<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, 1997
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission File Number 0-6612
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RLI CORP.
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(Exact name of registrant as specified in its charter)
Illinois 37-0889946
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(State or other jurisdiction of (I.R.S. Employers Identification No.)
incorporation or organization)
9025 North Lindbergh Drive, Peoria, Illinois 61615
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (309) 692-1000
-----------------------------
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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Common Stock $1.00 par value 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
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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
27, 1998 as reported on the New York Stock Exchange, was $354,629,102. 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 27, 1998 was 8,546,958.
DOCUMENTS INCORPORATED BY REFERENCES.
Portions of the Annual Report to Shareholders for the past year ended December
31, 1997, are incorporated by reference into Parts I and II of this document.
Portions of the Registrant's definitive Proxy Statement for the 1998 annual
meeting of security holders to be held May 7, 1998, are incorporated herein by
reference into Part III of this document.
Exhibit index is located on pages 33-34 of this document.
<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.
(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.,
RLI Insurance Agency, Ltd., and RLI Insurance Ltd.
Since 1977, when the Company first began underwriting specialty
property and casualty coverages for commercial risks, highly cyclical market
conditions and a number of other factors have influenced the Company's growth
and underwriting profits. The Company, as a "niche" company rather than an
"all lines" company, seeks to develop expertise and large homogeneous books
of business in areas generally overlooked by traditional markets.
In response to the soft market conditions of the early 1980's, which
were characterized by severe rate competition and excess underwriting
capacity, the Company limited its writings in specialty property and casualty
lines and terminated certain lines and sources of production.
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. Since 1996, as expected,
competition has reappeared for this type of business and the Company has
reduced rates somewhat. The Company's casualty book has continued to incur
flat to moderate rate decreases.
2
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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 four underwriting general agents in 1997. The majority
of its specialty property and casualty business is marketed through its
Specialty Markets and Surety divisions and eleven branch offices located in
Los Angeles, California; San Diego, California; San Francisco, California;
St. Paul, Minnesota; Overland Park, Kansas; Glastonbury, Connecticut;
Atlanta, Georgia; Alpharetta, Georgia; Chicago, Illinois; Dallas, Texas; and
Honolulu, Hawaii.
The following table provides for the year ended December 31, 1997 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, 1997, no
other state accounted for more than 2% of total direct premiums earned for all
product lines.
<TABLE>
<CAPTION>
Direct Premiums
State Earned Percent of Total
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<S> <C> <C>
California $105,546,214 39.3%
Texas 31,148,921 11.6
Florida 21,068,919 7.8
New York 18,735,576 7.0
Ohio 6,746,665 2.5
Pennsylvania 6,058,952 2.3
New Jersey 5,965,523 2.2
Illinois 5,859,848 2.2
Michigan 5,858,720 2.2
All other 61,579,933 22.9
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Total direct premiums $268,569,271 100.00%
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</TABLE>
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 Alpharetta branch offices are
responsible for underwriting this coverage. In 1997, 1996, and 1995, net
earned premiums totaled $48,799,000, $47,822,000, and $49,430,000 or 29%,
31%, and 32% respectively, of the Company's consolidated revenues.
GENERAL LIABILITY. The Company writes general liability coverages
through its St. Paul, Glastonbury, Chicago, Alpharetta and Dallas branch
offices. 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 $26,332,000, $34,834,000, and $36,499,000, or 16%, 22%, and 23% of
the Company's consolidated revenues for the years 1997, 1996, and 1995,
respectively.
3
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COMMERCIAL AND PERSONAL UMBRELLA LIABILITY. The Company's
commercial umbrella coverage is produced through its Overland Park, St. Paul,
Alpharetta, Glastonbury, and Dallas branch offices, and through an
underwriting general agency in San Francisco. 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 Markets Division, is written in excess of the homeowners and
automobile liability coverage provided by other carriers. Net earned
premiums totaled $22,566,000, $21,282,000, and $18,092,000 or 12%, 14%, and
12% of the Company's consolidated revenues for the years 1997, 1996, and
1995, respectively.
DIRECTORS' AND OFFICERS' LIABILITY/MISCELLANEOUS PROFESSIONAL
LIABILITY. The Company produces Directors' and Officers' Liability through
its 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 $4,430,000,
$5,000,000, and $6,025,000, or 3%, 3%, and 4% of the Company's consolidated
revenues for the years 1997, 1996, and 1995, respectively.
EMPLOYER'S EXCESS INDEMNITY. Since 1993, the Company has written
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. A return to
excessive competition for Texas workers' compensation business has reduced
the market for this product since 1996. Net earned premiums totaled
$5,130,000, $6,566,000, and $8,257,000, or 3%, 4%, and 5% of the Company's
consolidated revenues for 1997, 1996, and 1995, respectively.
SURETY. In 1993, the Company began writing surety business. This
product line is underwritten from the Home Office in Peoria and through the
Dallas, Texas branch office. 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 $$11,491,000, $4,407,000, and $2,956,000, or 8%, 3%,
and 2% of the Company's consolidated revenues for 1997, 1996, and 1995,
respectively.
HOMEOWNERS/RESIDENTIAL PROPERTY. In 1997, the Company assumed a
highly profitable book of homeowners and dwelling fire business for Hawaii
homeowners from the Hawaii Property Insurance Association. In the aftermath
of Hurricane Iniki in 1992, this business was available at reasonable rates
and terms. Net earned premiums totalled $13,229,000 or 8% of the Company's
consolidated revenues for the 1997 year.
TRANSPORTATION. In 1997, the Company opened a transportation
insurance facility in Atlanta to offer automobile liability and physical
damage insurance to local, intermediate and long haul truckers, public
transportation risks and equipment dealers. Incidental, related insurance
coverages are also offered, including general liability, commercial umbrella
and excess liability, and motor truck cargo. The facility is staffed by
highly experienced transportation underwriters who will produce business
through independent agents and brokers nationwide. The facility will begin
generating premium income in 1998.
OTHER. Smaller programs offered by the Company include: primary
employer's indemnity, excess medical, commercial multi-peril, in-home
business, and accident and health insurance. Net earned premiums from these
lines totaled $9,907,000, $10,744,000, and $12,209,000 or 5%, 7%, and 8% of
the Company's consolidated revenues for the years, 1997, 1996, and 1995,
respectively.
In June of 1995, a new facility was opened in Columbus, Ohio
specializing 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. This facility was closed October, 1997, and the coverage is
currently underwritten with the Atlanta branch office.
4
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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. In 1996, and continuing
through 1997, some rate softening occurred in these property lines as
competition reappeared. As a result, the Company reduced rates somewhat.
The Company has, however, continued to maintain its underwriting and
marketing standards by not seeking market share at the expense of earnings.
New products and new programs are offered where the opportunity exists to
provide needed insurance coverage with exceptional service on a profitable
basis.
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 1997, 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) with some companies not being 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 major debt rating agencies. Both Standard &
Poor's Ratings Group and Moody's Investor Service assigned investment grade
ratings to the issue. In July, 1997, the Company called for redemption the
entire $46 million issue. As of December 31, 1997, the Company had no public
debt outstanding.
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 $138,298,000, $140,928,000, and $131,772,000 in 1997,
1996, and 1995, respectively. Insurance is ceded principally to reduce net
liability on individual risks and to protect against catastrophic losses.
Although reinsurance does not legally discharge an insurer from its primary
liability for the full amount of the policies, it does make the assuming
reinsurer liable to the insurer to the extent of the insurance ceded.
5
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During the period 1995 through 1997, 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 1995 through 1997 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 1995 and 1996, the Company provided $613,296 and
$1,006,140 for uncollectible reinsurance balances. During 1997, no
additional provision was made. The Company believes that current reserve
levels for uncollectible reinsurance are sufficient to cover the related
exposure.
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, 1997, 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 $67,733,602. 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, 1997 and the amounts of
written premium ceded by the Company to such reinsurers during 1997.
<TABLE>
<CAPTION>
Gross Reinsurer Ceded
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Exposure as of Percent Premiums Percent
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December 31, 1997 of Total Written of Total
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<S> <C> <C> <C> <C>
American Re-Insurance Co. $ 67,733,602 29.92% $ 21,862,933 16.30%
General Reins Corp. 16,717,318 7.39 8,055,842 6.00
Transatlantic Reinsurance 12,610,119 5.57 11,973,090 8.92
Employer's Re 8,039,583 3.55 7,330,366 5.46
NAC Reinsurance Corporation 5,825,704 2.57 4,853,765 3.62
Lloyd's of London 5,737,797 2.53 14,257,401 10.63
Everest Re 5,648,534 2.50 4,603,867 3.43
Old Lyme Ins. Co. of RI 5,546,935 2.45 5,457,835 4.07
TIG Insurance Co. 4,989,331 2.20 834,632 0.62
Universal Bonding Ins. 4,830,367 2.13 8,160,494 6.08
All other reinsurers 88,667,959 39.19 46,779,323 34.87
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Total ceded exposure $226,347,249 100.00% $134,169,548 100.00%
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</TABLE>
As of December 31, 1997, the Company held $11,626,930 in irrevocable
letters of credit, $7,282,657 under trust agreements and $1,412,968 in cash to
collateralize a portion of the total amount recoverable.
Since 1992, the Company has purchased non-proportional contracts.
This allows the Company to retain a larger percentage of the premium and a
larger portion of the initial loss risk. Under non-proportional reinsurance,
the ceding company retains losses on a risk up to a specified amount and the
reinsurers assume any losses above that amount. Since 1989, through its
various reinsurance programs, the Company has generally limited its maximum
retained exposure on any one risk to $1,000,000. The Company 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.
6
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In 1997, the Company's underwriting was supported by up to
$200,000,000 in traditional reinsurance protection. In 1998, the Company has
enhanced this protection by adding an additional $20,000,000 in catastrophe
reinsurance protection at improved terms and conditions. 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 1997, the Company continued its 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 1996, the
industry experienced 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. As well, ongoing rate cuts are of concern to financial
analysts. For 1997, the industry's statutory combined ratio is estimated to
be 102.0. The Company believes that certain other factors affect its ability
to underwrite specialty lines successfully, including:
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.
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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 Markets 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. The Surety Division has authorized two
underwriting general agencies to underwrite and bind contract surety business
on behalf of RLI, primarily in the East and Southeast. One underwriting
general agency in San Francisco has been authorized to underwrite commercial
umbrella business in select Western states. Another underwriting agent in
New York has been authorized to underwrite and handle claims for low limit
deductible buy-backs on program business, primarily in the East.
These underwriting general agencies receive some compensation
through contingent profit commission. Otherwise, producers of business who
are not Company employees are generally 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.
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 1997, 1996, and 1995 were 7%, 6%, and 5%, 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.
8
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The following table represents inception-to-date paid and unpaid
environmental exposure data (including incurred but not reported losses) for
the periods ended 1997, 1996, and 1995:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Inception-to-date December 31
(in thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Loss and Loss Adjustment
Expense (LAE) payments
Gross $ 11,570 $ 8,267 $ 5,117
Ceded (7,646) (5,761) ($ 3,842)
- ---------------------------------------------------------------------------------
Net $ 3,924 $ 2,506 $ 1,275
- ---------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------
Unpaid losses and LAE at end of year
Gross $ 14,880 $17,596 $20,154
Ceded (8,842) (11,150) ($13,398)
- ---------------------------------------------------------------------------------
Net $ 6,038 $ 6,446 $ 6,756
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- ---------------------------------------------------------------------------------
</TABLE>
Although the Company's environmental exposure is limited as a
result of entering the liability lines after the industry had already
recognized it as a problem, Management cannot determine the Company's
ultimate liability within any reasonable degree of certainty. This ultimate
liability is difficult to assess due to evolving legislation on such issues
as joint and several liability, retroactive liability, and standards of
cleanup. Additionally, the Company participates primarily in the excess
layers, making it even more difficult to assess the ultimate impact.
LOSSES AND SETTLEMENT EXPENSES
Many years may elapse between the occurrence of an insured loss,
the reporting of the loss to the insurer and the insurer's payment of that
loss. To recognize liabilities for unpaid losses, insurers establish
reserves, which are balance sheet liabilities. The reserves represent
estimates of future amounts needed to pay claims and related expenses with
respect to insured events which have occurred.
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.
9
<PAGE>
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, 1997 are adequate to meet its future obligations.
The table which follows is a reconciliation of the Company's unpaid
losses and settlement expenses for the years 1997, 1996, and 1995.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
(Dollars in thousands) 1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Unpaid losses and settlement
expenses at beginning of year:
Gross $405,801 $418,986 $394,966
Ceded (165,017) (197,338) (199,737)
------- ------- -------
Net 240,784 221,648 195,229
------- ------- -------
Increase (decrease) in incurred
losses and settlement expenses:
Current accident year 61,771 69,724 62,619
Prior accident years (520) (1,463) 23,271
------- ------- -------
Total incurred 61,251 68,261 85,890
------- ------- -------
------- ------- -------
Loss and settlement expense payments
for claims incurred:
Current accident year (11,284) (11,026) (10,586)
Prior accident years (47,999) (37,505) (48,023)
------- ------- -------
Total paid (59,283) (48,531) (58,609)
------- ------- -------
------- ------- -------
Insolvent reinsurer charged
off (recovered) (627) 607 514
Loss reserves commuted 429 (1,201) (1,376)
------- ------- -------
Unpaid losses and settlement
expenses at end of year $242,554 $240,784 $221,648
------- ------- -------
------- ------- -------
Unpaid losses and settlement
expenses at end of year:
Gross 404,264 $405,801 $418,986
Ceded (161,710) (165,017) (197,338)
------- ------- -------
Net $242,554 $240,784 $221,648
------- ------- -------
------- ------- -------
</TABLE>
10
<PAGE>
Explanation of significant components of reserve development by
calendar year are as follows:
<TABLE>
<S> <C>
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.
1997 During 1997, the Company experienced approximately $520,000 of
favorable development on loss reserves. The development results
from loss reserve adjustments in various lines of business.
Reserve strengthening was necessary on the Property line of
business due to development on the Lender's Single Interest
program. As a result, an increase of $1,465,000 was made to IBNR
reserves. This increase, however, was offset by $1,985,000 of
favorable development on the Company's other casualty, in-home
business, and surety bonding programs.
