect of any
<PAGE>
claim, issue or matter as to which such person shall have been adjudged to be
liable for negligence or misconduct in the performance of his or her duty to the
Corporation, unless and only to the extent that the court in which such action
or suit was brought shall determine upon application that, despite the
adjudication of liability, but in view of all the circumstances of the case,
such person is fairly and reasonably entitled to indemnity for such expenses as
the court shall deem proper.
10.3 FEES. To the extent that a director, officer, employee or agent of the
Corporation has been successful, on the merits or otherwise, in the defense of
any action, suit or proceeding referred to in Sections 10.1 THIRD PARTY ACTION
or 10.2 CORPORATION ACTION, or in defense of any claim, issue or matter therein,
such person shall be indemnified against expenses, including attorneys' fees,
actually and reasonably incurred by such person in connection therewith.
10.4 CONDITIONS PRECEDENT. Any indemnification under Sections 10.1 THIRD PARTY
ACTION or 10.2 CORPORATION ACTION, unless ordered by a court, shall be made by
the Corporation only as authorized in the specific case, upon a determination
that indemnification of the director, officer, employee or agent is proper in
the circumstances because he or she has met the applicable standard of conduct
expressed in Sections 10.1 THIRD PARTY ACTION or 10.2 CORPORATION ACTION. Such
determination shall be made by the board of directors by a majority vote of a
quorum consisting of directors who were not parties to such action, suit or
proceeding, or if such quorum is not obtainable or, even if obtainable, if a
quorum of disinterested directors so directs, by independent legal counsel in a
written opinion, or by the shareholders.
10.5 EXPENSES. Expenses incurred in defending a civil or criminal action, suit
or proceeding may be paid by the Corporation in advance of the final disposition
of such action, suit or proceeding, as authorized by the board of directors in
the specific case, upon receipt of an undertaking by or on behalf of the
director, officer, employee or agent to repay such amount, unless it shall
ultimately be determined that he or she is entitled to be indemnified by the
Corporation as authorized in this Article.
10.6 NON-EXCLUSIVITY. The indemnification provided by this Article shall not be
deemed exclusive of any other rights to which those seeking indemnification may
be entitled under any by-law, the
<PAGE>
articles of incorporation, agreement, vote of shareholders or disinterested
directors or otherwise, both as to action in such person's official capacity and
as to action in another capacity while holding such office, and shall continue
as to a person who has ceased to be a director, officer, employee or agent, and
shall inure to the benefit of the heirs, executors and administrators of such a
person.
10.7 INSURANCE. The Corporation may purchase and maintain insurance on behalf
of any person who is or was a director, officer, employee or agent of the
Corporation or who is or was serving at the request of the corporation as a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust or other enterprise, against any liability asserted against such
person and incurred by such person in any such capacity, or arising out of such
person's status as such, whether or not the Corporation would have the power to
indemnify such person against such liability under the provisions of this
section.
10.8 REPORTING. If the Corporation has paid indemnity or has advanced expenses
to a director, officer, employee or agent, the Corporation shall report the
indemnification or advance in writing to the shareholders with or before the
notice of the next shareholders meeting.
10.9 DEFINITIONS. For purposes of this Article, references to "the Corporation"
or "this Corporation" shall include, in addition to any surviving corporation,
any merging corporation (including any corporation having merged with a merging
corporation) absorbed in a merger which, if its separate existence had
continued, would have had the power and authority to indemnify its directors,
officers and employees or agents, so that any person who was a director,
officer, employee or agent of such merging corporation, or was serving at the
request of such merging corporation as a director, officer, employee or agent of
another corporation, partnership, joint venture, trust or other enterprises,
shall stand in the same position under the provisions of this Article with
respect to the surviving corporation as such person would have with respect to
such merging corporation if its separate existence had continued.
For purposes of this Article, references to "other enterprises" shall include
employee benefit plans; references to "fines" shall include any excise taxes
assessed on a person with respect to an
<PAGE>
employee benefit plan; and references to "serving at the request of the
Corporation" shall include any service as a director, officer, employee or agent
of the Corporation which imposes duties on, or involves services by such
director, officer, employee or agent with respect to an employee benefit plan,
its participants or beneficiaries. A person who acted in good faith and in a
manner he or she reasonably believed to be in the best interests of the
participants and beneficiaries of an employee benefit plan shall be deemed to
have acted in a manner "not opposed to the best interest of the Corporation" as
referred to in this Article.
ARTICLE XI: AMENDMENTS
These By-Laws may be made, altered, amended or repealed by the shareholders or
the Board of Directors. Any By-Law made, altered, amended or repealed by the
shareholders may be altered, amended or repealed by the Board of Directors, or
by the shareholders.
<PAGE>
EXHIBIT 11.0
RLI CORP. AND SUBSIDIARIES
COMPUTATION OF PER SHARE EARNINGS
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995, AND 1996
<TABLE>
<CAPTION>
1994 1995 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Primary
Net earnings (loss) $(4,775,871) $7,949,541 $25,695,721
====================================================================================================
Earnings (loss) per share $(0.61) $1.01 $3.25
====================================================================================================
Weighted average shares outstanding 7,786,004 7,849,799 7,896,463
====================================================================================================
Fully Diluted
Net earnings (loss) $(4,775,871) $ 7,949,541 $25,695,721
Reduction of interest expense on assumed conversion
of convertible debentures (net of tax) Note (1) Note (1) 1,794,000
Reduced amortization of deferred loan costs on assumed
conversion of convertible debentures (net of tax) Note (1) Note (1) 80,057
- ----------------------------------------------------------------------------------------------------
Adjusted net earnings (loss) $(4,775,871) $ 7,949,541 $27,569,778
====================================================================================================
Earnings (loss) per share (1) $(0.61) $1.01 $2.85
====================================================================================================
Weighted average shares outstanding (1) 7,786,004 7,849,799 7,896,463
Dilutive effect of convertible debentures (2) Note (1) Note (1) 1,769,231
Adjusted weighted average shares outstanding 7,786,004 7,849,799 9,665,694
====================================================================================================
</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.)
36
<PAGE>
SELECTED FINANCIAL DATA
The following is selected financial data of RLI Corp. and Subsidiaries for the
eleven years ended December 31, 1996:
<TABLE>
<CAPTION>
1986 1987 1988 1989 1990
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
OPERATING RESULTS
Gross sales $195,805,801 151,492,336 143,785,384 149,230,331 181,215,877
Total revenue $111,029,407 106,846,379 104,279,172 89,984,262 92,957,578
Net earnings (loss) $10,978,773 13,965,174 7,253,913 8,200,264 14,267,002
Comprehensive earnings (loss) (2) $11,789,807 12,373,916 8,295,719 11,105,089 11,952,060
Net cash provided from operating activities $31,600,447 9,151,857 27,742,205 22,801,043 45,388,065
Net premiums written to statutory surplus 190% 156% 131% 96% 112%
GAAP combined ratio 93.5 84.4 96.1 97.8 85.1
Statutory combined ratio 89.5 84.7 98.3 99.5 92.2
FINANCIAL CONDITION
Total investments $131,902,026 152,777,063 165,956,870 177,025,151 213,160,198
Total assets $321,883,748 364,740,628 372,492,257 402,906,191 432,379,562
Unpaid losses and settlement expenses $159,383,894 194,707,865 217,230,839 230,523,717 235,806,989
Long-term debt $7,000,000 7,000,000 7,000,000 7,000,000 7,000,000
Total shareholders' equity $49,291,745 57,763,851 64,026,271 70,276,175 79,850,942
Statutory surplus $54,063,188 57,453,264 60,151,725 68,571,173 70,409,590
SHARE INFORMATION
Earnings (loss) per share:
Primary $1.46 1.82 .97 1.14 2.02
Fully-diluted (3) $1.46 1.82 .97 1.14 2.02
Comprehensive earnings (loss) per share: (2)
Primary $1.57 1.61 1.11 1.54 1.69
Fully-diluted (3) $1.57 1.61 1.11 1.54 1.69
Cash dividends declared per common share $.22 .25 .27 .30 .34
Book value $6.37 7.73 8.57 9.94 11.29
Closing stock price $11.00 7.70 6.10 6.80 11.60
Stock split 150%
Weighted average number of common shares outstanding:
Primary 7,526,375 7,704,938 7,475,369 7,189,076 7,073,718
Fully-diluted (3) 7,526,375 7,704,938 7,475,369 7,189,076 7,073,718
Common shares outstanding 7,738,619 7,475,369 7,475,369 7,073,718 7,073,718
==================================================================================================================================
</TABLE>
(1) 1992 through 1995 information has been restated to include the effect of
the change to the equity method of accounting for the company's former
subsidiary, RLI Vision Corp., renamed Maui Jim, Inc. The financial restatement
represents a change in presentation only and does not have a dilutive effect on
historical periods. See note 1B to the consolidated financial statements.
(2) The requirement to report comprehensive earnings is currently being
considered by the FASB. The primary difference between reporting the company's
GAAP and comprehensive earnings is that comprehensive earnings include
unrealized gains/losses net of tax. GAAP reporting directly credits or charges
shareholders' equity with unrealized gains/losses, rather than including them in
earnings.
18
<PAGE>
SELECTED FINANCIAL DATA
The following is selected financial data of RLI Corp. and Subsidiaries for the
eleven years ended December 31, 1996:
<TABLE>
<CAPTION>
1991 1992(1) 1993(1)
(restated) (restated)
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING RESULTS
Gross sales 215,497,602 220,048,369 266,480,414
Total revenue 102,342,998 117,581,830 143,100,340
Net earnings (loss) 16,800,050 16,207,127 15,947,627
Comprehensive earnings (loss) (2) 22,430,168 18,547,721 21,175,108
Net cash provided from operating activities 22,918,206 43,618,755 73,629,090
Net premiums written to statutory surplus 95% 110% 94%
GAAP combined ratio 85.2 91.4 97.2
Statutory combined ratio 91.6 95.8 87.9 (4)
FINANCIAL CONDITION
Total investments 237,932,089 281,112,588 401,608,917
Total assets 483,571,862 526,351,331 667,650,378
Unpaid losses and settlement expenses 244,666,938 268,042,761 310,767,026
Long-term debt 7,000,000 7,000,000 53,000,000
Total shareholders' equity 99,677,983 117,392,751 140,706,372
Statutory surplus 88,605,319 100,584,758 152,261,509
SHARE INFORMATION
Earnings (loss) per share:
Primary 2.38 2.26 2.10 (5)
Fully-diluted (3) 2.38 2.26 2.00 (5)
Comprehensive earnings (loss) per share: (2)
Primary 3.17 2.59 2.79 (5)
Fully-diluted (3) 3.17 2.59 2.63 (5)
Cash dividends declared per common share .37 .40 .42
Book value 14.09 16.30 18.25
Closing stock price 13.20 19.80 21.20
Stock split
Weighted average number of common shares outstanding:
Primary 7,073,718 7,158,890 7,599,563
Fully-diluted (3) 7,073,718 7,158,890 8,360,575
Common shares outstanding 7,073,718 7,201,343 7,711,065
<CAPTION>
1994(1) 1995(1) 1996
(restated) (restated)
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATING RESULTS
Gross sales 295,965,601 293,921,737 301,499,626
Total revenue 156,721,972 155,953,724 155,354,418
Net earnings (loss) (4,775,871) 7,949,541 25,695,721
Comprehensive earnings (loss) (2) (8,512,784) 31,373,771 41,969,893
Net cash provided from operating activities 27,041,297 24,648,625 48,946,600
Net premiums written to statutory surplus 108% 76% 64%
GAAP combined ratio 116.9 107.5 87.4
Statutory combined ratio 116.9 106.5 89.1
FINANCIAL CONDITION
Total investments 413,835,146 471,599,283 537,946,060
Total assets 751,085,888 810,199,958 845,473,784
Unpaid losses and settlement expenses 394,966,040 418,985,960 405,801,220
Long-term debt 52,255,000 46,000,000 46,000,000
Total shareholders' equity 131,169,961 158,607,716 200,039,361
Statutory surplus 136,124,530 172,312,961 207,786,596
SHARE INFORMATION
Earnings (loss) per share:
Primary (0.61) 1.01 3.25
Fully-diluted (3) (0.61) 1.01 2.85
Comprehensive earnings (loss) per share: (2)
Primary (1.09) 4.00 5.32
Fully-diluted (3) (1.09) 3.46 (6) 4.54
Cash dividends declared per common share .45 .51 .55
Book value 16.71 20.20 25.57
Closing stock price 16.40 25.00 33.38
Stock split 125%
Weighted average number of common shares outstanding:
Primary 7,786,004 7,849,799 7,896,463
Fully-diluted (3) 7,786,004 7,849,799 9,665,694
Common shares outstanding 7,849,443 7,850,882 7,821,730
=========================================================================================================
</TABLE>
(3) See note 1K 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."
(6) For 1995, fully-diluted earnings per share on a GAAP basis were
anti-dilutive. As such, GAAP fully-diluted and primary earnings per share were
equal. Fully-diluted comprehensive earnings per share, however, were not
anti-dilutive. The number of fully-diluted shares used for this calculation was
9,619,030.
19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OVERVIEW
RLI Corp. (the Company) is a holding company that underwrites selected property
and casualty insurance through its major subsidiaries collectively known as RLI
Insurance Group (the Group). The Group has accounted for approximately 85% of
consolidated revenue over the last two years by providing property and casualty
coverages primarily for commercial risks. 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 virtually 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 70.7% of
the Company's 1996 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. During 1996, the Company entered into an innovative
financing arrangement, known as Catastrophe Equity Puts, which provides for the
issuance of the Company's convertible preferred shares at a pre-negotiated rate
to restore surplus to a sufficient level and to continue writing business in the
event of a catastrophic loss.
The casualty portion of the Company's business consists largely of commercial
and personal umbrella and general liability coverages. In addition, the Group
provides directors & officers liability, employers excess indemnity (EEI-an
alternative to the Texas state-run workers' compensation system), contract and
miscellaneous surety bonds, and in-home business owners coverage. The casualty
book of business is subject to the risk of accurately estimating losses and
related 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 the extent of coverage
and the amount of compensation due for injuries or losses.
The consolidated financial statements and related notes found on pages 26-43
should be read in conjunction with the following discussion.
SIGNIFICANT DEVELOPMENTS
OPHTHALMIC MERGER
In November, the Company announced the merger of its ophthalmic services
subsidiary, RLI Vision Corp., with Hester Enterprises, Inc. The resulting
organization operates under the name Maui Jim, Inc. This transaction brings
together the infrastructure of RLI Vision to support the recent booming sales
growth of Maui Jim sunglasses. The Company has a 44% (34% at December 31, 1996)
minority interest in Maui Jim, Inc., which is reflected in the Company's
financial statements as an equity-based investment. Fourth quarter 1996 results
included a one-time charge to the Company of $733,000, or $.06 per share, for
the effect of the change from pooling to purchase accounting stemming from a
1995 RLI Vision Corp. business combination. This change was required because of
the aforementioned merger.
YEAR ENDED DECEMBER 31, 1996, COMPARED
TO YEAR ENDED DECEMBER 31, 1995
Consolidated gross sales--which consist of gross premiums written, net
investment income and realized investment gains (losses)-- totaled $301.5
million, a 2.6% increase from 1995. Consolidated revenue for 1996 was $155.4
million, down 0.4% from the previous year. The decline in revenue was
attributable to lower earned premiums of $130.7 million in 1996 compared to
$133.5 million in 1995. This decrease resulted from the 1995 discontinuation of
certain lines of business as well as the re-underwriting of the property book of
business. As written premiums increased during the year, net earned premiums
grew 4.0% in the fourth quarter of 1996 compared to 1995.
- --------------------------------------------------------------------------------
Year Ended December 31,
- --------------------------------------------------------------------------------
Gross sales (in thousands) 1994 1995 1996
- --------------------------------------------------------------------------------
Gross premiums written $279,428 $271,436 $276,802
Net investment income 20,132 22,029 23,681
Realized investment gains (losses) (3,595) 457 1,017
- --------------------------------------------------------------------------------
Total gross sales $295,965 $293,922 $301,500
================================================================================
Net after-tax earnings for the Company were a record $25.7 million ($3.25 per
share) in 1996 compared to $8.0 million ($1.01 per share) in 1995. The impact in
1995 from the adverse development of Northridge Earthquake claims was a loss of
$18.6 million ($2.37 per share). As of December 31, 1996, the Company had 36
outstanding open earthquake claims
20
<PAGE>
out of 688 originally reported as a result of this occurrence. Management
believes the reserve strengthening in the third quarter of 1995 appears adequate
to resolve the Company's remaining liabilities.
During the fourth quarter of 1996, the Company introduced the reporting of
comprehensive earnings in public releases of financial information. Based on an
exposure draft from the Financial Accounting Standards Board, comprehensive
earnings include not only traditional net income but other sources of equity
growth as well. The material adjustment applicable to the Company's net earnings
is the inclusion of net unrealized gains and losses, after tax. The following
table illustrates the Company's per-share comprehensive earnings performance
compared to traditional earnings for the last five years.
- --------------------------------------------------------------------------------
Primary Fully Diluted
Net Earnings Comp. Earnings Net Earnings Comp. Earnings
- --------------------------------------------------------------------------------
1992 $2.26 $2.59 $2.26 $2.59
1993 2.10 2.79 2.00 2.63
1994 ( .61) (1.09) ( .61) (1.09)
1995 1.01 4.00 1.01 3.46
1996 3.25 5.32 2.85 4.54
- --------------------------------------------------------------------------------
$8.01 $13.61 $7.51 $12.13
================================================================================
As this chart indicates, comprehensive earnings per share for the last five
years exceeds reported net earnings by 70% on a primary basis. As a result,
shareholders' equity reached an unprecedented level of over $200.0 million.
The Company has adopted this concept through its Market Value Potential (MVP)
program, which correlates executive compensation with increased value returned
to shareholders. This is accomplished by awarding bonuses only after equity
growth has exceeded the Company's own cost of capital and the Employee Stock
Ownership Plan contribution.
RLI INSURANCE GROUP
Gross written premiums of $276.8 million were higher than 1995 by 2.0% in total
while gross written premiums from continuing programs rose 4.9%. These modest
increases reflect the Company's focus on underwriting selection even during
periods of trying market conditions. The Group's pretax earnings for 1996 were
$16.4 million, compared to a loss of $9.9 million in 1995 that was impacted by
the strengthening of the Northridge Earthquake reserves.