The table on the following page presents the development under
generally accepted accounting principles of the Company's balance
sheet reserves for 1988 through 1997. 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.
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------------------------------------------
(Dollars in thousands) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
------- ------- -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net Liability for unpaid
losses and settlement
expenses at end of year $89,197 $95,953 $103,302 $110,844 $130,452 $165,559 $195,229 $221,648 $240,784 $242,554
Paid (cumulative) as of:
One year later 17,312 14,302 19,297 23,561 24,725 36,026 48,023 37,505 47,999
Two years later 26,093 26,685 35,963 37,763 46,342 63,675 73,972 75,485
Three years later 37,137 40,341 44,088 49,462 64,364 84,614 100,936
Four years later 47,617 44,714 52,322 57,085 78,994 96,741
Five years later 48,937 51,153 56,413 65,318 85,746
Six years later 53,670 54,546 62,989 70,270
Seven years later 56,254 59,444 66,254
Eight years later 60,499 62,266
Nine years later 62,689
Liability re-estimated as of:
One year later 86,230 91,646 101,251 108,249 128,600 166,666 218,499 220,185 240,264
Two years later 85,120 89,112 98,505 105,747 132,850 164,218 214,352 218,142
Three years later 84,426 87,981 95,690 107,777 132,377 157,286 211,451
Four years later 84,931 87,403 97,041 106,326 127,426 152,460
Five years later 84,217 90,030 96,490 100,968 122,789
Six years later 87,585 88,982 93,159 97,101
Seven years later 86,593 85,381 89,692
Eight years later 83,306 83,344
Nine years later 81,964
Net cumulative redundancy
(deficiency) $7,233 $12,609 $13,610 $13,743 $7,663 $13,099 $(16,222) $3,506 $520
Gross liability $268,043 $310,767 $394,966 $418,986 $405,801 $404,264
Reinsurance recoverable (137,591) (145,208) (199,737) (197,338) (165,017) (161,710)
-------- -------- -------- -------- -------- --------
Net liability $130,452 $165,559 $195,229 $221,648 $240,784 $242,554
Gross re-estimated liability $249,557 $284,294 $414,669 $403,825 $409,839
Re-estimated recoverable (126,768) (131,834) (203,218) (185,683) (169,575)
-------- -------- -------- -------- --------
Net re-estimated liability $122,789 $152,460 $211,451 $218,142 $240,264
Gross cumulative redundancy
(deficiency) $ 18,486 $ 26,473 $(19,703) $15,161 $(4,038)
</TABLE>
12
<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) 1997 1996 1995 1994 1993
--------- --------- --------- -------- ---------
<S> <C> <C> <C> <C> <C>
Statutory net premiums written $144,674 $130,908 $130,453 $131,164 $136,728
Policyholders' surplus $265,526 $207,787 $172,313 $136,125 $152,262
Ratio .5 to 1 .6 to 1 .8 to 1 1.0 to 1 .9 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 1997 1996 1995 1994 1993
---- ----- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Loss ratio 43.2 52.2 64.4 72.5 63.3
Expense ratio 43.6 35.2 43.1 44.4 33.9
---- ---- ----- ----- ----
Combined ratio 86.8 87.4 107.5 116.9 97.2
---- ---- ----- ----- ----
---- ---- ----- ----- ----
</TABLE>
(1) Excluding the effects of the Northridge Earthquake, the GAAP combined
ratio for the years ended 1995 and 1994 would have been 86.2 and 91.1,
respectively.
The Company also calculates the statutory combined ratio, which is not
indicative of GAAP underwriting profits due to accounting for multiple-year
retrospectively-rated reinsurance contracts and policy acquisition costs
differently for statutory accounting purposes compared to GAAP. The statutory
combined ratio is the sum of (a) the ratio of statutory loss and settlement
expenses incurred to statutory net premiums earned (loss ratio) and (b) the
ratio of statutory policy acquisition costs and other underwriting expenses to
statutory net premiums written.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------
Statutory 1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Loss ratio 43.0 52.3 63.6 73.4 65.8
Expense ratio 47.4 36.8 42.9 43.5 22.1 (4)
---- ---- ----- ----- -----
Combined ratio 90.4 89.1 106.5 (3) 116.9 (3) 87.9 (4)
---- ---- ----- ----- -----
---- ---- ----- ----- -----
Industry combined ratio 102.0 (1) 105.8 (2) 106.4 (2) 108.4 (2) 106.9 (2)
---- ---- ----- ----- -----
---- ---- ----- ----- -----
</TABLE>
13
<PAGE>
(1) Source: Insurance Information Institute. Estimated for the year
ended December 31, 1997.
(2) Source: A.M. Best Aggregate & Averages -- Property-Casualty (1997
Edition).
(3) Excluding the effects of the Northridge Earthquake, the statutory
combined ratio for the years ended 1995 and 1994 would have been 85.3
and 89.7, respectively.
(4) 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.
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 1997, 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 $25.1
million, to $139.8 million; and comprises 41.9% of the Company's total fixed
maturity portfolio, up 4.7% from year end 1996. The taxable U.S. Government,
Agency and Municipal portion of the fixed income portfolio declined by $3.3
million to $182.5 million, or 54.7% of the total versus 60.3% at year end
1996. Investment grade corporate securities totaled $4.9 million compared to
$3.7 million at year end 1996, while convertible debenture securities totaled
$6.5 million, or 1.9% of the fixed income portfolio.
Equity securities increased $62.6 million from $188.9 million at
the end of last year to $251.5 million at the end of 1997. During 1997, net
common equity investments totaling $6.9 million were purchased and pretax
unrealized appreciation of equity securities totaled $55.7 million. Equity
securities as a percentage of cash and invested assets increased to 41.6% at
the end of 1997 from 35.1% at year end 1996. Combined cash and short-term
investments totaling $18.7 million at year end 1997 represented 3.1% of cash
and invested assets versus 7.6% in 1996. 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.
14
<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>
1998 25,865,000 25,981,122 26,130,321 25,981,088
1999 34,985,000 35,197,887 36,030,860 35,364,470
2000 30,420,000 30,893,131 31,756,488 31,051,729
2001 20,370,000 20,946,461 21,440,505 20,970,047
2002 24,080,000 24,929,360 25,382,405 24,957,602
2003 41,270,000 41,465,570 41,584,515 41,426,089
2004 20,445,000 20,600,945 21,069,790 20,607,290
2005 30,290,000 30,489,946 31,462,432 30,453,708
2006 21,965,000 22,074,075 22,917,607 22,197,060
2007 15,800,000 15,968,813 16,272,714 15,933,831
2008 13,090,000 12,979,536 13,661,432 13,068,111
2009 23,125,000 23,158,055 23,907,396 23,158,055
2010 16,535,000 16,935,113 17,161,419 16,935,113
2011 4,000,000 3,972,741 4,033,570 4,009,119
2012 5,095,000 5,116,372 5,201,898 5,116,372
2013 2,000,000 1,734,360 1,762,629 1,772,899
2014 0 0 0 0
2015 500,000 520,376 566,250 566,250
2016 0 0 0 0
2017 250,000 131,416 131,250 131,250
------------ ------------ ------------ ------------
$330,085,000 $333,095,279 $340,473,481 $333,700,083
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</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, 1997, the Company's equity securities valued at
$251.5 million, accounted for 41.6% of total cash and invested assets and
94.7% of the combined statutory surplus of its insurance subsidiaries. At
December 31, 1997, net pretax unrealized capital appreciation of equity
securities was $132.8 million.
15
<PAGE>
The Company's investment results are summarized in the following table:
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------------------
(Dollars in thousands) 1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Average invested
assets (1) $570,971 $504,773 $442,717 $407,722 $341,361
Investment
income (2)(3) 24,558 23,681 22,029 20,133 16,857
Realized gains
(losses) (3) 2,982 1,018 457 (3,595) 254
Change in unreal-
ized appreciation/
depreciation (3)(4) 55,760 25,033 36,037 (5,749) 7,945
Annualized return
on average
invested assets 14.6% 9.9% 13.2% 2.7% 7.3%
</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 , 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, 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.
16
<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. During 1997, the Company issued refund
checks to policyholders. As of December 31, 1997, the total unclaimed refund
amount was $1,526,283. Any amounts unclaimed as of November 1, 1998 will
escheat to the California Division of Unclaimed Property.
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. A new congressional bill, "The Homeowners
Insurance Availability Act of 1997" addresses issues of catastrophe insurance
for homeowners through federal assistance to state guarantee funds. The
Company is monitoring the bill's progress and has neither opposed nor
supported the bill at this time.
SUPERFUND REFORM (ENVIRONMENTAL LIABILITY)--The Comprehensive
Environmental Response, Compensation and Liability Act ("CERCLA"), more
commonly known as Superfund, remains in effect, but no reform legislation was
passed in 1997. Insurance companies, other businesses, environmental groups
and municipalities are advocating a variety of reform proposals to revise the
cleanup and liability provisions of CERCLA. Any reform proposal could result
in additional taxation to fund cleanup efforts.
17
<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 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.
CORPORATE COMPLIANCE
The Company has developed a Code of Conduct and Compliance Manual which
provides employees with guidance on complying with a variety of federal and
state laws.
AGENCY LICENSES AND TRADEMARKS
Replacement Lens Inc. or its designated employees, must be licensed to
act as resident or non-resident brokers or agents by regulatory authorities
in the states in which it operates.
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 392 associates. Of the 392 total
associates, 35 are part-time and 357 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.
18
<PAGE>
Item 2. PROPERTIES
The Company owns a two-story, 80,000 square foot building in Peoria,
Illinois, which serves as the Corporate Headquarters for RLI Corp., RLI
Insurance Company and Mt. Hawley Insurance Company. Two RLI Insurance
Company Branch Offices also lease office space in this building.
Located on the same 15.0 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 used as office
space.
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 53 of the Annual Report to Shareholders
for the year ended December 31, 1997 attached in Exhibit 13.
Item 6. SELECTED FINANCIAL DATA
Refer to the Selected Financial Data on pages 20 through 21 of the Annual
Report to Shareholders for the year ended December 31, 1997 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 22 through 29 of the Annual Report to
Shareholders for the year ended December 31, 1997 attached in Exhibit 13.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Refer to the consolidated financial statements and supplementary data
included on pages 30 through 49 of the Annual Report to Shareholders for the
year ended December 31, 1997 attached in Exhibit 13. (See Index to Financial
Statements and Schedules attached on page 23.)
19
<PAGE>
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no changes in accountants or disagreements with accountants on
any matters of accounting principles or practices or financial statement
disclosure.
PART III
Items 10 to 13.
Pursuant to General Instructions G(3) of Form 10-K, Items 10 to 13,
inclusive, have not been restated or answered since the Company intends to file
within 120 days after the close of its fiscal year with the Securities and
Exchange Commission a definitive proxy statement pursuant to Regulation 14A
under the Securities Exchange Act of 1934, which proxy statement involves the
election of directors. The information required in these items 10 to 13,
inclusive, is incorporated by reference to that proxy statement.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (l-2) Consolidated Financial Statements and Schedules. See Index to
Financial Statements and Schedules attached.
(3) Exhibits. See Exhibit Index on pages 33-34.
(b) No reports on Form 8-K were filed during the last quarter of 1997.
(c) Exhibits. See Exhibit Index on pages 33-34.
(d) Financial Statement Schedules. The schedules included on attached pages
24 through 32 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 23. There is no other financial
information required by Regulation S-X which is excluded from the
Company's Annual Report to Shareholders.
20
<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 11, 1998
-----------------------------------------------
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 11, 1998
-----------------------------------------------
* * * * *
By: /s/Joseph E. Dondanville
-------------------------------------------------
J. E. Dondanville, Vice President,
Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: March 11, 1998
-----------------------------------------------
* * * * *
By: /s/Gerald D. Stephens
-------------------------------------------------
G. D. Stephens, Director
Date: March 11, 1998
-----------------------------------------------
* * * * *
By: /s/Bernard J. Daenzer
-------------------------------------------------
B. J. Daenzer, Director
Date: March 11, 1998
-----------------------------------------------
* * * * *
By: /s/Richard J. Haayen
-------------------------------------------------
R. J. Haayen, Director
Date: March 11, 1998
-----------------------------------------------
* * * * *
By: /s/William R. Keane
-------------------------------------------------
W. R. Keane, Director
Date: March 11, 1998
-----------------------------------------------
* * * * *
21
<PAGE>
By: /s/Gerald I. Lenrow
-------------------------------------------------
G. I. Lenrow, Director
Date: March 11, 1998
-----------------------------------------------
* * * * *
By: /s/Jonathan E. Michael
-------------------------------------------------
J.E. Michael, Director
Date: March 11, 1998
-----------------------------------------------
* * * * *
By: /s/Edwin S. Overman
-------------------------------------------------
E. S. Overman, Director
Date: March 11, 1998
-----------------------------------------------
* * * * *
By: /s/Edward F. Sutkowski
-------------------------------------------------
E. F. Sutkowski, Director
Date: March 11, 1998
-----------------------------------------------
* * * * *
By: /s/Robert O. Viets
-------------------------------------------------
R. O. Viets, Director
Date: March 11, 1998
-----------------------------------------------
* * * * *
22
<PAGE>
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
<CAPTION>
Reference (Page)
DATA SUBMITTED HEREWITH:
Report of Independent Auditors 24
Schedules:
<S> <C> <C>
I. Summary of Investments - Other than Investments in Related Parties
at December 31, 1997. 25
II. Condensed Financial Information of Registrant for the three years
ended December 31, 1997. 26 - 28
III. Supplementary Insurance Information for the three years ended
December 31, 1997. 29 - 30
IV. Reinsurance for the three years ended December 31, 1997. 31
V. Valuation and Qualifying Accounts 32
VI. Supplemental Information Concerning Property-Casualty Insurance
Operations for the three years ended December 31, 1997. 29 - 30
</TABLE>
Schedules other than those listed are omitted for the reason that they are
not required, are not applicable or that equivalent information has been
included in the financial statements, and notes thereto, or elsewhere herein.