The Company's property book of business produced the most growth with gross
written premiums of $138.1 million for the year ended 1996, increasing 8.8% over
the same period in 1995. The property line also exhibited considerable
profitability by achieving a GAAP combined ratio of 60.9 in 1996, compared to
63.8 in 1995, excluding the impact of the Northridge Earthquake. The property
GAAP expense ratio for 1996 was 38.5 compared to 43.1 in 1995. This decline was
the result of property reinsurance profit-sharing commissions earned due to
favorable loss experience over the past year.
Casualty gross written premiums declined 4.0% from 1995 to $138.7 million in
1996. Much of this decline was due to the discontinued aviation product line,
where $6.3 million was written in 1995. Other casualty lines were flat or
slightly down in 1996 from 1995, reflecting the Company's commitment to risk
selection even during protracted periods of soft market conditions. The
exception was in the surety product line where 1996 gross written premiums were
$11.6 million compared to $3.7 million in 1995. Reserve strengthening on the
Company's primary general liability line in 1996 affected casualty business
profitability as the GAAP combined ratio rose to 103.0, compared to 99.7 in
1995. Despite this strengthening, total reserve development in 1996 on prior
accident years' reserves was favorable as indicated in note 6 to the financial
statements.
INVESTMENT INCOME
Net dividend and interest income increased 7.5% during 1996. The increase was
due to the growth in invested assets throughout 1996 and substantial cash flow
provided from recoveries from our reinsurers. The Company realized $1.0 million
in capital gains in 1996, compared to $457,000 in 1995. Operating cash flows
were up substantially for 1996, increasing to $48.9 million from $24.6 million
in 1995. All cash flows in excess of current needs were used to reduce
outstanding short term debt, fund our stock repurchase program, purchase equity
securities, and acquire fixed-income instruments, composed of intermediate term,
high grade tax-exempt securities, convertible debenture securities and U.S.
government and agency securities. During 1996, $2.8 million in short term debt
was paid off, and the Company began a $10 million stock repurchase program. By
year end, the Company had repurchased 116,212 shares of stock at a total cost of
$3.0 million.
The yields on the Company's fixed-income investments for the years ended
December 31, 1995 and 1996, respectively, were as follows:
1995 1996
- --------------------------------------------------------------------------------
Taxable 6.84% 6.91%
Tax-exempt 5.06% 4.97%
Yields for 1996 remained relatively stable as a roller coaster bond market saw
yields rise significantly by midyear and then return to levels slightly above
those at year end 1995. Tax-exempt yields were down slightly as substantial
higher yielding securities matured or were called during the year and were
reinvested at the lower current levels. The taxable segment of the portfolio saw
a slight increase in yield through the inclusion of callable agencies and an
extension of the overall portfolio duration.
21
<PAGE>
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>
1992 259,522 13,483 921 3,546 6.9% 8.0%
1993 341,361 16,857 254 7,945 7.3% 8.3%
1994 407,722 20,133 (3,595) (5,749) 2.7% 3.6%
1995 442,717 22,029 457 36,037 13.2% 14.1%
1996 504,773 23,681 1,018 25,033 9.9% 10.7%
5-yr. $390,672 $19,236 $ (189) $13,362 8.3% 9.2%
</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.
- --------------------------------------------------------------------------------
The annualized return for 1996 was greatly enhanced by the strong performance of
our equity portfolio, which had unrealized appreciation of $25.8 million.
INTEREST AND GENERAL CORPORATE EXPENSE
Interest expense on debt was $2.8 million in 1996, down 16.1% from 1995. This
decline reflected the refinancing of an Industrial Revenue Bond with short-term
debt at a considerably lower interest rate at the end of 1995. The short-term
debt was subsequently paid off during the first quarter of 1996. General
corporate expenses increased 56.6% in 1996, primarily as a result of accrued
executive bonuses relating to the MVP program.
INCOME TAXES
The Company's effective tax rate in 1996 was 27.1% on pretax earnings of $35.2
million. These earnings include $8.0 million of investment income that is wholly
or partially exempt from federal income tax. In 1995, the Company reported a tax
benefit of $124,000 on pretax earnings of $7.8 million. Non-taxable income for
1995 was $7.4 million.
OUTLOOK FOR 1997
The Company's main focus in 1997 is top line growth. Home office infrastructure
was strengthened in 1996 to aggressively pursue a program of identifying,
evaluating, and pursuing new product opportunities in the coming year. This will
be accomplished either through new strategic alliances with producers on
existing products or by identifying new products that fit the Company's
philosophy as a specialty lines insurer.
PROPERTY INSURANCE
The Company anticipates that both the earthquake and fire property markets will
soften somewhat in 1997, thereby inhibiting significant growth on existing
products. Continued profitability is expected in 1997, absent any significant
catastrophies, due largely to the structure of the property reinsurance program.
The Company's reinsurance protection from earthquake has been continually
strengthened throughout the past two years. In 1997, existing protection will be
maintained at a cost savings of approximately 15%. Additionally, a newly
pioneered equity protection agreement, referred to as CatEPuts-SM-, was forged
in 1996. This program provides access to additional capital in the event a loss
exceeds the Company's current catastrophe reinsurance protection. This strategy
would allow the Company to continue to write business following a large
catastrophic event as the market capacity constricts.
CASUALTY AND OTHER LINES
Company projections for gross written premiums in 1997 include double digit
increases in the commercial umbrella, employers indemnity, professional
liability, and surety lines. The 1996 favorable reserve development, including
reserve strengthening, bodes well for the future profitability of this segment
of the Company's business. The goal for 1997 is to achieve a combined ratio
below 100.0, adding underwriting earnings to the considerable investment income
earned on these products' long-tail reserves.
YEAR ENDED DECEMBER 31, 1995,
COMPARED TO YEAR ENDED DECEMBER 31, 1994
Consolidated 1995 gross sales totaled $293.9 million, a 0.7% decline from 1994.
Consolidated revenue for 1995 was $156.0 million, down 0.5% 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.
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
22
<PAGE>
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 16,538 22,486 16,538 22,486
- ------------------------------------------------------------------------------------------------
Consolidated revenue 156,722 155,954 174,735 157,181
- ------------------------------------------------------------------------------------------------
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 20,217 19,196 20,217 19,196
- ------------------------------------------------------------------------------------------------
Total expenses 168,965 148,128 149,099 120,790
- ------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes (12,243) 7,826 25,636 36,391
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.
Gross written premiums in 1995 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 earthquake 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. 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 earlier. This 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
the aviation division, 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 in 1995. 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.
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 $24.6 million from $27.0 million in 1994. All cash flows in excess
of current needs were used to acquire equity securities and 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:
1994 1995
- --------------------------------------------------------------------------------
Taxable 6.82% 6.84%
Tax-exempt 5.25% 5.06%
In 1995, 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.
23
<PAGE>
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
In 1995, the Company recorded a tax benefit of $124,000 on pretax earnings of
$7.8 million. These earnings include $7.4 million of investment income that is
wholly or partially exempt from federal income tax. In 1994, the loss before
taxes was $12.2 million, with a tax benefit of $7.5 million, producing an
effective rate of 61%. 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.
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. Previously, the
Company supported the proposed Natural Disaster Act as the most desirable
alternative. That Act was never passed and the Company is considering other
proposed alternatives.
SUPERFUND REFORM (ENVIRONMENTAL LIABILITY)--In 1996, the president asked
congress to reinstate the corporate levies that provide funds for Superfund
cleanup. Congressional representatives indicate they would not support a
reinstatement but are considering comprehensive reform of this bill that, if
passed, could impose some tax liability on the Company.
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. During the second quarter of 1996, the Company reached
a settlement with the California Department of Insurance resolving its total
liability for refunds and interest under Proposition 103. The settlement
required the Company to return $2,987,050 in premiums and interest, which
resulted in a 1996 pretax charge of $487,370 to recognize the difference between
the actual settlement and the amount previously accrued. The Company is
currently in the process of issuing refund checks to policyholders.
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, 1996, the Company had no
outstanding short term debt. Management believes that cash generated from
operations, investments, and cash available from financing activities will
provide sufficient liquidity to meet the Company's anticipated needs over the
next 12 to 24 months.
In 1996, the Company entered into an innovative catastrophe reinsurance and loss
financing program with Centre Reinsurance (Centre Re). The program, called
Catastrophe Equity Puts (CatEPuts)SM, augments the Company's traditional
reinsurance by integrating its loss financing needs with a pre-negotiated sale
of securities linked to exchange-traded shares. CatEPuts allows the Company to
put up to $50.0 million of its convertible preferred shares to Centre Re at a
pre-negotiated rate in the event of a catastrophic loss, provided the loss does
not reduce GAAP equity to less than $55.0 million. CatEPuts is intended to be a
three-year program and is designed to enable the Company to continue operating
after a loss of such magnitude that its reinsurance capacity is exhausted. If
the Company exercises its option to put preferred shares to Centre Re, then
Centre Re, in turn, has the option to reinsure certain business written by the
Company on a prospective basis.
During 1996, the Company generated net operating cash flows of $48.9 million, up
substantially from 1995's $24.6 million. Financing activities included net use
of $2.8 million of funds to retire all short term debt. Additionally, the
Company began a stock repurchase program, repurchasing 116,212 shares at a total
cost of $3.0 million. The remainder of excess 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 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 majority of the Company's
24
<PAGE>
fixed-income portfolio consists of securities rated A or better, with 98% rated
AA or better. Currently, 72.2% of the Company's fixed-income portfolio is
noncallable. 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 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.
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. During 1996, the Company maintained $44.9 million in fixed income
securities within the available-for-sale classification. Although it is likely
that the majority of these securities will be held by the Company 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.
Equity portfolios increased $35.0 million during 1996. The Company had net
purchases of $9.2 million of common stock, with a portfolio appreciation of
$25.8 million. Capital gains of $124,000 were realized during the year. 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) continues its work on
developing a model investment law. This law, which is expected to be passed
during 1997, 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.
The NAIC has a project to codify statutory accounting practices, the result of
which is expected to constitute the only source of "prescribed" statutory
accounting practices. Accordingly, that project will likely change the
definitions of what comprises prescribed versus permitted statutory accounting
practices and may result in changes to the accounting policies that insurance
enterprises use to prepare their statutory financial statements.
25
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, 1995 1996
(restated)
- --------------------------------------------------------------------------------------------------------------
Assets
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Investments:
Fixed maturities:
Held-to-maturity, at amortized cost
(fair value--$260,957,796 in 1995 and $266,025,419 in 1996) $251,637,536 $ 263,282,430
Available-for-sale, at fair value
(amortized cost--$43,990,338 in 1995 and $44,525,564 in 1996) 45,119,811 44,904,303
Equity securities available-for-sale, at fair value
(cost--$102,580,834 in 1995 and $111,773,203 in 1996) 153,957,535 188,935,360
Short-term investments, at cost which approximates fair value 20,884,401 40,823,967
- --------------------------------------------------------------------------------------------------------------
Total investments 471,599,283 537,946,060
Cash 3,506,945
Accrued investment income 5,854,731 5,835,885
Premiums and reinsurance balances receivable, net of allowances for
insolvent reinsurers of $16,336,146 in 1995 and $16,897,798 in 1996 36,447,284 37,166,516
Ceded unearned premiums 50,189,740 53,705,078
Reinsurance balances recoverable on unpaid losses and settlement expenses 197,337,466 165,017,149
Deferred policy acquisition costs, net 15,806,911 16,663,603
Property and equipment, at cost, net of accumulated depreciation
of $17,346,327 in 1995 and $19,381,473 in 1996 11,967,331 12,126,552
Income taxes--current 2,488,863
Investment in unconsolidated investee 7,856,130 8,970,691
Other assets 7,145,274 8,042,250
- --------------------------------------------------------------------------------------------------------------
Total assets $810,199,958 $845,473,784
==============================================================================================================
Liabilities and Shareholders' Equity
- --------------------------------------------------------------------------------------------------------------
Liabilities:
Unpaid losses and settlement expenses $418,985,960 $405,801,220
Unearned premiums 126,013,957 129,781,639
Reinsurance balances payable 37,744,456 23,699,837
Income taxes--current 2,134,692
Income taxes--deferred 4,903,627 17,170,687
Notes payable, short-term 2,800,000
Long-term debt--convertible debentures 46,000,000 46,000,000
Other liabilities 15,144,242 20,846,348
- --------------------------------------------------------------------------------------------------------------
Total liabilities 651,592,242 645,434,423
- --------------------------------------------------------------------------------------------------------------
Commitments and contingent liabilities
- --------------------------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock ($1 par value, authorized 12,000,000 shares in 1995 and
50,000,000 shares in 1996, issued 8,453,449 shares in 1995 and 1996) 8,453,449 8,453,449
Paid-in capital 23,831,969 31,691,793
Net unrealized appreciation of securities, net of tax 34,334,524 50,608,696
Retained earnings 95,378,097 115,164,415
Treasury stock, at cost (602,567 shares in 1995 and 631,719 shares in 1996) (3,390,323) (5,878,992)
- --------------------------------------------------------------------------------------------------------------
Total shareholders' equity 158,607,716 200,039,361
- --------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $810,199,958 $845,473,784
==============================================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
26
<PAGE>
CONSOLIDATED STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
Years ended December 31, 1994 1995 1996
(restated) (restated)
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net premiums earned $140,184,488 $133,468,133 $130,656,095
Net investment income 20,132,585 22,029,081 23,680,751
Net realized investment gains (losses) (3,595,101) 456,510 1,017,572
- -----------------------------------------------------------------------------------------------
156,721,972 155,953,724 155,354,418
- -----------------------------------------------------------------------------------------------
Losses and settlement expenses 101,641,666 85,889,995 68,261,307
Policy acquisition costs 47,106,098 43,042,045 29,556,390
Insurance operating expenses 15,142,384 14,470,053 16,441,332
Interest expense on debt 3,431,464 3,347,378 2,808,470
General corporate expenses 2,845,289 2,093,034 3,277,630
- -----------------------------------------------------------------------------------------------
170,166,901 148,842,505 120,345,129
- -----------------------------------------------------------------------------------------------
Equity in earnings of unconsolidated investee 1,201,965 714,818 230,741
- -----------------------------------------------------------------------------------------------
Earnings (loss) before income taxes (12,242,964) 7,826,037 35,240,030
- -----------------------------------------------------------------------------------------------
Income tax expense (benefit):
Current (4,585,566) 730,725 6,037,849
Deferred (2,881,527) (854,229) 3,506,460
- -----------------------------------------------------------------------------------------------
(7,467,093) (123,504) 9,544,309
- -----------------------------------------------------------------------------------------------
Net earnings (loss) $ (4,775,871) $ 7,949,541 $ 25,695,721
===============================================================================================
Earnings per share:
Primary
Net earnings (loss) per share from operations $(0.31) $0.97 $3.17
Realized gains (losses), net of tax (0.30) 0.04 0.08
- -----------------------------------------------------------------------------------------------
Primary net earnings (loss) per share $(0.61) $1.01 $3.25
===============================================================================================
Fully diluted
Net earnings (loss) per share from operations $(0.31) $0.97 $2.78
Realized gains (losses), net of tax (0.30) 0.04 0.07
- -----------------------------------------------------------------------------------------------
Fully diluted net earnings (loss) per share $(0.61) $1.01 $2.85
===============================================================================================
Weighted average number of common shares outstanding:
Primary 7,786,004 7,849,799 7,896,463
===============================================================================================
Fully diluted 7,786,004 7,849,799 9,665,694
===============================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
27
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Net
Unrealized Treasury Total
Common Paid-in Appreciation Retained Stock Shareholders'
Years ended December 31, Stock Capital of Securities Earnings at Cost Equity
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1994 $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 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
($.51 per share) (3,965,673) (3,965,673)
- -------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 8,453,449 23,831,969 34,334,524 95,378,097 (3,390,323) 158,607,716
Net earnings 25,695,721 25,695,721
Treasury shares reissued
(87,060 shares) 1,655,524 552,002 2,207,526
Treasury shares purchased
(116,212 shares) (3,040,671) (3,040,671)
Adjustement to accounting
for business combination
(see note 1B) 6,204,300 (1,570,477) 4,633,823
Net change in unrealized
appreciation of available-
for-sale securities 16,274,172 16,274,172
Dividends declared
($.55 per share) (4,338,926) (4,338,926)
- -------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 $8,453,449 $31,691,793 $50,608,696 $115,164,415 $(5,878,992) $200,039,361
=========================================================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
28
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1994 (restated) 1995 (restated) 1996
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net earnings (loss) $ (4,775,871) $ 7,949,541 $25,695,721
Adjustments to reconcile net earnings (loss) to net cash
provided by operating activities:
Provision for insolvencies 1,000,000 613,296 1,006,140
Net realized investment losses (gains) 3,595,101 (456,510) (1,017,572)
Depreciation 3,063,478 2,866,105 2,454,543
Other items, net (4,085,962) 696,046 6,378,410
Change in:
Accrued investment income (761,455) (688,648) 18,846
Premiums and reinsurance balances receivable
(net of direct write-offs and commutations) 145,383 (10,977,648) (1,725,372)
Reinsurance balances payable 9,090,049 (2,115,290) (14,044,619)
Ceded unearned premium (7,308,036) (9,211,652) (3,515,338)
Reinsurance balances recoverable on unpaid losses (54,528,764) 2,399,330 32,320,317
Deferred policy acquisition costs (485,817) 3,401,301 (856,692)
Unpaid losses and settlement expenses 84,199,014 24,019,920 (13,184,740)
Unearned premiums 13,785,231 6,196,415 3,767,682
Income taxes:
Current (11,807,562) 1,525,466 4,623,555
Deferred (2,881,527) (854,229) 3,506,460
Changes in investment in unconsolidated investee:
Undistributed earnings (1,201,965) (714,818) (230,741)
Dividends received 3,750,000
- ------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 27,041,297 24,648,625 48,946,600
- ------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchase of:
Fixed maturities, held-to-maturity (64,032,621) (59,029,702) (29,681,906)
Fixed maturities, available-for-sale (4,793,980) (9,091,447) (11,792,359)
Equity securities, available-for-sale (18,979,331) (32,221,842) (11,648,835)
Short-term investments, net (6,604,323) (19,939,566)
Property and equipment (3,271,057) (1,647,414) (3,408,835)
Proceeds from sale of:
Fixed maturities, available-for-sale 1,260,031 3,383,745 8,297,553
Equity securities, available-for-sale 22,481,402 17,187,726 2,579,172
Short-term investments, net 28,748,056
Property and equipment 50,496 511,631 795,071
Proceeds from call or maturity of:
Fixed maturities, held-to-maturity 46,181,373 25,234,977 17,380,750
Fixed maturities, available-for-sale 2,335,000 3,730,000 2,860,000
- ------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (25,373,010) (23,194,270) (44,558,955)
- ------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Proceeds from issuance of debt 2,800,000
Payments on debt (745,000) (6,255,000) (2,800,000)
Fractional shares paid (4,010)
Treasury shares reissued 2,513,375 33,667 2,207,526
Treasury shares purchased (3,040,671)
Cash dividends paid (3,461,217) (3,849,521) (4,261,445)
- ------------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (1,692,842) (7,274,864) (7,894,590)
- ------------------------------------------------------------------------------------------------------------------------
Net decrease in cash (24,555) (5,820,509) (3,506,945)
Cash at beginning of year 9,352,009 9,327,454 3,506,945
- ------------------------------------------------------------------------------------------------------------------------
Cash at end of year $ 9,327,454 $ 3,506,945 $ 0
========================================================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. DESCRIPTION OF BUSINESS: RLI Corp. is a holding company that, through its
subsidiaries, underwrites selected property and casualty insurance products.