23
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
RLI Corp.:
Under date of January 21, 1998, we reported on the consolidated balance
sheets of RLI Corp. and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of earnings and comprehensive earnings,
shareholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1997, as contained in the 1997 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
1997. 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, 1998
24
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE I--SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS
IN RELATED PARTIES
DECEMBER 31, 1997
<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 $153,767,160 $156,388,429 $153,767,160
States, political subdivisions, and revenues 136,267,149 140,419,278 136,267,149
- -----------------------------------------------------------------------------------------------------------
Total held-to-maturity 290,034,309 296,807,707 290,034,309
- -----------------------------------------------------------------------------------------------------------
Trading
U.S. governments 3,655,128 3,712,755 3,712,755
Foreign governments 440,589 448,026 448,026
Corporate 4,919,479 4,977,849 4,977,849
States, political subdivisions & revenues 404,082 406,942 406,942
- -----------------------------------------------------------------------------------------------------------
Total trading 9,419,278 9,545,572 9,545,572
- -----------------------------------------------------------------------------------------------------------
Available-for-sale
U.S. governments 20,248,316 20,464,950 20,464,950
Corporates 6,342,006 6,472,500 6,472,500
States, political subdivisions, and revenues 7,051,370 7,182,572 7,182,572
- -----------------------------------------------------------------------------------------------------------
Total available-for-sale 33,641,692 34,120,202 34,120,202
- -----------------------------------------------------------------------------------------------------------
Total fixed maturities 333,095,279 340,473,481 333,700,083
- -----------------------------------------------------------------------------------------------------------
Equity securities, available-for-sale:
Common stock:
Public utilities 38,504,391 66,506,467 66,506,467
Banks, trusts and insurance companies 9,844,003 31,739,750 31,739,750
Industrial, miscellaneous and all other 70,287,038 153,212,226 153,212,226
Preferred stock 1,958 1,400 1,400
- -----------------------------------------------------------------------------------------------------------
Total equity securities 118,637,390 251,459,843 251,459,843
- -----------------------------------------------------------------------------------------------------------
Short-term investments 18,696,896 18,696,896 18,696,896
- -----------------------------------------------------------------------------------------------------------
Total investments $470,429,565 $610,630,220 $603,856,822
- -----------------------------------------------------------------------------------------------------------
</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.
25
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY)
CONDENSED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash $ 135,663 $ 9,597,834
Investments in subsidiaries, at equity 264,146,254 228,205,464
Equity securities available-for-sale, at fair value
(Cost--$6,677,285 in 1997 and $6,800,912 in 1996) 12,288,528 9,676,285
Investment in Rabbi Trust 6,432,355 4,062,723
Deferred debt costs 805,701
Property and equipment 1,045,298 1,051,637
Other assets 418,040 898,113
- -------------------------------------------------------------------------------------------
Total assets $284,466,138 $254,297,757
- -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable, current $ 1,996,859 $ 1,283,960
Notes payable, short-term 7,500,000
Deferred compensation--Rabbi Trust 6,432,355 4,062,723
Interest payable--Convertible debentures 1,265,000
Income taxes payable--current 332,621 10,878
Income taxes payable--deferred 1,523,663 805,121
Long-term debt--Convertible debentures 46,000,000
Other liabilities 128,200 830,714
- -------------------------------------------------------------------------------------------
Total liabilities 17,913,698 54,258,396
- -------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock ($1 par value, authorized 50,000,000 shares,
issued 10,229,673 in 1997 and 8,453,449 shares in 1996) 10,229,673 8,453,449
Other shareholders' equity 301,872,049 197,464,904
Treasury shares at cost (1,595,419 shares in 1997
and 631,719 shares in 1996) (45,549,282) (5,878,992)
- -------------------------------------------------------------------------------------------
Total shareholders' equity 266,552,440 200,039,361
- -------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $284,466,138 $254,297,757
- -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements, as attached in Exhibit 13.
26
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY)--(CONTINUED)
CONDENSED STATEMENTS OF EARNINGS AND COMPREHENSIVE EARNINGS
YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net investment income (expense) $ 454,906 $ 164,181 $ (100,881)
Selling, general, and administrative expenses 4,118,010 3,559,113 2,093,019
Interest expense on debt 1,547,542 2,808,470 3,347,378
- --------------------------------------------------------------------------------------------------------------------------------
(5,210,646) (6,203,402) (5,541,278)
Income tax benefit (1,675,135) (2,186,013) (2,147,995)
- --------------------------------------------------------------------------------------------------------------------------------
Net loss before equity
in net earnings of subsidiaries (3,535,511) (4,017,389) (3,393,283)
Equity in net earnings of subsidiaries 33,706,994 29,713,110 11,342,824
- --------------------------------------------------------------------------------------------------------------------------------
Net earnings $30,171,483 $25,695,721 $ 7,949,541
- --------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
Other Comprehensive Earnings, net of tax
Unrealized gains on securities:
Unrealized holding gains arising
during the period $1,859,712 $901,569 $1,245,523
Less: Reclassification adjustment for
(gains) losses included in
Net Earnings (81,383) 1,778,329 10,846 912,415 54,384 1,299,907
- --------------------------------------------------------------------------------------------------------------------------------
Other Comprehensive Earnings--parent only 1,778,329 912,415 1,299,907
Equity in Other Comprehensive
Earnings of Subsidiaries 34,465,638 15,361,757 22,124,323
- --------------------------------------------------------------------------------------------------------------------------------
Other Comprehensive Earnings 36,243,967 16,274,172 23,424,230
- --------------------------------------------------------------------------------------------------------------------------------
Comprehensive Earnings $66,415,450 $41,969,893 $31,373,771
- --------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
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 CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1997 1996 1995
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Losses before equity in net earnings of subsidiaries $ (3,535,511) $(4,017,389) $(3,393,283)
Adjustments to reconcile net losses to net
cash provided by operating activities:
Other items, net (1,792,215) (55,262) (399,566)
Change in:
Affiliate balances payable 451,029 (207,668) 135,916
Interest Payable (1,265,000)
Federal income taxes 140,485 437,303 1,658,597
Deferred debt costs 805,701 123,164 123,165
- ----------------------------------------------------------------------------------------------------
Net cash used in operating activities (5,195,511) (3,719,852) (1,875,171)
- ----------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchase of:
Equity securities, available-for-sale (135,001) (387,395) (857,883)
Property and equipment (37,210) (9,600)
Unconsolidated investee ownership interest (3,694,118)
Sale of:
Equity securities, available-for-sale 383,838 236,986 1,004,380
Cash dividends received-subsidiaries 16,998,248 21,125,783 7,823,965
- ----------------------------------------------------------------------------------------------------
Net cash provided by investing activities 13,515,757 20,975,374 7,960,862
- ----------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Proceeds from issuance of debt 7,500,000 2,800,000
Payments on debt (2,800,000) (6,255,000)
Fractional share paid (1,211) (4,010)
Shares issued under stock option plan 161,356
Treasury shares reissued 2,207,526 33,667
Treasury shares purchased (20,738,547) (3,040,671)
Cash dividends paid (4,704,015) (4,261,445) (3,849,521)
- ----------------------------------------------------------------------------------------------------
Net cash used in financing activities (17,782,417) (7,894,590) (7,274,864)
- ----------------------------------------------------------------------------------------------------
Net increase (decrease) in cash (9,462,171) 9,360,932 (1,189,173)
Cash at beginning of year 9,597,834 236,902 1,426,075
- ----------------------------------------------------------------------------------------------------
Cash at end of year $ 135,663 $ 9,597,834 $ 236,902
- ----------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------
</TABLE>
Interest paid on outstanding debt for 1997, 1996, and 1995 amounted to
$2,809,903, $2,834,192, and $3,372,479, respectively.
See Notes to Consolidated Financial Statements, as attached in Exhibit 13.
28
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION
SCHEDULE VI--SUPPLEMENTARY INFORMATION CONCERNING
PROPERTY-CASUALTY INSURANCE OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
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
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year ended
December 31, 1997
RLI Insurance Group $ 21,984,585 $242,554,249 $ 78,865,812 $141,884,445 $ 61,771,256
- -----------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
Year ended
December 31, 1996
RLI Insurance Group $ 16,663,603 $240,784,071 $ 76,076,561 $130,656,095 $ 69,724,730
- -----------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
Year ended
December 31, 1995
RLI Insurance Group $ 15,806,911 $221,648,494 $ 75,824,217 $133,468,133 $ 62,618,745
- -----------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
</TABLE>
NOTE 1: Investment income is not allocated to the segments, therefore net
investment income (column G) has not been provided.
29
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION
SCHEDULE VI--SUPPLEMENTARY INFORMATION CONCERNING
PROPERTY-CASUALTY INSURANCE OPERATIONS
(CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
Column A Column H Column I Column J Column K
Incurred
Losses and
settlement Policy Other Net
expenses acquisition operating Premiums
Segment Prior year costs expenses written
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Year ended
December 31, 1997
RLI Insurance Group $ (519,822) $43,140,381 $18,741,377 $144,673,696
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
Year ended
December 31, 1996
RLI Insurance Group $ (1,463,423) $29,556,390 $16,441,332 $132,357,640
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
Year ended
December 31, 1995
RLI Insurance Group $ 23,271,250 $43,042,045 $14,470,053 $130,452,895
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
</TABLE>
30
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE IV--REINSURANCE
FOR THE YEARS 1997, 1996, AND 1995
<TABLE>
<CAPTION>
Column A Column B Column C Column D Column E Column F
Percentage
Ceded to Assumed of Amount
Gross Other From Other Net Assumed to
Amount Companies Companies Amount Net
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997
- ----------------------------------------------------------------------------------------------------
RLI Insurance Group
premiums earned $268,569,271 $138,197,583 $11,512,757 $141,884,445 8.1%
- ----------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------
1996
- ----------------------------------------------------------------------------------------------------
RLI Insurance Group
premiums earned $271,551,708 $140,928,326 $ 32,713 $130,656,095 .02%
- ----------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------
1995
RLI Insurance Group
premiums earned $264,651,370 $131,771,599 $ 588,362 $133,468,133 .4%
- ----------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------
</TABLE>
NOTES: Column B, "Gross Amount" includes only direct premiums earned.
31
<PAGE>
RLI CORP. AND SUBSIDIARIES
SCHEDULE V--VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<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>
1997 Allowance for
insolvent reinsurers $16,897,798 -- $ 159,396 -- $17,057,194
1996 Allowance for
insolvent reinsurers $16,336,146 $1,006,140 $(444,488) -- $16,897,798
1995 Allowance for
insolvent reinsurers $15,547,400 $ 613,296 $ 261,373 $(85,923) $16,336,146
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT INDEX
Exhibit No. Description of Document Reference (page)
- ----------- ----------------------- ----------------
<S> <C> <C>
2.1 Plan of Reorganization and Agreement Incorporated by reference to the 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 incorporation Incorporated by reference to the Company's
Quarterly Form 10-Q for the Second Quarter ended June 30, 1997.
3.2 By-Laws Incorporated by reference to the Company's Quarterly Form
10-Q for the Second Quarter ended June 30, 1997.
4.1 Indenture dated July 28, 1993 between Incorporated by reference to the Company's Registration
the Company and Norwest Bank Statement on Form S-3 filed on July 21, 1993.
Minnesota, National Association as
Trustee
10.1 Market Value Potential Plan Incorporated by reference to the Company's Quarterly
Form 10-Q for the Second Quarter ended June 30, 1997.
10.2 RLI Corp. Director Deferred Incorporated by reference to the Company's Registration
Compensation Plan Statement on Form 10-Q for the Second Quarter ended
June 30, 1993.
10.3 The RLI Corp. Directors' Irrevocable Incorporated by reference to the Company's Registration
Trust Agreement Statement on Form 10-Q for the Second Quarter ended
June 30, 1993.
10.4 Key Employee Excess Benefit Plan Incorporated by reference to the Company's
Annual Form 10-K/A for the year ended December 31, 1992.
10.5 RLI Corp. Incentive Stock Incorporated by reference to Company's Registration Statement
Option Plan on Form S-8 filed on March 11, 1996, File No. 333-01637
10.6 Directors' Stock Option Plan Incorporated by reference to the Company's Quarterly
Form 10-Q for the Second Quarter ended June 30, 1997.
10.9 Reinsurance Agreements between the Incorporated by reference to the Company's Annual Form 10-K/A
Company and American Re-Insurance for the year ended December 31, 1992.
Company
10.10 Reinsurance Agreements between the Incorporated by reference to the Company's Annual Form 10-K/A
Company and Lloyds of London for the year ended December 31, 1992.
10.11 Reinsurance Agreements between the Incorporated by reference to the Company's Annual Form 10-K/A
Company and NAC Reinsurance Corp. for the year ended December 31, 1992.
11.0 Statement re computation of per Refer to the Notes to Consolidated Financial Statements--Note 1K
share earnings "Earnings per share", on page 36 of the Annual Report to Shareholders
attached in Exhibit 13.
33
<PAGE>
Exhibit No. Description of Document Reference (page)
- ----------- ----------------------- ----------------
<S> <C> <C>
13.1 Refer to the Annual Report to Share- Attached Exhibit 13.
holders for the year ended
December 31, 1997, pages 20-49
and 53.
21.1 Subsidiaries of the Registrant Attached page 35.
23.1 Consent of KPMG Peat Marwick LLP Attached page 36.
23.2 Consent of Kirkland & Ellis Incorporated by reference to the Company's Registration
Statement on Form S-3 filed July 21, 1993.
24.1 Powers of Attorney Incorporated by reference to the Company's Registration
Statement on Form S-3 filed on July 21, 1993.