The property and casualty insurance segment, RLI Insurance Group (the Group), is
composed of two 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.
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 December 1, 1996, RLI Vision Corp., the Company's wholly-owned optical goods
distributor, merged with Hester Enterprises, Inc., the manufacturer of Maui Jim
sunglasses. The Company retained a 34% minority interest in the combined entity,
renamed Maui Jim, Inc. The Company accounted for this merger as a non-monetary
exchange of ownership interests with no gain or loss recognized.
As a result of the merger, the Company has presented its minority interest in
Maui Jim, Inc. under the equity method of accounting beginning December 1, 1996.
Additionally, for comparative purposes, the Company has restated prior period
financial information to present its 100% ownership in RLI Vision Corp. under
the equity method. This restatement is a change in presentation only and has no
impact on earnings. In January 1997, the Company paid $3,694,119 for an
additional 10% ownership interest in Maui Jim, Inc., bringing the Company's
total minority interest in Maui Jim, Inc. to 44%.
On May 4, 1995, RLI Vision 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. This business combination was
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., including Target Industries, Inc. stand-alone net income for the year
ended December 31, 1994 of $225,440.
As a result of the aforementioned merger with Hester Enterprises, Inc., the
accounting for the merger with Target Industries, Inc. as a pooling-of-interests
is no longer applicable. Accordingly, the 1996 financial statements reflect an
adjustment to shareholders' equity of $4,633,823 to recognize the change from
pooling-of-interests to purchase accounting, and a charge to earnings of
$732,847, or $.06 per share, for cumulative goodwill amortization from May 4,
1995, through November 30, 1996. Prior period financial information has not been
restated to reflect this change in accounting due to immateriality.
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 that, 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.
Following is a summary of the effects of the Northridge Earthquake. All amounts
are shown in thousands, except per share data.
- --------------------------------------------------------------------------------
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)
================================================================================
30
<PAGE>
As of December 31, 1996, the Company had 36 open earthquake claims from a total
of 688 claims reported from this occurrence. No additional development from this
event occurred in 1996. The Company continually monitors all open earthquake
claims and current reserve levels. Management believes that the reserve
strengthening performed in September 1995 was sufficient to resolve the
remaining outstanding liabilities.
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 "onetime 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 continuously monitors 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 reinsurance does not
relieve the Company of its legal liability to its policyholders.
The Company continuously 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 1994, 1995, and 1996, the
Company provided $1,000,000, $613,296, and $1,006,140, 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, 1996, 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 commissions
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
31
<PAGE>
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.
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. STOCK BASED COMPENSATION: The Company grants to officers stock options for a
fixed number of shares with an exercise price equal to or greater than the fair
market value of the shares at the date of grant. The Company accounts for stock
option grants in accordance with APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and accordingly recognizes no compensation expense for the
stock option grants. See note 8 for further discussion and related disclosures.
N. 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 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 (70.7% of gross
property premiums written during 1996). 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 discontinued 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 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 continuously 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
32
<PAGE>
affect the reported financial statement balances as well as the disclosure of
contingent assets and liabilites. 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,
deferred tax assets 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, and by the 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 continuously monitors 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>
- ------------------------------------------------------------------------------------------
1994 1995 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest on fixed maturities $15,311,817 $17,333,118 $18,862,096
Dividends on equity securities 5,290,715 5,444,146 5,715,310
Interest on short-term investments 1,846,881 1,893,693 1,572,512
- ------------------------------------------------------------------------------------------
Gross investment income 22,449,413 24,670,957 26,149,918
Less investment expenses 2,316,828 2,641,876 2,469,167
- ------------------------------------------------------------------------------------------
Net investment income $20,132,585 $22,029,081 $23,680,751
==========================================================================================
</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>
- ------------------------------------------------------------------------------------------
1994 1995 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net realized investment gains (losses)
Fixed maturities
Held-to-maturity $ 79,124 $(21,428) $ 10,656
Available-for-sale 27,217 6,324 24,043
Equity securities (3,701,442) 471,614 982,873
- ------------------------------------------------------------------------------------------
(3,595,101) 456,510 1,017,572
- ------------------------------------------------------------------------------------------
Net changes in unrealized
appreciation/depreciation on investments
Fixed maturities
Held-to-maturity (22,112,459) 21,130,309 (6,577,271)
Available-for-sale (475,597) 1,605,070 (750,734)
Equity securities (5,273,316) 34,432,410 25,785,456
- ------------------------------------------------------------------------------------------
(27,861,372) 57,167,789 18,457,451
- ------------------------------------------------------------------------------------------
Net realized investment gains (losses)
and changes in unrealized
appreciation/depreciation
on investments $(31,456,473) $57,624,299 $19,475,023
==========================================================================================
</TABLE>
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>
1994
Available-for-sale 1,260,031 (603) (603)
1995
Available-for-sale 3,383,745 15,447 (7,875) 7,572
1996
Available-for-sale 8,297,553 84,116 (59,117) 24,999
=========================================================================================================
Calls/Maturities
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
Proceeds Gross Realized Net Realized
from sales Gains Losses gain (loss)
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
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)
1996
Held-to-maturity 17,380,750 11,305 (649) 10,656
Available-for-sale 2,860,000 (956) (956)
=========================================================================================================
</TABLE>
33
<PAGE>
The following is a schedule of amortized costs and estimated fair values of
investments in fixed maturities and equity securities as of December 31, 1995
and 1996. Estimated fair values for fixed maturities 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>
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 subdi-
visions & 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 $ 31,050,335 $ 32,065,236 $ 1,101,235 $ (86,334)
Corporate 2,680,000 2,701,961 25,241 (3,280)
States, political subdi-
visions & 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)
=========================================================================================================
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
Amortized Estimated Gross Unrealized
Cost Fair Value Gains Losses
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1996
Held-to-maturity
U.S. governments $152,612,589 $154,134,493 $ 2,909,178 $ (1,387,274)
States, political subdi-
visions & revenues 110,669,841 111,890,926 1,327,765 (106,680)
- ---------------------------------------------------------------------------------------------------------
Total held-to-maturity $263,282,430 $266,025,419 $ 4,236,943 $ (1,493,954)
- ---------------------------------------------------------------------------------------------------------
Available-for-sale
U.S. governments $ 29,461,455 $ 29,681,299 $ 586,656 $ (366,812)
Foreign governments 443,198 435,094 (8,104)
Corporate 7,585,492 7,736,658 186,975 (35,809)
States, political subdi-
visions & revenues 7,035,419 7,051,252 56,454 (40,621)
- ---------------------------------------------------------------------------------------------------------
Fixed maturities 44,525,564 44,904,303 830,085 (451,346)
Equity securities 111,773,203 188,935,360 77,847,867 (685,710)
- ---------------------------------------------------------------------------------------------------------
Total available-for-sale 156,298,767 233,839,663 78,677,952 (1,137,056)
- ---------------------------------------------------------------------------------------------------------
Total $419,581,197 $499,865,082 $82,914,895 $(2,631,010)
=========================================================================================================
</TABLE>
The amortized cost and estimated fair value of fixed maturity securities at
December 31, 1996, by contractual maturity, are shown as follows.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------
Amortized Cost Estimated Fair Value
- -----------------------------------------------------------------------------------
<S> <C> <C>
Held-to-maturity
Due in one year or less $ 15,619,384 $ 15,727,511
Due after one year through five years 100,585,229 103,043,780
Due after five years through ten years 111,941,124 112,010,661
Due after ten years 35,136,693 35,243,467
- -----------------------------------------------------------------------------------
$263,282,430 $266,025,419
- -----------------------------------------------------------------------------------
Available-for-sale
Due in one year or less $ 1,099,844 $ 1,102,379
Due after one year through five years 22,360,480 22,826,826
Due after five years through ten years 18,207,959 17,997,847
Due after ten years 2,857,281 2,977,251
- -----------------------------------------------------------------------------------
$ 44,525,564 $ 44,904,303
- -----------------------------------------------------------------------------------
</TABLE>
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.
At December 31, 1995, the net unrealized appreciation of available-for-sale
fixed maturities and equity securities totaled $34,334,524. This amount was net
of deferred taxes of $18,171,600. At December 31, 1996, the net unrealized
appreciation of available-for-sale fixed maturities and equity securities
totaled $50,608,696. This amount is net of deferred taxes of $26,932,200.
The Company is party to a securities lending program whereby fixed-income
securities are loaned to third parties, primarily major brokerage firms. As of
December 31, 1995 and 1996, fixed maturities with a fair value of $59,511,460
and $73,949,327, respectively, were loaned. 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 $13,454,695 at December 31, 1996, were on deposit with either
regulatory authorities or banks. Additionally, the Company has certain fixed
maturities held in trust amounting to $9,567,621 at December 31, 1996. 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).
34
<PAGE>
3. POLICY ACQUISITION COSTS
Policy acquisition costs deferred and amortized to income for the years ended
December 31 are summarized as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
1994 1995 1996
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Deferred policy acquisition costs, beginning of year $18,722,395 $19,208,212 $15,806,911
- ---------------------------------------------------------------------------------------------------------
Deferred:
Direct commissions 47,187,978 44,232,003 46,740,471
Premium taxes 4,135,567 4,185,861 4,034,201
Other direct underwriting
expenses 12,088,813 12,122,153 14,194,203
Ceding commissions (16,939,817) (24,666,527) (31,056,079)
- ---------------------------------------------------------------------------------------------------------
Net deferred 46,472,541 35,873,490 33,912,796
- ---------------------------------------------------------------------------------------------------------
Amortized 45,986,724 39,274,791 33,056,104
- ---------------------------------------------------------------------------------------------------------
Deferred policy acquisition costs, end of year $19,208,212 $15,806,911 $16,663,603
=========================================================================================================
Policy acquisition costs:
Amortized to expense 45,986,724 39,274,791 33,056,104
Period costs:
Ceding commission--contingent 60,227 (456,527) (5,275,063)
Other 1,059,147 4,223,781 1,775,349
- ---------------------------------------------------------------------------------------------------------
Total policy acquisition costs $47,106,098 $43,042,045 $29,556,390
=========================================================================================================
</TABLE>
4. LONG-TERM DEBT
On July 28, 1993, the Company issued $46 million of 6.0% convertible debentures
that 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 was 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 before 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 estimated fair values of
the convertible debentures at December 31, 1995 and 1996, were $47,800,000 and
$58,400,000, respectively.
On December 1, 1995, the Company retired its 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.
During the first quarter of 1996, the Company paid off its short term borrowings
of $2,800,000 utilizing excess funds from operations.
Interest paid on outstanding debt for 1994, 1995, and 1996 amounted to
$3,345,714, $3,372,479, and $2,834,192, 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 $30.0 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, 1996, the
Company had no outstanding short term borrowings.
5. REINSURANCE
In the ordinary course of business, the insurance subsidiaries assume and cede
premiums with other insurance companies. A large portion of the reinsurance 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 that 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 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.
In 1996, the Company entered into an innovative catastrophe reinsurance and loss
financing program with Centre Reinsurance (Centre Re). The
35
<PAGE>
program, called Catastrophe Equity Puts (CatEPuts)SM, augments the Company's
traditional reinsurance by integrating its loss financing needs with a
pre-negotiated sale of securities linked to exchange-traded shares. CatEPuts
allows the Company to put up to $50.0 million of its convertible preferred
shares to Centre Re at a pre-negotiated rate in the event of a catastrophic
loss, provided the loss does not reduce GAAP equity to less than $55.0 million.
CatEPuts is intended to be a three-year program and is designed to enable the
Company to continue operating after a loss of such magnitude that its
reinsurance capacity is exhausted. If the Company exercises its option to put
preferred shares to Centre Re, then Centre Re, in turn, has the option to
reinsure certain business written by the Company on a prospective basis.
Premiums written and earned along with losses and settlement expenses incurred
for the years ended December 31 are summarized as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
WRITTEN 1994 1995 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Direct $279,410,212 $270,887,545 $276,707,492
Reinsurance assumed 17,905 548,601 93,811
Reinsurance ceded (132,766,433) (140,983,251) (144,443,663)
- ------------------------------------------------------------------------------------------
Net $146,661,684 $130,452,895 $132,357,640
==========================================================================================
<CAPTION>
- ------------------------------------------------------------------------------------------
EARNED 1994 1995 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Direct $265,453,514 $264,651,370 $271,551,708
Reinsurance assumed 189,371 588,362 32,713
Reinsurance ceded (125,458,397) (131,771,599) (140,928,326)
- ------------------------------------------------------------------------------------------
Net $140,184,488 $133,468,133 $130,656,095
==========================================================================================
<CAPTION>
- ------------------------------------------------------------------------------------------
LOSSES AND SETTLEMENT EXPENSES INCURRED 1994 1995 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Direct $280,126,708 $160,294,644 $109,527,903
Reinsurance assumed (349,972) 809,657 10,256
Reinsurance ceded (178,135,070) (75,214,306) (41,276,852)
- ------------------------------------------------------------------------------------------
Net $101,641,666 $ 85,889,995 $68,261,307
==========================================================================================
</TABLE>
At December 31, 1996, 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) that
amounted to $59,492,246. 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 reconciles the Company's liability for unpaid losses and
settlement expenses (LAE) for the three years ended December 31, 1996. 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) 1994 1995 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Unpaid losses and LAE at beginning of year:
Gross $310,767 $394,966 $418,986
Ceded (145,208) (199,737) (197,338)
- ------------------------------------------------------------------------------------------
Net 165,559 195,229 221,648
- ------------------------------------------------------------------------------------------
Increase (decrease) in incurred losses and LAE:
Current accident year 100,535 62,619 69,724
Prior accident years 1,107 23,271 (1,463)
- ------------------------------------------------------------------------------------------
Total incurred 101,642 85,890 68,261
- ------------------------------------------------------------------------------------------
Loss and LAE payments for claims incurred:
Current accident year (36,501) (10,586) (11,026)
Prior accident years (36,026) (48,023) (37,505)
- ------------------------------------------------------------------------------------------
Total paid (72,527) (58,609) (48,531)
- ------------------------------------------------------------------------------------------
Insolvent reinsurer charge off 643 514 607
Loss reserves commuted (88) (1,376) (1,201)
- ------------------------------------------------------------------------------------------
Net unpaid losses and LAE at end of year $195,229 $221,648 $240,784
==========================================================================================
Unpaid losses and LAE at end of year:
Gross 394,966 418,986 405,801
Ceded (199,737) (197,338) (165,017)
- ------------------------------------------------------------------------------------------
Net $195,229 $221,648 $240,784
==========================================================================================
</TABLE>
During 1994 and 1996, 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 was significantly impacted by the effects of 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 discontinued 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
claims data (including incurred but not reported losses) for the periods ended
1994, 1995 and 1996:
36
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
Inception-to-date December 31,
(In thousands) 1994 1995 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Loss and LAE payments for claims incurred
Gross $ 3,549 $ 5,117 $ 8,267
Ceded (2,933) (3,842) (5,761)
- ----------------------------------------------------------------------------------------------------
Net $ 616 $ 1,275 $ 2,506
====================================================================================================
Unpaid losses and LAE at end of year
Gross $15,519 $20,154 $17,596
Ceded (9,875) (13,398) (11,150)
- ----------------------------------------------------------------------------------------------------
Net $ 5,644 $ 6,756 $ 6,446
====================================================================================================
</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 with 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
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are summarized in the
following table.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
1994 1995 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
DEFERRED TAX ASSETS:
Tax discounting of claim reserves $15,402,122 $15,635,860 $12,874,704
Unearned premium offset 5,419,657 5,307,695 5,326,460
Other, net 2,060,970 2,365,467 492,246
- ----------------------------------------------------------------------------------------------------
22,882,749 23,309,022 18,693,410
Less valuation allowance (300,000) (300,000) (300,000)
- ----------------------------------------------------------------------------------------------------
Total deferred tax assets $22,582,749 $23,009,022 $18,393,410
- ----------------------------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES:
Net unrealized appreciation of securities $ 5,764,109 $18,171,600 $26,932,200
Deferred policy acquisition costs 6,722,874 5,532,419 5,832,261
Book/tax depreciation 1,720,598 1,535,324 1,349,846
Other, net 1,519,824 2,673,306 1,449,790
- ----------------------------------------------------------------------------------------------------
Total deferred tax liabilities 15,727,405 27,912,649 35,564,097
- ----------------------------------------------------------------------------------------------------
Net deferred tax asset (liability) $ 6,855,344 $(4,903,627) $(17,170,687)
====================================================================================================
</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 that 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, 1994, 1995, and 1996 differed from the amounts computed by applying
the U.S. federal tax rate of 35% to pretax income from continuing operations as
demonstrated in the following table.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
1994 1995 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Provision for income taxes at
the statutory federal tax rates $(4,285,037) $2,739,113 $12,334,011
Increase (reduction) in taxes
resulting from:
Dividends received deduction (1,126,519) (1,170,146) (1,216,013)
Dividends paid deduction (258,474) (265,754) (258,252)
Tax exempt interest income (1,607,296) (1,428,846) (1,566,608)
State income tax provision 66,430 127,205 131,755
Other items, net (256,197) (125,076) 119,416
- ----------------------------------------------------------------------------------------------------
$(7,467,093) $ (123,504) $9,544,309
====================================================================================================
</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%.
Net federal and state income taxes paid (refunded) in 1994, 1995, and 1996
amounted to $7,221,986, $(794,741), and $1,415,994, respectively.