27 Financial Data Schedule Attached Exhibit 27.
28.1 Information from reports furnished to Attached page 37.
state insurance regulatory authorities
</TABLE>
34
<PAGE>
SELECTED FINANCIAL DATA
The following is selected financial data of RLI Corp. and Subsidiaries for
the eleven years ended December 31, 1997:
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
OPERATING RESULTS
Gross sales $306,382,972 301,499,626 293,921,737 295,965,601 266,480,414
Total revenue $169,424,173 155,354,418 155,953,724 156,721,972 143,100,340
Net operating earnings (loss) (1) $28,233,258 25,034,299 7,648,244 (2,403,104) 14,117,563
Net earnings (loss) $30,171,483 25,695,721 7,949,541 (4,775,871) 15,947,627
Comprehensive earnings (loss) (2) $66,415,450 41,969,893 31,373,771 (8,512,784) 21,175,108
Net cash provided from operating
activities $35,022,352 48,946,600 24,648,625 27,041,297 73,629,090
Net premiums written to statutory
surplus 54% 64% 76% 108% 94%
GAAP combined ratio 86.8 87.4 107.5 116.9 97.2
Statutory combined ratio 90.4 89.1 106.5 116.9 87.9 (6)
FINANCIAL CONDITION
Total investments $603,856,822 537,946,060 471,599,283 413,835,146 401,608,917
Total assets $911,740,605 845,473,784 810,199,958 751,085,888 667,650,378
Unpaid losses and settlement
expenses $404,263,638 405,801,220 418,985,960 394,966,040 310,767,026
Long-term debt -- 46,000,000 46,000,000 52,255,000 53,000,000
Total shareholders' equity $266,552,440 200,039,361 158,607,716 131,169,961 140,706,372
Statutory surplus $265,526,172 207,786,596 172,312,961 136,124,530 152,261,509
SHARE INFORMATION
Net operating earnings (loss) per
share:
Basic (3) $3.40 3.17 0.97 (5) (0.31) (5) 1.86
Diluted (3) $3.12 2.78 0.97 (5) (0.31) (5) 1.78
Net earnings (loss) per share:
Basic (3) $3.63 3.25 1.01 (5) (0.61) (5) 2.10 (7)
Diluted (3) $3.33 2.85 1.01 (5) (0.61) (5) 2.00 (7)
Comprehensive earnings (loss) per
share: (2)
Basic (3) $7.98 5.32 4.00 (1.09) 2.79 (7)
Diluted (3) $7.20 4.53 3.46 (4) (1.09) 2.63 (7)
Cash dividends declared per common share $.59 .55 .51 .45 .42
Book value $30.87 25.57 20.20 16.71 18.25
Closing stock price $49.81 33.38 25.00 16.40 21.20
Stock split 125%
Weighted average number of common
shares outstanding:
Basic (3) 8,321,787 7,896,463 7,849,799 7,786,004 7,599,563
Diluted (3) 9,371,235 9,684,005 7,849,799 7,786,004 8,360,575
Common shares outstanding 8,634,254 7,821,730 7,850,882 7,849,443 7,711,065
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
</TABLE>
(1) For all periods presented, net operating earnings represent the Company's
net earnings reduced by after-tax realized gains. For 1993, the financial
impact of SFAS 109, as discussed in note 7, has also been deducted in
arriving at operating earnings.
(2) See note 1L to the consolidated financial statements.
(3) See note 1K to the consolidated financial statements.
(4) For 1995, diluted earnings per share on a GAAP basis were anti-dilutive.
As such, GAAP diluted and basic earnings per share were equal. Diluted
comprehensive earnings per share, however, were not anti-dilutive. The number
of diluted shares used for this calculation was 9,619,030.
20
<PAGE>
SELECTED FINANCIAL DATA
The following is selected financial data of RLI Corp. and Subsidiaries for
the eleven years ended December 31, 1997:
<TABLE>
<CAPTION>
1992 1991 1990 1989 1988 1987
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
OPERATING RESULTS
Gross sales 220,048,369 215,497,602 181,215,877 149,230,331 143,785,384 151,492,336
Total revenue 117,581,830 102,342,998 92,957,578 89,984,262 104,279,172 106,846,379
Net operating earnings
(loss) (1) 15,598,954 15,985,916 14,997,525 7,959,689 6,927,222 12,979,988
Net earnings (loss) 16,207,127 16,800,050 14,267,002 8,200,264 7,253,913 13,965,174
Comprehensive earnings (loss) (2) 18,547,721 22,430,168 11,952,060 11,105,089 8,295,719 12,373,916
Net cash provided from
operating activities 43,618,755 22,918,206 45,388,065 22,801,043 27,742,205 9,151,857
Net premiums written to
statutory surplus 110% 95% 112% 96% 131% 156%
GAAP combined ratio 91.4 85.2 85.1 97.8 96.1 84.4
Statutory combined ratio 95.8 91.6 92.2 99.5 98.3 84.7
FINANCIAL CONDITION
Total investments 281,112,588 237,932,089 213,160,198 177,025,151 165,956,870 152,777,063
Total assets 526,351,331 483,571,862 432,379,562 402,906,191 372,492,257 364,740,628
Unpaid losses and
settlement expenses 268,042,761 244,666,938 235,806,989 230,523,717 217,230,839 194,707,865
Long-term debt 7,000,000 7,000,000 7,000,000 7,000,000 7,000,000 7,000,000
Total shareholders' equity 117,392,751 99,677,983 79,850,942 70,276,175 64,026,271 57,763,851
Statutory surplus 100,584,758 88,605,319 70,409,590 68,571,173 60,151,725 57,453,264
SHARE INFORMATION
Net operating earnings (loss) per
share:
Basic (3) 2.18 2.26 2.12 1.11 .93 1.69
Diluted (3) 2.18 2.26 2.12 1.11 .93 1.69
Net earnings (loss) per share:
Basic (3) 2.26 2.38 2.02 1.14 .97 1.82
Diluted (3) 2.26 2.38 2.02 1.14 .97 1.82
Comprehensive earnings (loss) per
share: (2)
Basic (3) 2.59 3.17 1.69 1.54 1.11 1.61
Diluted (3) 2.59 3.17 1.69 1.54 1.11 1.61
Cash dividends declared per
common share .40 .37 .34 .30 .27 .25
Book value 16.30 14.09 11.29 9.94 8.57 7.73
Closing stock price 19.80 13.20 11.60 6.80 6.10 7.70
Stock split
Weighted average number of common
shares outstanding:
Basic (3) 7,158,890 7,073,718 7,073,718 7,189,076 7,475,369 7,704,938
Diluted (3) 7,158,890 7,073,718 7,073,718 7,189,076 7,475,369 7,704,938
Common shares outstanding 7,201,343 7,073,718 7,073,718 7,073,718 7,475,369 7,475,369
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(5) The combined effects of the Northridge Earthquake--including losses,
expenses and the reduction in revenue due to the reinstatement of reinsurance
coverages--reduced 1994 after-tax earnings by $25.0 million ($3.21 per basic
share, $2.62 per diluted share) and 1995 after-tax earnings by $18.6 million
($2.37 per basic share, $1.93 per diluted share). See note 1C to the
consolidated financial statements for further details.
(6) 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.
(7) Basic and diluted earnings per share include $.22 and $.20 per share,
respectively, from the initial application of SFAS 109 "Accounting for Income
Taxes."
21
<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 84% 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 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 over 60% of the Company's 1997 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 up
to $50 million in surplus.
The casualty portion of the Company's business consists largely of commercial
and personal umbrella, general liability, and contract and miscellaneous
surety bond coverages. In addition, the Group provides directors & officers
liability, employers' indemnity, 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 settlement of a casualty
claim may take several years to fully develop. The casualty line may also be
affected by evolving legislation and court decisions that define the extent
of coverage and the amount of compensation due for injuries or losses.
The surety division of RLI specializes in writing small- and medium-sized
commercial and contract surety products. The commercial surety products
usually involve a statutory requirement for bonds placed by governmental
entities or the court system. This industry has historically maintained a
relatively low loss ratio. Losses may fluctuate, however, due to adverse
economic conditions that may affect the financial viability of an insured.
The contract surety market guarantees the construction work of a commercial
contractor for a specific project. As such, this line has historically
produced marginally higher loss ratios than the commercial surety line.
Generally, losses occur due to adverse economic conditions, inclement weather
conditions, or the deteriorated financial condition of the contractor.
The consolidated financial statements and related notes found on pages 30-49
should be read in conjunction with the following discussion.
YEAR ENDED DECEMBER 31, 1997, COMPARED
TO YEAR ENDED DECEMBER 31, 1996
Consolidated gross sales--which consist of gross premiums written, net
investment income and realized investment gains (losses)--totaled $306.4
million, a 1.6% increase from 1996. Consolidated revenue for 1997 was $169.4
million, up 9.1% from the previous year. The increase in revenue was
attributable in part to increased realized investment gains of nearly $3.0
million, compared to $1.0 million in 1996. Also, an 8.6% increase in net
earned premiums reflected the addition of the Hawaii Residential Insurance
program at a higher net retention than many of the Company's other lines.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------
Year Ended December 31,
Gross sales (in thousands) 1997 1996 1995
- ---------------------------------------------------------------
<S> <C> <C> <C>
Gross premiums written $278,843 $276,802 $271,436
Net investment income 24,558 23,681 22,029
Realized investment gains 2,982 1,017 457
- ---------------------------------------------------------------
Total gross sales $306,383 $301,500 $293,922
- ---------------------------------------------------------------
- ---------------------------------------------------------------
</TABLE>
Net after-tax earnings for the Company were a record $30.2 million ($3.33 per
diluted share) in 1997, compared to $25.7 million ($2.85 per share) in 1996.
The following table illustrates the respective contributions of the Company's
major sources of pretax earnings:
22
<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------
(in thousands) 1997 1996 Increase
- --------------------------------------------------------------------------
<S> <C> <C> <C>
Insurance Group $18,751 $16,397 $2,354
Net investment income 24,558 23,681 877
Net realized investment gains 2,982 1,018 1,964
Equity in investee earnings 951 231 720
- --------------------------------------------------------------------------
</TABLE>
During the fourth quarter of 1996, the Company introduced the reporting of
comprehensive earnings in public releases of financial information. The
Company has elected for early adoption of Financial Accounting Standards
Board Statement 130 which requires this disclosure. 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.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------
Diluted (per share)
Net Earnings Comp. Earnings
<S> <C> <C>
1993 2.00 2.63
1994 (.61) (1.09)
1995 1.01 3.46
1996 2.85 4.53
1997 3.33 7.20
- --------------------------------------------------------------------------
Total $8.58 $16.73
- --------------------------------------------------------------------------
</TABLE>
As this chart indicates, comprehensive earnings per share for the last five
years exceed reported net earnings by 95% on a diluted basis. As a result,
shareholders' equity reached an unprecedented level of nearly $267.0 million,
up over 33% from 1996.
A line chart that depicts cumulative diluted comprehensive earnings on one
line and cumulative diluted net earnings on a second line for the years ended
1993 through 1997 has been excluded from this electronic filing. The chart,
labeled the true measure of our value--cumulative comprehensive earnings vs.
net earnings, plots the cumulative per share values from the above five-year
table and concludes with the statement--over the past five years, cumulative
after-tax comprehensive earnings have accounted for 95.0% more of RLI's
increased value than after-tax net earnings.
RLI INSURANCE GROUP
Gross written premiums in 1997 were $278.8 million, compared to $276.8
million in 1996. This modest increase reflected the Company's firm commitment
to sound underwriting practices during this period of unusually arduous
pricing and market conditions. The Group's pretax underwriting earnings for
1997 were $18.8 million, a 14.6% increase over the $16.4 million reported in
1996 as a result of this focus on underwriting profit.
The Company's property segment gross written premiums were basically flat in
1997 at $139.5 million, compared to $138.1 million in 1996. There were,
however, significant changes in the product mix of this segment. While
existing product gross premiums were down due to rate reductions and
increased competitor capacity, the reductions in net written premiums were
mitigated through better use of reinsurance. Fire and difference in
conditions (earthquake) gross written premiums were down 16% and 12%
respectively from 1996, compared to declines in net written premiums of only
3% and 7%. Meanwhile, the Group bolstered its overall premium production in
this segment with the addition of the Hawaii Residential Insurance program.
Including the assumption of $10.8 million of unearned premium upon
acquisition, gross and net premiums written for this program were $19.5
million and $19.1 million, respectively, for the year ended 1997.
The property segment contributed the largest share of the Group's pretax
profits, increasing to $21.4 million in 1997, compared to $18.8 million in
1996. These results were reflected in the property segment GAAP combined
ratio of 65.5 for 1997. The combined ratio increase from 60.9 in 1996
reflected the incremental acquisition costs associated with the assumption of
Hawaiian homeowner in-force business from the Hawaii Property Insurance
Association. Such costs will not be associated with the continued production
of these premiums in 1998. These increased expenses were offset by a lower
property segment loss ratio of 19.2 in 1997, compared to 22.4 in the previous
year.
Casualty gross written premiums declined 10.7% from 1996, to $113.5 million
in 1997. Much of this decline was due to discontinuing certain production
source relationships in the general liability area as a result of prolonged
declines in profitability. Despite premium declines, the casualty segment
GAAP combined ratio was 104.6 for 1997. While lower premiums have negatively
influenced the
23
<PAGE>
expense ratio component of this indicator, the loss ratio for 1997 was 68.5,
compared to 72.1 in 1996. Even at this level, management believes that loss
reserves for this segment will be adequate and that the investment income
derived from these reserved funds will provide significant future earnings
potential. Such optimism is additionally warranted by the favorable total
reserve development in 1997 on prior accident years' reserves, as indicated
in note 6 of the financial statements.
The surety segment provided the most notable premium growth among existing
products, increasing to $25.8 million, a 123% increase over the $11.6 million
for the prior year. Much of this growth was achieved specifically through the
increased writing of contract bonds, which added $12.5 million of additional
premium in 1997. The surety segment profit picture also improved dramatically
as pretax underwriting profits came in at $526,000, compared to an
underwriting loss of $406,000 in 1996. This was largely the result of the
anticipated payoff in premium writings from production investments made over
the last several years. The combined ratio for this segment fell to 95.4 in
1997 from 109.2 in 1996, mostly from the expense ratio improvement of 8.8
points.
INVESTMENT INCOME
Net dividend and interest income increased 3.7% during 1997, due to growth in
invested assets. The Company realized $3.0 million in capital gains in 1997,
compared to $1.0 million in 1996. Operating cash flows were $35.0 million in
1997, compared to $48.9 million in 1996. All cash flows in excess of current
needs were used to fund our common 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.