The Internal Revenue Service (IRS) has examined the Company's income tax returns
through the tax year ended December 31, 1990. In 1994, the Company received tax
refunds from certain of these tax years, the majority of which was previously
accrued. As a result, the Company recorded a tax benefit of $73,893 in 1994 and
received interest from the IRS for the same period of $56,590, which was
recorded as investment income. For 1995, the Company's net taxes refunded
include a $3.9 million refund received as a result of carrying back the 1994 net
operating loss and capital loss to prior years. The IRS is currently examining
the Company's income tax returns through the tax year ended December 31, 1994.
Management believes any tax implication from examinations of these years should
not materially impact the Company's consolidated financial position or results
of operations.
8. EMPLOYEE BENEFITS
PENSION PLAN
The Company maintains a non-contributory defined benefit pension plan covering
substantially all employees meeting age and service requirements. The plan
provides a benefit based on a participant's service and the highest five
consecutive years' average compensation out of the last 10 years. The Company
funds pension costs as accrued, except that in no case will the Company
contribute amounts less than the minimum contribu-
37
<PAGE>
tion 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. During
1994, 1995, and 1996, the Company made the maximum tax deductible contribution
allowed, totaling $312,740, $397,158, and $413,977, 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>
- ----------------------------------------------------------------------------------------------------
1994 1995 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost $405,796 $277,870 $419,349
Interest cost 234,127 239,607 270,965
Actual return on assets 190,316 (796,106) (403,266)
Net amortization and deferral (534,183) 486,482 68,323
- ----------------------------------------------------------------------------------------------------
Net pension expense $296,056 $207,853 $355,371
====================================================================================================
</TABLE>
The following table sets forth the plan's funded status at December 31, 1995 and
1996:
- --------------------------------------------------------------------------------
1995 1996
- --------------------------------------------------------------------------------
Actuarial present value of benefit obligation:
Accumulated benefit obligation:
Vested $3,055,535 $2,855,363
Nonvested 90,201 241,590
- --------------------------------------------------------------------------------
$3,145,736 $3,096,953
================================================================================
Projected benefit obligation $3,835,535 $4,039,460
Plan assets at fair market value 3,253,386 3,328,525
- --------------------------------------------------------------------------------
Plan assets under
projected benefit obligation $(582,149) $ (710,935)
Unrecognized net asset at January 1,
being amortized over 17.2 years (267,045) (234,479)
Unrecognized prior service cost 12,367 9,316
Unrecognized net loss 307,666 465,543
- --------------------------------------------------------------------------------
Accrued pension costs $(529,161) $ (470,555)
================================================================================
At December 31, 1996, plan assets at fair value are comprised of approximately
2% fixed maturities, 96% equity securities and 2% invested cash.
In 1995, the Company used a settlement rate of 7.25%, an increase in salary
levels of 6%, and an expected long-term return on plan assets of 10% in
determining the projected benefit obligation. In 1996, the Company used the
following rates to determine its projected benefit obligation: 7.5% settlement
rate, 6% increase in salary, and 10% expected long-term return on plan assets.
EMPLOYEE STOCK OWNERSHIP AND OFFICER PERFORMANCE INCENTIVE PLANS
The Company has both an Employee Stock Ownership Plan (ESOP) and an Officer
Performance Incentive Plan. In 1996, the Company adopted a new approach for
evaluating the funding of these plans. Called the Market Value Potential (MVP)
plan, the new program is designed to ensure that the interests of company
insiders correspond with those of our shareholders.
MVP requires that the Company generates a return on equity in excess of its cost
of capital, before either the funding of the ESOP or the payment of officer
bonuses. Under MVP, funds in excess of the cost of capital are first designated
to fund the Company's ESOP up to the maximum allowable contribution of 15% of
eligible wages. MVP in excess of the ESOP funding is then shared by the officers
of the Company and its shareholders. Officers can receive a maximum of 8% of the
excess on an after-tax basis, while the remainder is reinvested in the Company
for the benefit of the shareholders. MVP restricts the officer payout in a given
year to 60% of the bonus earned for the previous fiscal year. The remaining 40%
is at risk and is retained by the Company. This amount is posted to a
participant's "bank account" and is subject to achieving the MVP target return
in the succeeding fiscal year. In 1996, $2,810,050 (7.07% of the excess return)
was earned under this plan. The actual payout of $1,686,030 (60% of bonus
earned) occurred in January 1997.
The Company's ESOP is non-leveraged and covers substantially all employees
meeting eligibility requirements. ESOP contributions are determined annually by
the Company's board of directors and are expensed in the year earned. During
1994, 1995, and 1996, the Company recognized expense of $160,154, $2,046,474,
and $2,791,463, respectively, related to the ESOP. At its December 1996 meeting,
the board voted in favor of making a contribution to the ESOP for 1996 based on
the MVP projections for the year. In 1995, the board had authorized this
contribution as well. In 1994, the board did not authorize a contribution based
on that year's projected net loss.
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 shares were purchased. During 1996, the ESOP purchased 76,500 shares of
the Company's treasury stock at an average price of $25.38 ($1,941,288). 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.
38
<PAGE>
DIRECTORS DEFERRED COMPENSATION AND EXCESS ESOP
The Company has a deferred compensation plan for directors 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
1994, 1995, and 1996, the Company recognized expenses of $81,850, $145,550, and
$139,075, respectively, under these plans. In 1996, the Rabbi Trusts purchased
10,560 shares of the company's treasury stock, at an average price of $25.22
($266,339) and 4,300 shares of the Company's common stock on the open market at
an average price of $32.13 ($138,138). At December 31, 1996, the Trusts' assets
were valued at $4,062,723.
STOCK OPTION PLAN
During 1995, the Company adopted and the shareholders approved an Incentive
Stock Option Plan (the Plan). The Company accounts for the plan in accordance
with APB Opinion No. 25, under which no compensation cost has been recognized.
Had compensation cost for the plan been determined consistent with FASB
Statement No. 123, "Accounting for Stock-Based Compensation," the Company's net
income and earnings per share would have been reduced to the following pro forma
amounts:
- --------------------------------------------------------------------------------
1995 1996
- --------------------------------------------------------------------------------
Net income: As reported $7,949,541 $25,695,721
Pro forma 7,862,144 25,511,517
- --------------------------------------------------------------------------------
Primary EPS: As reported $1.01 $3.25
Pro forma 1.00 3.21
- --------------------------------------------------------------------------------
Fully Diluted EPS: As reported $1.01 $2.85
Pro forma 1.00 2.82
================================================================================
These pro forma amounts may not be representative of the effects of FASB
Statement No. 123 on pro forma net income for future years because options vest
over several years and additional awards may be granted in the future.
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. An option may be granted only during
the 10-year period ending in May 2005. An optionee must exercise an option
within 10 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, whichever occurs first.
The Company may grant options for up to 1,250,000 shares under the Plan. Through
December 31, 1996, the Company has granted 125,275 options. Under the Plan, the
option exercise price equals the stock's market price on the date of grant and
full vesting occurs at the end of five years.
A summary of the status of the Plan at December 31, 1995 and 1996, and changes
during the years then ended are presented in the table and narrative below:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
1995 1996
- --------------------------------------------------------------------------------------------------------------
Number Weighted-Average Number Weighted-Average
of Shares Exercise Price of Shares Exercise Price
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Outstanding at
beginning of year 65,625 $20.60
Granted 65,625 $20.60 59,650 23.45
Exercised
Forfeited 3,975 20.60
Expired
- --------------------------------------------------------------------------------------------------------------
Outstanding at
end of year 65,625 20.60 121,300 22.00
- --------------------------------------------------------------------------------------------------------------
Exercisable at
end of year 12,550 20.60
Weighted-average fair
value of options
granted during year $ 7.00 $ 7.86
==============================================================================================================
</TABLE>
Of the 121,300 options outstanding at December 31, 1996, 61,650 have an exercise
price of $20.60 and a weighted-average remaining contractual life of 8.5 years.
Of these options, 12,550 are exercisable. Of the remaining outstanding options,
56,650 options have exercise prices between $22.88 and $24.00 with a
weighted-average exercise price of $22.97 and a remaining contractual life of
9.3 years, and 3,000 options have an exercise price of $32.50 and a remaining
contractual life of 9.9 years. None of these options was exercisable at December
31, 1996.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1995 and 1996, respectively: risk-free interest
rates of 6.67% and 6.80%; expected dividend yields of 3.14% and 3.15%; expected
lives of 10 years; and expected volatility of 28.46% and 27.34%.
39
<PAGE>
POST-RETIREMENT BENEFITS OTHER THAN PENSION
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 that 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) 1994 1995 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Consolidated net income (loss),
statutory basis $(4,057,703) $12,638,658 $29,486,443
Proposition 103 liability (71,280) 2,499,680
Deferred policy acquisition costs 485,817 (3,401,296) 856,692
Deferred income tax benefit (expense) 2,881,527 854,229 (3,506,460)
Net income of non-insurance operations,
interest expense on debt and
general corporate expense (3,114,127) (2,038,397) (3,605,318)
Other (900,105) (103,653) (35,316)
- ----------------------------------------------------------------------------------------------------
As reported in accompanying
financial statements $(4,775,871) $ 7,949,541 $25,695,721
====================================================================================================
<CAPTION>
- ----------------------------------------------------------------------------------------------------
December 31,
Shareholders' Equity 1995 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
Consolidated surplus, statutory basis $172,312,961 $207,786,596
Deferred policy acquisition costs 15,806,911 16,663,603
Non-admitted assets 2,237,739 1,862,610
Proposition 103 liability (2,499,680)
Deferred tax liability (4,903,627) (17,170,687)
Statutory liability for reinsurance 2,045,800 3,813,800
Proceeds from RLI Corp. debt
contributed to RLI Insurance Co. (30,500,000) (30,500,000)
Equity of non-insurance companies 2,854,479 17,038,853
Other 1,253,133 544,586
- ----------------------------------------------------------------------------------------------------
As reported in accompanying financial statements $158,607,716 $200,039,361
====================================================================================================
</TABLE>
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 1997 without prior notice or approval amounts to
$26,864,913--RLI Insurance Company's 1996 statutory net income. The actual
amount paid to the Company during 1996 was $17,000,637.
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.
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. Beginning in 1989 and ending in 1994, the
Company deferred premium revenue of $1,449,200 and accrued interest in the
amount of $1,050,480 to cover the proposed rollback. No additional provision was
made during 1995 and the total funds accrued for rollback remained $2,499,680 at
December 31, 1995.
During 1996, the Company reached a settlement with the California Department of
Insurance resolving its total liability for refunds and interest under
Proposition 103. The settlement requires the Company to pay $2,987,050 in
refunds and interest. In the second quarter of 1996, the Company recorded a
pretax charge of $487,370 to record the difference between the actual settlement
and the amount previously accrued. The Company is currently in the process of
issuing refund checks to policyholders.
The Company leases regional office facilities and automobiles under operating
leases expiring in various years through 2001. Minimum future rental payments
under noncancellable operating leases are as follows:
1997 $ 592,020
1998 468,913
1999 381,719
2000 278,097
2001 158,952
-----------
Total minimum future rental payments $1,879,701
===========
40
<PAGE>
11. INDUSTRY SEGMENT INFORMATION
Selected information by industry segment for 1994, 1995, and 1996 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.
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)
Segment Data Revenue before income taxes Assets
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1994 (restated)--
RLI Insurance Group $140,184,488 $(23,705,660) $730,755,447
Net investment income 20,132,585 20,132,585
Net realized investment losses (3,595,101) (3,595,101)
Equity in earnings of unconsolidated investee 1,201,965
General corporate and interest expense (6,276,753) 20,330,441
- ---------------------------------------------------------------------------------------------------------
Consolidated $156,721,972 $(12,242,964) $751,085,888
=========================================================================================================
1995 (restated)--
RLI Insurance Group $133,468,133 $(9,933,960) $787,812,455
Net investment income 22,029,081 22,029,081
Net realized investment gains 456,510 456,510
Equity in earnings of unconsolidated investee 714,818
General corporate and interest expense (5,440,412) 22,387,503
- ---------------------------------------------------------------------------------------------------------
Consolidated $155,953,724 $ 7,826,037 $810,199,958
=========================================================================================================
1996--
RLI Insurance Group $130,656,095 $16,397,066 $809,315,884
Net investment income 23,680,751 23,680,751
Net realized investment gains 1,017,572 1,017,572
Equity in earnings of unconsolidated investee 230,741
General corporate and interest expense (6,086,100) 36,157,900
- ---------------------------------------------------------------------------------------------------------
Consolidated $155,354,418 $35,240,030 $845,473,784
=========================================================================================================
</TABLE>
41
<PAGE>
12. UNAUDITED INTERIM FINANCIAL INFORMATION
Selected quarterly information is as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
1995 (restated) First Second Third Fourth Year
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net premiums earned $35,562,960 $33,226,482 $32,170,742 $32,507,949 $133,468,133
Net investment income 5,400,021 5,280,007 5,628,253 5,720,800 22,029,081
Net realized investment gains (losses) (29,391) 136,542 11,297 338,062 456,510
Earnings (loss) before income taxes 7,080,846 7,493,101 (15,941,982) 9,194,072 7,826,037
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
========================================================================================================================
1996
- ------------------------------------------------------------------------------------------------------------------------
Net premiums earned $32,166,978 $32,390,263 $32,294,530 $33,804,324 $130,656,095
Net investment income 5,727,445 6,091,854 5,819,777 6,041,675 23,680,751
Net realized investment gains (losses) 141,310 (36,190) 37,671 874,781 1,017,572
Earnings before income taxes 7,336,099 8,862,237 9,406,763 9,634,931 35,240,030
Net earnings 5,515,896 6,380,662 6,798,678 7,000,485 25,695,721
Primary earnings per share* $0.70 $0.80 $0.86 $0.89 $3.25
Fully diluted earnings per share* $0.62 $0.71 $0.75 $0.78 $2.85
========================================================================================================================
</TABLE>
*Since the weighted-average shares for the quarters are calculated independently
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.
42
<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, 1996 and 1995, 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, 1996. 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, 1996 and 1995, and the results of their operations
and their cash flows for each of the years in the three-year period ended
December 31, 1996, in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
January 21, 1997
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 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, 1996, 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.
43
<PAGE>
INVESTOR INFORMATION
ANNUAL MEETING
The annual meeting of shareholders will be held at 2:00 p.m., local time, on
May 1, 1997, at the company's offices at 9025 North Lindbergh Drive, Peoria, IL.
REQUESTS FOR ADDITIONAL INFORMATION
Additional copies of this report and the Annual Report to the Securities and
Exchange Commisssion, 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.
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.
Stock Price Dividends
High Low Close Declared
- --------------------------------------------------------------------------------
1995
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
- --------------------------------------------------------------------------------
1996
1st Quarter 25 7/8 24 1/4 24 3/4 $.13
2nd Quarter 24 3/8 22 3/8 24 3/8 .14
3rd Quarter 26 1/8 23 3/8 26 .14
4th Quarter 33 1/2 26 33 3/8 .14
- --------------------------------------------------------------------------------
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 20 consecutive years. Since 1989, RLI dividends qualify for the enterprise
zone dividend subtraction modification for Illinois state income tax returns.
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 following transfer agent and
registrar address.
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 following
transfer agent and registrar address.
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]
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
STOCK OWNERSHIP
At December 31, 1996, stock ownership was as follows:
SHARES %
- ------------------------------------------------
Insiders 725,685 9.28
ESOP 1,258,335 16.09
Institutions 3,443,924 44.03
Other Public 2,393,786 30.60
- ------------------------------------------------
7,821,730 100.00%
CONTACTING RLI
CORPORATE HEADQUARTERS
9025 North Lindbergh Drive
Peoria, IL 61615-1431
(309) 692-1000
(800) 331-4929
Fax: (309) 692-1068
Internet: HTTP://WWW.RLICORP.COM
FINANCIAL INFORMATION
For management's perspective on specific issues, call RLI Treasurer Mike Price
direct at (309) 693-5880.
49
<PAGE>
Exhibit 21.1
Subsidiaries of the Registrant
The following companies are subsidiaries of the Registrant as of December 31,
1996.
Jurisdiction of Percentage
Name Incorporation Ownership
- ---- --------------- ----------
RLI Insurance Company Illinois 100%
RLI Aviation, Inc. Illinois 100%
Replacement Lens Inc. Illinois 100%
Maui Jim, Inc. Illinois 34%
Mt. Hawley Insurance Company Kansas 99.5%
License Express Services, Inc. Illinois 100%
RLI Insurance Ltd. Bermuda 100%
RLI Insurance Agency Ltd. Canada 100%
37
<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 on
Form S-8 (No. 333-1637) and Form S-3 (No. 33-61788) of RLI Corp. of our reports
dated January 21, 1997, relating to the consolidated balance sheets of RLI Corp.
and subsidiaries as of December 31, 1996 and 1995, 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, 1996, and all related
schedules, which reports are incorporated by reference in, or appear in (with
respect to the schedules), the 1996 annual report on Form 10-K of RLI Corp.
KPMG Peat Marwick LLP
Chicago, Illinois
March 21, 1997
38
<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, 1996, 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> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 0
<SECURITIES> 537,946
<RECEIVABLES> 37,167
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 833,347
<PP&E> 31,508
<DEPRECIATION> (19,381)
<TOTAL-ASSETS> 845,474
<CURRENT-LIABILITIES> 582,263
<BONDS> 46,000
0
0
<COMMON> 8,453
<OTHER-SE> 191,586
<TOTAL-LIABILITY-AND-EQUITY> 845,474
<SALES> 0
<TOTAL-REVENUES> 155,354
<CGS> 0
<TOTAL-COSTS> 117,306
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,808
<INCOME-PRETAX> 35,240
<INCOME-TAX> 9,544
<INCOME-CONTINUING> 25,696
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 25,696
<EPS-PRIMARY> 3.25
<EPS-DILUTED> 2.85
</TABLE>
<PAGE>
Exhibit 28.1
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:
At December 31, 1996
(In thousands)
--------------
Net liability reported on a statutory basis $241,079
Adjustments:
Interest imputed on commutation settlements (295)
--------
Net liability reported on a GAAP basis $240,784
--------
--------
Reconciliation of the GAAP net liability:
Gross unpaid losses and settlement expenses $405,801
Reinsurance balances recoverable on unpaid losses
and settlement expenses (165,017)
--------
Net liability reported on a GAAP basis $240,784
--------
--------
39