The yields on the Company's fixed-income investments for the years ended
December 31, 1997 and 1996, respectively, were as follows:
<TABLE>
<CAPTION>
1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C>
Taxable 6.91% 6.91%
Tax-exempt 5.00% 4.97%
</TABLE>
Yields for 1997 rose during the first half of the year and remained fairly
stable throughout the third quarter. A significant bond price rally during
the fourth quarter brought yields in the Treasury market close to their
historic lows. Tax-exempt yields were up slightly as the Company extended its
portfolio duration to gain additional yield and minimize the effect of
declining interest rates. The taxable segment of the portfolio remained
fairly stable during the year with the overall yield unchanged.
The investment results of the Company for the last five years are shown in
the following table.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
(in thousands)
Tax Equivalent
Change inAnnualized 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>
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%
1997 570,901 24,558 2,982 55,760 14.6% 15.5%
5-yr. $451,660 $21,451 $ 223 $23,805 10.07% 11.0%
</TABLE>
(1) Average of amounts at beginning and end of year.
(2) Investment income, net of investment expenses, including non-debt
interest expense.
(3) Before income taxes.
(4) Relates to available-for-sale fixed maturities and equity securities.
- ------------------------------------------------------------------------------
The annualized return for 1997 was again enhanced by the strong performance
of our equity portfolio, which contributed unrealized appreciation of $55.7
million to the 33.9% of the portfolio's total return.
INTEREST AND GENERAL CORPORATE EXPENSE
Interest expense on debt was $1.5 million in 1997, down 44.9% from $2.8
million in 1996. This decline was the direct result of the Company's call for
redemption and subsequent conversion of all of its outstanding convertible
debentures during July, 1997. General corporate expenses increased 27.3% in
1997, as a result of accrued executive bonuses relating to the MVP program
and recognition of the expense of issuing directors' stock options.
INCOME TAXES
The Company's effective tax rates for 1997 and 1996 were 27.3% and 27.1%,
respectively. Effective rates are dependent upon components of pretax
earnings and the related tax effects. The Company's pretax earnings include
$9.1 million of investment income in 1997 that is wholly or partially exempt
from federal income tax, compared to $8.0 million in 1996.
<PAGE>
OUTLOOK FOR 1998
In 1998, the Company will continue to pursue opportunities for top line
growth. There is an ongoing process of evaluating various avenues for growth
such as the acquisition of underwriting talent in certain product lines,
strategic alliances with producers on existing products, or through
acquisition. The particular materiality or viability of any future new
ventures or products is not
24
<PAGE>
known at this time. Specific details regarding events in the Group's various
business segments follows.
PROPERTY INSURANCE
The Company expects further softening of earthquake rates during 1998.
Exposure will remain constant while reduced reinsurance costs will serve to
mitigate the bottom line impact of lost premiums.
The Company's fire book of business was affected in 1997 by the loss of the
product vice president in this line. While this caused a temporary loss of
momentum, new leadership has been established to provide growth with the
potential for adding limited international exposures.
The following information appeared as an inset on the top right-hand corner
of this annual report page: RLI Fact--Regulating our catastrophe
exposure--Every month, we use our catastrophe modeling system to simulate
events against our earthquake exposures. We proactively monitor hundreds of
fault lines, helping us control our probable maximum loss to any one event.
CASUALTY AND OTHER LINES
Several initiatives took place late in 1997 to combat the loss of casualty
premiums to some of the questionable pricing trends seen in 1996. Offices for
writing both general liability business and commercial umbrella were opened
in Dallas and Los Angeles.
During November of 1997, the Company entered the transportation business by
opening an office in Atlanta, which began writing business in 1998. This
office is staffed by underwriters with extensive experience in the areas of
truck, public transportation and commercial auto fleet insurance coverages.
SURETY
Gross written premiums are expected to continue to increase, although not quite
at the pace of last year's growth. Increased revenues should continue to drive
down the expense ratio during 1998.
CAPITAL MANAGEMENT
In February, the Company completed a $10 million common stock repurchase
program. After the conversion of the $46 million debenture issue in July, the
Company implemented an additional 1.8 million share repurchase program. As of
December 31, this program was more than 42% completed, with 767,151 shares
repurchased at a total cost of $32.7 million. Based on the price of RLI stock
and the availability of both funds and shares, it is anticipated that the
repurchase program will continue into 1998.
The repurchase program has been funded by the use of available short-term
borrowing facilities, reverse repurchase agreements and operating cash flows.
It is anticipated that future repurchases will be funded primarily by
short-term debt facilities.
As the availability of shares to repurchase and the accumulated level of
short-term debt warrant, it is possible that the Company may issue a
longer-term debt facility, thereby repaying short-term debt. Such an issuance
will depend upon many factors, including the Company's need for funds and the
prevailing conditions in the capital markets.
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--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,
<TABLE>
<CAPTION>
Gross sales (in thousands) 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C>
Gross premiums written $276,802 $271,436
Net investment income 23,681 22,029
Realized investment gains (losses) 1,017 457
- --------------------------------------------------------------------------------
Total gross sales $301,500 $293,922
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
Net after-tax earnings for the Company were a record $25.7 million ($2.85 per
diluted 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 ($1.93 per share).
25
<PAGE>
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, reflecting an
8.8% improvement 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, 1996 and 1995, respectively, were as follows:
<TABLE>
<CAPTION>
1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C>
Taxable 6.91% 6.84%
Tax-exempt 4.97% 5.06%
</TABLE>
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
substantially 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.
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.
Nontaxable income for 1995 was $7.4 million.
ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement No.128, "Earnings Per Share" (Statement 128). Statement 128
supersedes APB Opinion No. 15, "Earnings Per Share" (APB 15), and specifies
the computation, presentation, and disclosure requirements for earnings per
share (EPS) for entities with publicly held common stock or potential common
stock. Statement 128 was issued to simplify the computation of EPS and to
make the U.S. standard more compatible with the EPS standards of other
countries. Statement 128 replaces the presentation of primary EPS with a
presentation of basic EPS and fully diluted EPS with diluted EPS. Basic EPS,
unlike primary EPS, excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common
shares outstanding for the period. Diluted EPS
26
<PAGE>
reflect the dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shares in the earnings of the entity. Diluted
EPS is computed similarly to fully diluted EPS under APB 15.
Statement 128 is effective for financial statements for both interim and
annual periods ending after December 15, 1997. The Company adopted this
statement during the fourth quarter of 1997. All prior period EPS data
presented has been restated to conform to Statement 128.
In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive
Income" (Statement 130), which established standards for the reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements. Under Statement 130, comprehensive income is
divided into net income and other comprehensive income. This Statement does
not change or modify the reporting or display of net income, but does provide
a basis for classification and display of other comprehensive income. Items
representing comprehensive income include foreign currency translation items,
minimum pension liability adjustments and unrealized gains and losses on
certain investments in debt and equity securities. Currently, the Company's
only component of other comprehensive income comes from unrealized gains and
losses on its available-for-sale debt and equity portfolio.
Statement 130 becomes effective for interim and annual periods beginning
after December 15, 1997. In the fourth quarter of 1997, the Company elected
for early adoption of this Statement. As such, comparative financial
statements provided have been reclassified to reflect the application of the
provisions of this Statement.
In June 1997, the FASB also issued Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information" (Statement 131). Statement
131 establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. This Statement is effective for fiscal
periods beginning after December 15, 1997. The Company is currently
evaluating this recently issued Statement.
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. A new congressional bill, "The Homeowners
Insurance Availability Act of 1997," addresses issues of catastrophe
insurance for homeowners through federal assistance to state guarantee funds.
The Company is monitoring the bill's progress and has neither opposed nor
supported the bill at this time.
SUPERFUND REFORM (ENVIRONMENTAL LIABILITY)--The Comprehensive Environmental
Response, Compensation and Liability Act (CERCLA), more commonly known as
Superfund, remains in effect, but no reform legislation was passed in 1997.
Insurance companies, other businesses, environmental groups and
municipalities are advocating a variety of reform proposals to revise the
cleanup and liability provisions of CERCLA. Any reform proposal could result
in additional taxation to fund cleanup efforts.
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.
During 1997, the Company issued refund checks to policyholders. As of
December 31, 1997, the total unclaimed refund amount was $1.5 million. Any
amounts unclaimed as of November 1, 1998, will escheat to the California
Division of Unclaimed Property.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the primary sources of the Company's liquidity have been funds
generated from insurance premiums (operating activities), 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 short-term borrowings.
The Company maintains two sources of credit from one financial institution:
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, 1997, the Company had $10.0 million in
outstanding short-term debt. Additionally, the Company was party to two
reverse repurchase transactions, totaling $14.9 million. All funds were
utilized to fund the
27
<PAGE>
Company's stock repurchase program. 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 agreement with Centre Reinsurance (Centre Re). The agreement,
called Catastrophe Equity Puts (CatEPuts)-SM-, augments the Company's
traditional reinsurance programs 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 1997, the Company generated net operating cash flows of $35.0 million,
up from 1996's $48.9 million. Financing activities included the conversion of
our $46 million convertible debenture into 1,769,199 shares of RLI Corp.
common stock, borrowings of $10.0 million from our line of credit, and $14.9
million in reverse repurchase agreements. All borrowings, as well as a
portion of operational cash flows, were utilized to repurchase shares of the
Company's stock. During 1997, 963,700 shares were repurchased at a total cost
of $39.7 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 highly liquid 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). Virtually all of the Company's fixed-income
portfolio consists of securities rated A or better, with 98% rated AA or
better. Currently, the majority 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.
A pie chart depicting the Company's investment portfolio split between common
stock and fixed maturities has been omitted from this electronic filing. The
chart shows common stock (large cap, high dividend yield, value stocks) make
up $251.5 million of the Company's investment portfolio. The balance of the
portfolio, $352.4 million, is labeled as fixed maturities and footnoted as
being $193.9 million taxable securities, $139.8 million municipal securities,
and $18.7 million short-term securities. The caption below the pie chart
reads: The equity markets have generated significant value for RLI
shareholders, as nearly 42% of our portfolio is invested in common stocks.
Since 1982, our equity portfolio has averaged a 18.7% annual return.
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. 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 87% 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. A small
portion (3%) of the fixed-income portfolio is classified as trading, with the
unrealized capital gains and losses on these securities included in earnings,
net of deferred income taxes. The remaining 10% are classified as
available-for-sale and are carried at fair value. Unrealized capital gains
and losses on these securities are excluded from net earnings but are
recorded as a separate component of comprehensive earnings and shareholders'
equity, net of deferred income taxes. During 1997, the Company maintained
$34.1 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 provide an additional source of
liquidity and can be used to react to future changes in the Company's
asset/liability structure.
The equity portfolios increased $62.5 million during 1997. The Company had
net purchases of $6.9 million of
28
<PAGE>
common stock, with a portfolio appreciation of $55.7 million. Capital gains
of $2.0 million were realized during the year. The securities within the
equity portfolio remain invested in conservative, blue-chip, value-oriented
companies. Consistent dividend yield and performance is also valued as over
25% of the portfolio is invested in the utility and telecommunications
sectors. The general investment philosophy is to generate long-term portfolio
growth. Trading is kept to a minimum.
The National Association of Insurance Commissioners (NAIC) continues its work
on developing a model investment law. This law 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.
OTHER MATTERS
The Company is aware of the issues associated with the programming code in
existing computer systems as the millennium (Year 2000) approaches. The "Year
2000" problem is pervasive and complex as many computerized systems are
exposed to the rollover of the two-digit year value to 00. The issue is
whether computer systems will properly recognize date-sensitive information
when the year changes to 2000. Systems that do not properly recognize such
information could generate erroneous data or cause a system to fail.
The Company is utilizing both internal and external resources to identify,
correct or modify, and test the systems for the Year 2000 compliance. It is
anticipated that reprogramming efforts will be complete by December 31, 1998,
allowing adequate time for testing. To date, confirmations have been received
from the Company's primary system vendors that plans are being developed to
address processing of transactions in the year 2000. Based on preliminary
information, costs of addressing potential problems are not currently
expected to have a material adverse impact on the Company's financial
position, results of operations or cash flows in future periods. However, if
the Company, its customers or vendors are unable to resolve such processing
issues in a timely manner, it could result in a material financial risk.
From an underwriting perspective, the Company has identified potential
exposures by product line. Management is investigating alternative solutions
by consulting with other industry leaders in our lines of business. While all
policies could be affected by Year 2000 issues, those lines the Company has
identified to be most susceptible are: general liability, directors and
officers liability, errors and omissions coverage, and property insurance.
The Company has temporarily ceased writing policies extending coverage beyond
the year 1999. However, a small number of policies with Year 2000 exposures
has been written. Insurance Services Office has created endorsements that
exclude Year 2000 exposures, but state regulators have yet to address these
exclusions. The states' reaction to these endorsements will help management
decide what approach to ultimately take on coverages written beyond the year
1999.
The following information appeared as an inset on the top right-hand corner
of this annual report page: RLI Fact--Proactive Year 2000 efforts
underway--RLI has identified Year 2000 risks by product line and system
needs. We anticipate few coverage exposures. Internal system safeguards are
expected to be completed in 1998. This is an ongoing situation that we will
continue to monitor and re-evaluate.
29
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
December 31, 1997 1996
- ----------------------------------------------------------------------------------------------------------------------
Assets
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Investments:
Fixed maturities:
Held-to-maturity, at amortized cost
(fair value--$296,807,707 in 1997 and $266,025,419 in 1996) $290,034,309 $263,282,430
Trading, at fair value (amortized cost--$9,419,278 in 1997) 9,545,572 --
Available-for-sale, at fair value
(amortized cost--$33,641,692 in 1997 and $44,525,564 in 1996) 34,120,202 44,904,303
Equity securities available-for-sale, at fair value
(cost--$118,637,390 in 1997 and $111,773,203 in 1996) 251,459,843 188,935,360
Short-term investments, at cost which approximates fair value 18,696,896 40,823,967
- ----------------------------------------------------------------------------------------------------------------------
Total investments 603,856,822 537,946,060
- ----------------------------------------------------------------------------------------------------------------------
Cash -- --
Accrued investment income 6,348,257 5,835,885
Premiums and reinsurance balances receivable, net of allowances for
insolvent reinsurers of $17,057,146 in 1997 and $16,897,798 in 1996 30,719,768 37,166,516
Ceded unearned premiums 49,677,041 53,705,078
Reinsurance balances recoverable on unpaid losses and
settlement expenses 161,709,389 165,017,149
Deferred policy acquisition costs, net 21,984,585 16,663,603
Property and equipment, at cost, net of accumulated depreciation
of $20,735,039 in 1997 and $19,381,473 in 1996 12,387,500 12,126,552
Investment in unconsolidated investee 13,615,577 8,970,691
Other assets 11,441,666 8,042,250
- ----------------------------------------------------------------------------------------------------------------------
Total assets $911,740,605 $845,473,784
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
- ----------------------------------------------------------------------------------------------------------------------
Liabilities:
Unpaid losses and settlement expenses $404,263,638 $405,801,220
Unearned premiums 128,542,853 129,781,639
Reinsurance balances payable 24,390,338 23,699,837
Income taxes--current 2,701,964 2,134,692
Income taxes--deferred 36,339,801 17,170,687
Notes payable, short-term 24,900,000 --
Long-term debt--convertible debentures -- 46,000,000
Other liabilities 24,049,571 20,846,348
- ----------------------------------------------------------------------------------------------------------------------
Total liabilities 645,188,165 645,434,423
- ----------------------------------------------------------------------------------------------------------------------
Commitments and contingent liabilities
- ----------------------------------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock ($1 par value, authorized 50,000,000 shares,
issued 10,229,673 in 1997 and 8,453,449 shares in 1996) 10,229,673 8,453,449
Paid-in capital 74,587,595 31,691,793
Accumulated other comprehensive earnings, net of tax 86,852,663 50,608,696
Retained earnings 140,431,791 115,164,415
Treasury stock, at cost (1,595,419 shares in 1997 and 631,719 shares in 1996) (45,549,282) (5,878,992)
- ----------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 266,552,440 200,039,361
- ----------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $911,740,605 $845,473,784
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
30
<PAGE>
CONSOLIDATED STATEMENTS OF EARNINGS AND COMPREHENSIVE EARNINGS
<TABLE>
<CAPTION>
Years ended December 31, 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net premiums earned $141,884,445 $130,656,095 $133,468,133
Net investment income 24,557,844 23,680,751 22,029,081
Net realized investment gains 2,981,884 1,017,572 456,510
- ----------------------------------------------------------------------------------------------------------------------------------
169,424,173 155,354,418 155,953,724
- ----------------------------------------------------------------------------------------------------------------------------------
Losses and settlement expenses 61,251,434 68,261,307 85,889,995
Policy acquisition costs 43,140,381 29,556,390 43,042,045
Insurance operating expenses 18,741,377 16,441,332 14,470,053
Interest expense on debt 1,547,542 2,808,470 3,347,378
General corporate expenses 4,172,039 3,277,630 2,093,034
- ----------------------------------------------------------------------------------------------------------------------------------
128,852,773 120,345,129 148,842,505
- ----------------------------------------------------------------------------------------------------------------------------------
Equity in earnings of
unconsolidated investee 950,768 230,741 714,818
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings before income taxes 41,522,168 35,240,030 7,826,037
- ----------------------------------------------------------------------------------------------------------------------------------
Income tax expense (benefit):
Current 11,697,571 6,037,849 730,725
Deferred (346,886) 3,506,460 (854,229)
- ----------------------------------------------------------------------------------------------------------------------------------
11,350,685 9,544,309 (123,504)
- ----------------------------------------------------------------------------------------------------------------------------------
Net earnings $ 30,171,483 $ 25,695,721 $ 7,949,541
- ----------------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------------
Other comprehensive earnings, net of tax
Unrealized gains on securities:
Unrealized holding gains arising
during the period $37,681,935 $16,524,646 $23,734,890
Less: Reclassification adjustment for
gains included in net earnings (1,437,968) 36,243,967 (250,474) 16,274,172 (310,660) 23,424,230
- ----------------------------------------------------------------------------------------------------------------------------------
Other comprehensive earnings 36,243,967 16,274,172 23,424,230
- ----------------------------------------------------------------------------------------------------------------------------------
Comprehensive earnings 66,415,450 41,969,893 31,373,771
- ----------------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings per share:
Basic
Net earnings per share from operations $3.40 $3.17 $0.97
Realized gains, net of tax 0.23 0.08 0.04
- ----------------------------------------------------------------------------------------------------------------------------------
Basic net earnings per share $3.63 $3.25 $1.01
- ----------------------------------------------------------------------------------------------------------------------------------
Basic comprehensive earnings per share $7.98 $5.32 $4.00
- ----------------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------------
Diluted
Net earnings per share from operations $3.12 $2.78 $0.97
Realized gains, net of tax 0.21 0.07 0.04
- ----------------------------------------------------------------------------------------------------------------------------------
Diluted net earnings per share $3.33 $2.85 $1.01
- ----------------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------------
Diluted comprehensive earnings per share $7.20 $4.53 $3.46
- ----------------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------------
Weighted average number of common shares outstanding:
Basic 8,321,787 7,896,463 7,849,799
- ----------------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------------
Diluted 9,371,235 9,684,005 7,849,799
- ----------------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
31
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Accumulated
Other Treasury Total
Common Paid-in Comprehensive Retained Stock Shareholders'
Stock Capital Earnings Earnings at Cost Equity
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1995 6,762,905 25,503,282 10,910,294 91,394,229 (3,400,749) 131,169,961
Net earnings 7,949,541 7,949,541
Other comprehensive
earnings, net of tax 23,424,230 23,424,230
Treasury shares reissued
(1,448 shares) 23,241 10,426 33,667
5-for-4 stock split 1,690,544 (1,694,554) (4,010)
Dividends declared
($.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
Other comprehensive
earnings, net of tax 16,274,172 16,274,172
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)
Adjustment to accounting
for business combination
(see note 1B) 6,204,300 (1,570,477) 4,633,823
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) $200,039,361
Net earnings 30,171,483 30,171,483
Other comprehensive
earnings, net of tax 36,243,967 36,243,967
Net change from conversion
of convertible debentures 1,769,199 43,485,471 45,254,670
Treasury shares purchased
(963,700 shares) (39,670,290) (39,670,290)
Shares issued from exercise
of stock options 7,025 154,331 161,356
Other capital items, including
Catastrophe Equity Put
(CatEPuts) amoritization (744,000) (744,000)
Dividends declared
($.59 per share) (4,904,107) (4,904,107)
- --------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 $10,229,673 $74,587,595 $86,852,663 $140,431,791 $(45,549,282) $266,552,440
- --------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
32
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years ended December 31, 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net earnings $30,171,483 $25,695,721 $ 7,949,541
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Provision for insolvencies -- 1,006,140 613,296
Net realized investment losses (gains) (2,981,884) (1,017,572) (456,510)
Depreciation 2,289,835 2,454,543 2,866,105
Other items, net (328,255) 6,378,410 696,046
Change in:
Accrued investment income (512,372) 18,846 (688,648)
Premiums and reinsurance balances receivable
(net of direct write-offs and commutations) 6,446,748 (1,725,372) (10,977,648)
Reinsurance balances payable 690,501 (14,044,619) (2,115,290)
Ceded unearned premium 4,028,037 (3,515,338) (9,211,652)
Reinsurance balances recoverable on unpaid losses 3,307,760 32,320,317 2,399,330
Deferred policy acquisition costs (5,320,982) (856,692) 3,401,301
Unpaid losses and settlement expenses (1,537,582) (13,184,740) 24,019,920
Unearned premiums (1,238,786) 3,767,682 6,196,415
Income taxes:
Current 567,272 4,623,555 1,525,466
Deferred (346,886) 3,506,460 (854,229)
Changes in investment in unconsolidated investee:
Undistributed earnings (950,768) (230,741) (714,818)
Dividends received -- 3,750,000 --
Net proceeds from (used in) trading portfolio activity 738,231 -- --
- -------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 35,022,352 48,946,600 24,648,625
- -------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchase of:
Fixed maturities, held-to-maturity (56,644,180) (29,681,906) (59,029,702)
Fixed maturities, available-for-sale (8,889,525) (11,792,359) (9,091,447)
Equity securities, available-for-sale (10,608,927) (11,648,835) (32,221,842)
Short-term investments, net -- (19,939,566) --
Property and equipment (2,745,329) (3,408,835) (1,647,414)
Unconsolidated investee ownership interest (3,694,118) -- --
Proceeds from sale of:
Fixed maturities, available-for-sale 8,385,633 8,297,553 3,383,745
Equity securities, available-for-sale 5,780,045 2,579,172 17,187,726
Short-term investments, net 22,127,071 -- 28,748,056
Property and equipment 194,546 795,071 511,631
Proceeds from call or maturity of:
Fixed maturities, held-to-maturity 29,083,072 17,380,750 25,234,977
Fixed maturities, available-for-sale 1,303,520 2,860,000 3,730,000
- -------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (15,708,192) (44,558,955) (23,194,270)
- -------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Proceeds from issuance of debt 24,900,000 -- 2,800,000
Payments on debt -- (2,800,000) (6,255,000)
Fractional shares paid (1,211) -- (4,010)
Shares issued under stock option plan 161,356 -- --
Treasury shares reissued -- 2,207,526 33,667
Treasury shares purchased (39,670,290) (3,040,671) --
Cash dividends paid (4,704,015) (4,261,445) (3,849,521)
- -------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (19,314,160) (7,894,590) (7,274,864)
- -------------------------------------------------------------------------------------------------------------
Net decrease in cash 0 (3,506,945) (5,820,509)
Cash at beginning of year 0 3,506,945 9,327,454
- -------------------------------------------------------------------------------------------------------------
Cash at end of year $ 0 $ 0 $ 3,506,945
- -------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
33
<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 began presenting its minority interest
in Maui Jim, Inc. under the equity method of accounting beginning December 1,
1996. Additionally in 1996, for comparative purposes, the Company restated
prior period financial information to present its 100% ownership in RLI
Vision Corp. under the equity method. This restatement was a change in
presentation only and had no impact on earnings. In January 1997, the Company
paid $3,694,118 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 were, at the time, 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 was 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 $.05 per diluted share,
for cumulative goodwill amortization from May 4, 1995, through November 30,
1996. Prior period financial information was not 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. 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 $1.93 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 of reinsurance. 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.
34
<PAGE>
As of December 31, 1997, the Company had 26 open earthquake claims from a
total of 688 claims reported from this occurrence. No additional development
from this event has occurred in 1996 or 1997. The Company continually
monitors all open earthquake claims and current reserve levels. Management
believes that the reserve strengthening performed in September 1995 is
sufficient to resolve the remaining outstanding liabilities.
D. INVESTMENTS: In compliance with Statement of Financial Accounting
Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," the Company classifies its investments in all debt
securities and those equity securities with readily determinable fair values
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 87% 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. These securities are reported at fair value with
unrealized gains and losses included in earnings. The Company has classified
approximately 3% of its portfolio of debt securities as trading.
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 net earnings but are
recorded as a separate component of comprehensive earnings and shareholders'
equity, net of deferred income taxes. All of the Company's equity securities
and approximately 10% of debt securities are classified as available-for-sale.
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 periodically charge to earnings an estimate of
unrecoverable amounts from troubled or insolvent reinsurers. During 1995 and
1996, the Company provided $613,296 and $1,006,140, respectively, for
uncollectible reinsurance balances. No additional charges occurred in 1997.
The Company believes that current reserve levels for uncollectible
reinsurance are sufficient to cover the related exposure.
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, 1997, 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
35
<PAGE>
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 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: In February 1997, the Financial Accounting Standards
Board (FASB) issued Statement No. 128, "Earnings Per Share" (Statement 128).
Statement 128 supersedes APB Opinion No. 15, "Earnings Per Share" (APB 15),
and specifies the computation, presentation, and disclosure requirements for
earnings per share (EPS) for entities with publicly held common stock or
potential common stock. Statement 128 is effective for financial statements
for both interim and annual periods ending after December 15, 1997. The
Company adopted this statement during the fourth quarter of 1997. All prior
period EPS data presented has been restated to conform to Statement 128.
Statement 128 replaces the presentation of primary EPS with a presentation of
basic EPS and fully diluted EPS with diluted EPS. Basic EPS, unlike primary
EPS, excludes dilution and is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for
the period. Diluted EPS reflects the dilution that could occur if securities
or other contracts to issue common stock (common stock equivalents) were
exercised or converted into common stock. Diluted EPS is computed similarly
to fully diluted EPS under APB 15. When inclusion of common stock equivalents
increases the earnings per share or reduces the loss per share, the effect on
earnings is antidilutive. Under these circumstances, the diluted net earnings
or net loss per share is computed excluding the common stock equivalents.
Pursuant to disclosure requirements contained in Statement 128, the following
represents a reconciliation of the numerator and denominator of the basic and
diluted EPS computations contained in the financial statements:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
For the year ended December 31, 1997
- -------------------------------------------------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
BASIC EPS
Income available to
common stockholders 30,171,483 8,321,787 3.63
EFFECT OF DILUTIVE SECURITIES
Convertible debentures 1,011,778 983,984
Incentive Stock Options -- 65,464
- -------------------------------------------------------------------------------------------------------
DILUTED EPS
Income available to common stock-
holders and assumed conversions 31,183,261 9,371,235 3.33
- -------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
</TABLE>
Conversion of the Company's $46.0 million convertible debenture occurred in July
1997. See note 4 for further discussion and related disclosures.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
For the year ended December 31, 1996
- -------------------------------------------------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
BASIC EPS
Income available to
common stockholders 25,695,721 7,896,463 3.25
EFFECT OF DILUTIVE SECURITIES
Convertible debentures 1,874,057 1,769,231
Incentive Stock Options -- 18,311
- -------------------------------------------------------------------------------------------------------
DILUTED EPS
Income available to common stock-
holders and assumed conversions 27,569,778 9,684,005 2.85
- -------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
</TABLE>
For the year ended December 31, 1995, the calculation of dilutive EPS was
anti-dilutive. As such, the effect of dilutive securities has been excluded.
EPS as stated on a basic and diluted basis were equal.
L. COMPREHENSIVE EARNINGS: Financial Accounting Standards Board (FASB)
Statement No. 130, "Reporting Comprehensive Income," was issued in June 1997
and becomes effective for interim and annual periods beginning after December
15, 1997. The Company has elected early adoption of this Statement. The
primary difference between reporting the Company's net and comprehensive
earnings is that comprehensive earnings include unrealized gains/losses net
of tax. Traditional reporting of net earnings directly credits or charges
shareholders' equity with unrealized gains/losses, rather than including them
in earnings. In reporting the
36
<PAGE>
components of comprehensive earnings on a net basis in the income statement,
the Company has used a 35% tax rate. Other comprehensive income, as shown, is
net of tax expense of $19,516,100, $8,760,550, and $12,613,250, respectively,
for 1997, 1996, and 1995.
M. 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.
N. STOCK BASED COMPENSATION: The Company grants to officers and directors
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.
O. 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 (60.0% of gross
property premiums written during 1997). 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 affect the
reported financial statement balances as well as the disclosure of contingent
assets and liabilities. Actual results could differ from those estimates. The
most significant of these amounts is the liability for unpaid losses and
settlement expenses. Management continually updates its estimates as
additional data becomes available and adjusts the financial statements
37
<PAGE>
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 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>
- -----------------------------------------------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
Interest on fixed maturities $19,659,280 $18,862,096 $17,333,118
Dividends on equity securities 6,360,835 5,715,310 5,444,146
Interest on short-term investments 1,530,587 1,572,512 1,893,693
- -----------------------------------------------------------------------------
Gross investment income 27,550,702 26,149,918 24,670,957
Less investment expenses 2,992,858 2,469,167 2,641,876
- -----------------------------------------------------------------------------
Net investment income $24,557,844 $23,680,751 $22,029,081
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
</TABLE>
Pretax net realized investment gains (losses) and net changes in unrealized
appreciation/depreciation of investments for the years ended December 31 are
summarized as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Net realized investment gains (losses)
Fixed maturities
Held-to-maturity $ 27,184 $ 10,656 $ (21,428)
Trading 117,015 -- --
Available-for-sale 175,262 24,043 6,324
Equity securities 2,036,996 361,301 471,614
Other 625,427 621,572 --
- -------------------------------------------------------------------------------------
2,981,884 1,017,572 456,510
- -------------------------------------------------------------------------------------
Net changes in unrealized appreciation/depreciation on investments
Fixed maturities
Held-to-maturity 4,030,409 (6,577,271) 21,130,309
Available-for-sale 99,771 (750,734) 1,605,070
Equity securities 55,660,296 25,785,456 34,432,410
- -------------------------------------------------------------------------------------
59,790,476 18,457,451 57,167,789
- -------------------------------------------------------------------------------------
Net realized investment gains (losses)
and changes in unrealized
appreciation/depreciation
on investments $62,772,360 $19,475,023 $57,624,299
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
</TABLE>
Following is a summary of the disposition of fixed maturities for the years
ended December 31, with separate presentations for sales and calls/maturities.
SALES
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------
Proceeds Gross Realized Net Realized
from sales Gains Losses gain (loss)
- ---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997
Available-for-sale 8,385,633 259,073 (83,538) 175,535
Trading 4,353,523 16,308 (25,435) (9,127)
1996
Available-for-sale 8,297,553 84,116 (59,117) 24,999
1995
Available-for-sale 3,383,745 15,447 (7,875) 7,572
- ---------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------
CALLS/MATURITIES
- ---------------------------------------------------------------------------------
Proceeds Gross Realized Net Realized
from sales Gains Losses gain (loss)
- ---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997
Held-to-maturity 29,083,072 47,575 (20,391) 27,184
Available-for-sale 1,303,520 -- (273) (273)
Trading 55,000 -- (152) (152)
1996
Held-to-maturity 17,380,750 11,305 (649) 10,656
Available-for-sale 2,860,000 -- (956) (956)
1995
Held-to-maturity 25,234,977 11,569 (32,997) (21,428)
Available-for-sale 3,730,000 -- (1,248) (1,248)
- ---------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------
</TABLE>
38
<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, 1997
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>
1997
Held-to-maturity
U.S. governments $153,767,160 $156,388,429 $ 2,963,462 $ (342,193)
States, political subdi-
visions & revenues 136,267,149 140,419,278 4,167,111 (14,982)
- -------------------------------------------------------------------------------------------------------
Total held-to-maturity $290,034,309 $296,807,707 $ 7,130,573 $ (357,175)
- -------------------------------------------------------------------------------------------------------
Trading
U.S. governments $ 3,655,128 $ 3,712,755 $ 60,508 $ (2,881)
Foreign governments 440,589 448,026 7,437 --
Corporate 4,919,479 4,977,849 58,739 (369)
States, political subdi-
visions & revenues 404,082 406,942 2,860 --
- -------------------------------------------------------------------------------------------------------
Total trading $ 9,419,278 $ 9,545,572 $ 129,544 $ (3,250)
- -------------------------------------------------------------------------------------------------------
Available-for-sale
U.S. governments $ 20,248,316 $ 20,464,950 $ 298,818 $ (82,184)
Corporate 6,342,006 6,472,500 308,013 (177,519)
States, political subdi-
visions & revenues 7,051,370 7,182,752 137,183 (5,801)
- -------------------------------------------------------------------------------------------------------
Fixed maturities 33,641,692 34,120,202 744,014 (265,504)
Equity securities 118,637,390 251,459,843 133,273,484 (451,031)
- -------------------------------------------------------------------------------------------------------
Total available-for-sale $152,279,082 $285,580,045 $134,017,498 $ (716,535)
- -------------------------------------------------------------------------------------------------------
Total $451,732,669 $591,933,324 $141,277,615 $(1,076,960)
- -------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<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, 1997, 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 $ 25,941,100 $ 26,090,333
Due after one year through five years 87,593,749 89,860,158
Due after five years through ten years 114,837,073 117,526,152
Due after ten years 61,662,387 63,331,064
- -------------------------------------------------------------------------------------
$290,034,309 $296,807,707
- -------------------------------------------------------------------------------------
Trading
Due in one year or less $ 40,022 $ 39,988
Due after one year through five years 6,790,826 6,842,536
Due after five years through ten years 2,588,430 2,663,048
Due after ten years -- --
- -------------------------------------------------------------------------------------
$ 9,419,278 $ 9,545,572
- -------------------------------------------------------------------------------------
Available-for-sale
Due in one year or less -- --
Due after one year through five years $ 17,582,264 $ 17,907,564
Due after five years through ten years 13,173,845 13,117,858
Due after ten years 2,885,583 3,094,780
- -------------------------------------------------------------------------------------
$ 33,641,692 $ 34,120,202
- -------------------------------------------------------------------------------------
</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, 1997, the net unrealized appreciation of available-for-sale
fixed maturities and equity securities totaled $86,852,663. This amount was
net of deferred taxes of $46,448,300. 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, 1997 and 1996, fixed maturities with a fair value of
$91,140,762 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.
39
<PAGE>
As required by law, certain fixed maturities and short-term investments
amounting to $13,572,523 at December 31, 1997, were on deposit with either
regulatory authorities or banks. Additionally, the Company has certain fixed
maturities held in trust amounting to $9,545,572 at December 31, 1997. These
funds cover net premiums, losses, and expenses related to a property and
casualty insurance program.
The Company does not invest in derivative securities or collateralized
mortgage obligations (CMOs).
3. POLICY ACQUISITION COSTS
Policy acquisition costs deferred and amortized to income for the years ended
December 31 are summarized as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
1997 1996 1995
- ----------------------------------------------------------------------------
<S> <C> <C> <C>
Deferred policy acquisition
costs, beginning of year $16,663,603 $15,806,911 $19,208,212
- ----------------------------------------------------------------------------
Deferred:
Direct commissions 57,033,823 46,740,471 44,232,003
Premium taxes 4,381,914 4,034,201 4,185,861
Other direct underwriting
expenses 16,340,350 14,194,203 12,122,153
Ceding commissions (27,811,748) (31,056,079) (24,666,527)
- ----------------------------------------------------------------------------
Net deferred 49,944,339 33,912,796 35,873,490
- ----------------------------------------------------------------------------
Amortized 44,623,357 33,056,104 39,274,791
- ----------------------------------------------------------------------------
Deferred policy acquisition
costs, end of year $21,984,585 $16,663,603 $15,806,911
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
Policy acquisition costs:
Amortized to expense 44,623,357 33,056,104 39,274,791
Period costs:
Ceding commission--contingent (4,399,983) (5,275,063) (456,527)
Other 2,917,007 1,775,349 4,223,781
- ----------------------------------------------------------------------------
Total policy acquisition costs $43,140,381 $29,556,390 $43,042,045
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
</TABLE>
4. DEBT
On July 28, 1993, the Company issued $46.0 million of 6.0% convertible
debentures that were to 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, were
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. The
Company retained 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. On June 20, 1997, the Company announced
that it was calling for redemption all convertible debentures. The entire
issue was to be redeemed for cash on July 22, 1997 at 103% of its principal
amount, plus accrued interest. Holders of the debenture had the option to
convert, at any time prior to the close of business on July 21, 1997, the
debentures at an exchange rate of 38.4615 shares of RLI common stock for each
$1,000 principal amount of convertible debt. On July 22, 1997, the entire
$46.0 million had been converted into RLI common stock. This conversion
created an additional 1,769,199 new shares of RLI common stock.
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, using excess funds from operations.
During 1997 the Company utilized its short-term credit facilities, as well as
engaged in two reverse repurchase transactions, to partially fund the
Company's common stock repurchase program.
Interest paid on outstanding debt for 1997, 1996, and 1995 amounted to
$2,809,903, $2,834,192, and $3,372,479, respectively.
The Company maintains two sources of credit from one financial institution: 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, 1997, the Company had
$9,958,000 in outstanding short-term borrowings. Additionally, the Company
was party to two reverse repurchase transactions totaling $14,942,000.
40
<PAGE>
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 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 1997 1996 1995
- ---------------------------------------------------------------------------------
<S> <C> <C> <C>
Direct $ 265,850,308 $ 276,707,492 $ 270,887,545
Reinsurance assumed 12,992,936 93,811 548,601
Reinsurance ceded (134,169,548) (144,443,663) (140,983,251)
- ---------------------------------------------------------------------------------
Net $ 144,673,696 $ 132,357,640 $ 130,452,895
- ---------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------
EARNED 1997 1996 1995
- ---------------------------------------------------------------------------------
Direct $ 268,569,271 $ 271,551,708 $ 264,651,370
Reinsurance assumed 11,512,757 32,713 588,362
Reinsurance ceded (138,197,583) (140,928,326) (131,771,599)
- ---------------------------------------------------------------------------------
Net $ 141,884,445 $ 130,656,095 $ 133,468,133
- ---------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------
LOSSES AND SETTLEMENT
EXPENSES INCURRED 1997 1996 1995
- ---------------------------------------------------------------------------------
Direct $ 96,378,982 $109,527,903 $160,294,644
Reinsurance assumed 5,960,495 10,256 809,657
Reinsurance ceded (41,088,043) (41,276,852) (75,214,306)
- ---------------------------------------------------------------------------------
Net $ 61,251,434 $68,261,307 $ 85,889,995
- ---------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------
</TABLE>
At December 31, 1997, 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 $67,733,602. 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, 1997. 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).
41
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
(In thousands) 1997 1996 1995
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Unpaid losses and LAE at beginning of year:
Gross $ 405,801 $ 418,986 $ 394,966
Ceded (165,017) (197,338) (199,737)
- ----------------------------------------------------------------------------------------
Net 240,784 221,648 195,229
- ----------------------------------------------------------------------------------------
Increase (decrease) in incurred losses and LAE:
Current accident year 61,771 69,724 62,619
Prior accident years (520) (1,463) 23,271
- ----------------------------------------------------------------------------------------
Total incurred 61,251 68,261 85,890
- ----------------------------------------------------------------------------------------
Loss and LAE payments for claims incurred:
Current accident year (11,284) (11,026) (10,586)
Prior accident years (47,999) (37,505) (48,023)
- ----------------------------------------------------------------------------------------
Total paid (59,283) (48,531) (58,609)
- ----------------------------------------------------------------------------------------
Insolvent reinsurer charge off (627) 607 514
Loss reserves commuted 429 (1,201) (1,376)
- ----------------------------------------------------------------------------------------
Net unpaid losses and LAE at end of year $ 242,554 $ 240,784 $ 221,648
- ----------------------------------------------------------------------------------------
Unpaid losses and LAE at end of year:
Gross 404,264 405,801 418,986
Ceded (161,710) (165,017) (197,338)
- ----------------------------------------------------------------------------------------
Net $ 242,554 $ 240,784 $ 221,648
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
</TABLE>
During 1997 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 table on the following page represents inception-to-date paid and unpaid
environmental claims data (including incurred but not reported losses) for
the periods ended 1997, 1996 and 1995:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Inception-to-date December 31,
(In thousands) 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Loss and LAE payments for claims incurred
Gross $11,570 $ 8,267 $ 5,117
Ceded (7,646) (5,761) (3,842)
- --------------------------------------------------------------------------------
Net $ 3,924 $ 2,506 $ 1,275
- --------------------------------------------------------------------------------
Unpaid losses and LAE at end of year
Gross $14,880 $ 17,596 $20,154
Ceded (8,842) (11,150) (13,398)
- --------------------------------------------------------------------------------
Net $ 6,038 $ 6,446 $ 6,756
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
Although the Company's environmental exposure is limited as a result of
entering the liability lines after the industry had already recognized it as
a problem, management cannot determine the Company's ultimate liability 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>
- -----------------------------------------------------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
DEFERRED TAX ASSETS:
Tax discounting of claim reserves $ 14,775,459 $ 12,874,704 $15,635,860
Unearned premium offset 5,521,050 5,326,460 5,307,695
Other, net 3,015,624 492,246 2,365,467
- -----------------------------------------------------------------------------------
23,312,133 18,693,410 23,309,022
Less valuation allowance (300,000) (300,000) (300,000)
- -----------------------------------------------------------------------------------
Total deferred tax assets $ 23,012,133 $ 18,393,410 $23,009,022
- -----------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES:
Net unrealized appreciation
of securities $ 46,448,400 $ 26,932,200 $18,171,600
Deferred policy acquisition costs 7,694,605 5,832,261 5,532,419
Book/tax depreciation 1,606,493 1,349,846 1,535,324
Other, net 3,602,436 1,449,790 2,673,306
- -----------------------------------------------------------------------------------
Total deferred tax liabilities 59,351,934 35,564,097 27,912,649
- -----------------------------------------------------------------------------------
Net deferred tax asset (liability) $(36,339,801) $(17,170,687) $(4,903,627)
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
</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.
42
<PAGE>
Income tax expense attributable to income from operations for the years ended
December 31, 1997, 1996, and 1995 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>
- -------------------------------------------------------------------------------------
1997 1996 1995
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
Provision for income taxes at
the statutory federal tax rates $14,532,759 $12,334,011 $2,739,113
Increase (reduction) in taxes
resulting from:
Dividends received deduction (1,321,942) (1,216,013) (1,170,146)
Dividends paid deduction (235,527) (258,252) (265,754)
Tax exempt interest income (1,876,087) (1,566,608) (1,428,846)
State income tax provision 159,835 131,755 127,205
Other items, net 91,647 119,416 (125,076)
- -------------------------------------------------------------------------------------
$11,350,685 $9,544,309 $ (123,504)
- -------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
</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 1997, 1996, and 1995
amounted to $11,130,299, $1,415,994, and $(794,741), respectively.
The Internal Revenue Service (IRS) has examined the Company's income tax
returns through the tax year ended December 31, 1990. 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 contribution required under
the Employee Retirement Income Security Act of 1974 or more than the maximum
tax deductible contribution for the year. The plan reached the full funding
limitation in 1986 and remained fully funded through 1993. During 1995, 1996,
and 1997, the Company made the maximum tax deductible contribution allowed,
totaling $397,158, $413,977, and $453,146, 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>
- --------------------------------------------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost $ 414,301 $419,349 $277,870
Interest cost 291,324 270,965 239,607
Actual return on assets (852,855) (403,266) (796,106)
Net amortization and deferral 470,527 68,323 486,482
- --------------------------------------------------------------------------------
Net pension expense $ 323,297 $355,371 $207,853
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
The following table sets forth the plan's funded status at December 31, 1997
and 1996:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Actuarial present value of benefit obligation:
Accumulated benefit obligation:
Vested $2,817,578 $2,855,363
Nonvested 404,882 241,590
- --------------------------------------------------------------------------------
$3,222,460 $3,096,953
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Projected benefit obligation $4,416,028 $4,039,460
Plan assets at fair market value 4,157,321 3,328,525
- --------------------------------------------------------------------------------
Plan assets under
projected benefit obligation $(258,707) $(710,935)
Unrecognized net asset at January 1,
being amortized over 17.2 years (201,913) (234,479)
Unrecognized prior service cost 6,265 9,316
Unrecognized net loss 113,649 465,543
- --------------------------------------------------------------------------------
Accrued pension costs $(340,706) $ (470,555)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
At December 31, 1997, plan assets at fair value are comprised of
approximately 94% equity securities and 6% invested cash.
In 1997, the Company used the following rates to determine its projected
benefit obligation: 7.25% settlement rate, 6% increase in salary, and 10%
expected long-term return on plan assets. In 1996, the Company used a
settlement rate of 7.5%, an increase in salary levels of 6%, and an expected
long-term return on plan assets of 10% in determining the projected benefit
obligation.
43
<PAGE>
EMPLOYEE STOCK OWNERSHIP AND BONUS AND 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. Beginning in
1997, the Company established an additional provision allowing for employee
bonus participation.
MVP requires that the Company generate a return on equity in excess of its
cost of capital before either the funding of the ESOP or the payment of
employee or 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 employees and officers of the Company and its
shareholders. Employees can receive a maximum of 1% of the excess on an
after-tax basis, while officers can receive a maximum of 8% of the excess on
an after-tax basis. All remaining funds are reinvested in the Company for the
benefit of the shareholders. MVP further restricts the officer payout in a
given year. Officer payout is restricted to 60% of the combination of bonuses
earned in the previous fiscal year plus any unpaid balance carried forward
from prior years. 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
1997, $5,390,191 (7.91% of the excess return) was earned by officers under
the plan. The actual officer payout of $3,857,990 (60% of bonus earned and
bank balance for previous fiscal year) was completed in January 1998.
Additionally, employee bonuses totaling $688,700 were earned under the plan
in 1997 and were fully paid in January 1998. In 1996, $2,810,050 (7.07% of
the excess return) was earned by officers under the 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 1997, 1996, and 1995, the Company recognized expense of $2,565,350,
$2,791,463, and $2,046,474, respectively, related to the ESOP. At its
December 1997 meeting, the board voted in favor of making a contribution to
the ESOP for 1997 based on the MVP projections for the year. In 1996 and
1995, the board had authorized this contribution as well.
During 1997, the ESOP purchased 63,841 shares of the Company's common stock
on the open market at an average price of $33.28 ($2,124,461). During 1996,
the ESOP purchased 76,500 shares of the Company's treasury stock at an
average price of $25.38 ($1,941,288). During 1995, no shares were purchased.
All shares held by the ESOP are treated as outstanding in computing the
Company's earnings per share. Dividends on ESOP shares are passed through to
the participants.
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 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 1997, 1996, and 1995, the Company recognized
expenses of $158,600, $139,075, and $145,550, respectively, under these
plans. In 1997, the Rabbi Trusts purchased 7,743 shares of the Company's
common stock on the open market at an average price of $39.52 ($306,027). 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, 1997, the Trusts' assets were valued at
$6,432,355.
STOCK OPTION PLAN
During 1995, the Company adopted and the shareholders approved an Incentive
Stock Option Plan (the Incentive Plan). During 1997, the shareholders
approved the Outside Directors' Stock Option Plan (the Directors' 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:
44
<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income: As reported $30,171,483 $25,695,721 $7,949,541
Pro forma 29,789,406 25,462,490 7,862,144
- --------------------------------------------------------------------------------
Diluted EPS: As reported $3.33 $2.85 $1.01
Pro forma 3.29 2.82 $1.00
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
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 Incentive 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. Full vesting of
options granted occurs at the end of five years.
Under the Directors' Plan, shares granted are not incentive stock options.
Directors may be granted non-qualified options to purchase shares at 100% of
the grant date fair market value. An optionee must exercise an option within
10 years from the grant date. Full vesting occurs at the end of three years,
except in the case of death, disability, or termination of Director status,
at which time all options become fully vested and exercisable.
Additionally, subject to the Directors' Plan's approval by shareholders, the
Directors' Plan included a grant of 24,000 shares (3,000 per Director)
effective on May 2, 1996. Shareholder approval occurred at the May 1997
shareholder meeting. As a result, 1996 plan data, as provided, has been
restated to include the impact of this grant.
The Company may grant options for up to 1,250,000 shares under the Incentive
Plan and 200,000 shares under the Directors' Plan. Through December 31, 1997,
the Company has granted 232,875 options under these plans. Under both plans,
the option exercise price equals the stock's market price on the date of
grant.
A summary of the status of the plans at December 31, 1997, 1996 and 1995, and
changes during the years then ended are presented in the following table and
narrative:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------------------------------------
Number Weighted-Average Number Weighted-Average Number Weighted-Average
of Shares Exercise Price of Shares Exercise Price of Shares Exercise Price
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year 145,300 $22.15 65,625 $20.60 -- --
Granted 83,600 33.59 83,650 23.29 65,625 $20.60
Exercised 7,025 22.97 -- -- -- --
Forfeited -- -- 3,975 20.60 -- --
- --------------------------------------------------------------------------------------------------------------
Outstanding at
end of year 221,875 26.43 145,300 22.15 65,625 $20.60
- --------------------------------------------------------------------------------------------------------------
Exercisable at
end of year 40,330 21.81 12,550 20.60 -- --
Weighted-average fair
value of options
granted during year $10.97 $ 7.81 $7.00
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
</TABLE>
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 1997, 1996 and 1995, respectively: risk-free
interest rates of 6.64%, 6.82% and 6.67%; expected dividend yields of 3.10%,
3.15% and 3.14%; expected lives of 10 years; and expected volatility of
26.30%, 27.35% and 28.46%.
Information on the range of exercise prices for options outstanding as of
December 31, 1997, is as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Options Outstanding Options Exercisable
- --------------------------------------------------------------------------------
Weighted
Average Weighted- Weighted-
Outstanding Remaining Average Exercisable Average
Range of as of Contractual Exercise as of Exercise
Exercise Price 12/31/97 Life Price 12/31/97 Price
<S> <C> <C> <C> <C> <C>
$ 0.00-$20.60 58,775 7.6 $20.60 21,950 $20.60
$20.61-$24.00 77,100 8.3 $22.95 17,780 $22.94
$24.01-$32.50 74,200 9.3 $32.50 600 $32.50
- --------------------------------------------------------------------------------
$32.51-$44.88 11,800 9.5 $40.13 0 $0.00
- --------------------------------------------------------------------------------
221,875 8.5 $26.43 40,330 $21.81
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
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."
45
<PAGE>
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) 1997 1996 1995
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
Consolidated net income (loss),
statutory basis $26,896,695 $29,486,443 $12,638,658
Proposition 103 liability -- 2,499,680 --
Deferred policy acquisition costs 5,320,982 856,692 (3,401,296)
Deferred income
tax benefit (expense) 346,886 (3,506,460) 854,229
Net income of non-insurance
operations, interest expense
on debt and general corporate
expense (2,328,239) (3,605,318) (2,038,397)
Other (64,841) (35,316) (103,653)
- -----------------------------------------------------------------------------
As reported in accompanying
financial statements $30,171,483 $25,695,721 $ 7,949,541
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
December 31,
Shareholders' Equity 1997 1996
- -----------------------------------------------------------------------------
<S> <C> <C>
Consolidated surplus, statutory basis $265,526,172 $207,786,596
Deferred policy acquisition costs 21,984,585 16,663,603
Non-admitted assets 2,738,031 1,862,610
Subsidiary ownership in RLI Corp. (11,412,337) --
Deferred tax liability (36,339,801) (17,170,687)
Statutory liability for reinsurance 881,200 3,813,800
Proceeds from RLI Corp. debt
contributed to RLI Insurance Co. -- (30,500,000)
Equity of non-insurance companies 22,427,483 17,038,853
Other 747,107 544,586
- -----------------------------------------------------------------------------
As reported in accompanying
financial statements $266,552,440 $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 1998 without prior notice or approval amounts to
$26,552,617--10% of RLI Insurance Company's 1997 policyholder surplus. The
actual amount paid to the Company during 1997 was $16,678,225.
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. During 1997, the Company issued
refund checks to policyholders. As of December 31, 1997, the total unclaimed
refund amounted to $1,526,283. Any amounts unclaimed as of November 1, 1998
will escheat to the California Division of Unclaimed Property.
The Company leases regional office facilities and automobiles under operating
leases expiring in various years through 2002. Minimum future rental payments
under non-cancellable operating leases are as follows:
<TABLE>
<CAPTION>
<S> <C>
1998 $ 879,852
1999 892,685
2000 835,894
2001 717,252
2002 425,417
-----------
Total minimum future rental payments $3,751,100
-----------
-----------
</TABLE>
46
<PAGE>
11. INDUSTRY SEGMENT INFORMATION
Selected information by industry segment for 1997, 1996, and 1995 is
summarized in the chart below.
RLI Insurance Group: Specialty coverages of property and casualty insurance
provided on a direct basis, primarily on commercial risks.
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>
1997--
RLI Insurance Group--Property $ 62,028,217 $ 21,409,581 $872,553,044
RLI Insurance Group--Casualty 68,365,056 (3,184,502)
RLI Insurance Group--Surety 11,491,172 526,174
Net investment income 24,557,844 24,557,844
Net realized investment losses 2,981,884 2,981,884
Equity in earnings of unconsolidated
investee 950,768 13,615,577
General corporate and interest expense (5,719,581) 25,571,984
- -------------------------------------------------------------------------------------------
Consolidated $169,424,173 $ 41,522,168 $911,740,605
- -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
1996--
RLI Insurance Group--Property $ 48,181,678 $ 18,830,859 $809,315,884
RLI Insurance Group--Casualty 78,067,784 (2,028,201)
RLI Insurance Group--Surety 4,406,633 (405,592)
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 8,970,691
General corporate and interest expense (6,086,100) 27,187,209
- -------------------------------------------------------------------------------------------
Consolidated $155,354,418 $ 35,240,030 $845,473,784
- -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
1995--
RLI Insurance Group--Property $ 50,820,350 $(10,243,636) $787,812,455
RLI Insurance Group--Casualty 79,690,875 1,003,179
RLI Insurance Group--Surety 2,956,908 (693,503)
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 7,856,130
General corporate and interest expense (5,440,412) 14,531,373
- -------------------------------------------------------------------------------------------
Consolidated $155,953,724 $ 7,826,037 $810,199,958
- -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
</TABLE>
47
<PAGE>
12. UNAUDITED INTERIM FINANCIAL INFORMATION
Selected quarterly information is as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
First Second Third Fourth Year
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997
Net premiums earned $33,065,635 $35,974,352 $35,895,116 $36,949,342 $141,884,445
Net investment income 6,021,551 5,999,346 6,246,661 6,290,286 24,557,844
Net realized investment gains (losses) 560,024 1,734,460 544,529 142,871 2,981,884
Earnings (loss) before income taxes 8,869,278 11,006,361 10,848,720 10,797,809 41,522,168
Net earnings (loss) 6,555,785 7,983,669 7,896,720 7,735,309 30,171,483
Basic earnings per share (1) $0.85 $1.05 $0.88 $0.86 $3.63
Basic operating earnings per share (1) (2) $0.80 $0.90 $0.84 $0.85 $3.40
Diluted earnings per share (1) $0.74 $0.90 $0.84 $0.85 $3.33
Diluted operating earnings per share (1) (2) $0.70 $0.78 $0.81 $0.84 $3.12
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
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
Basic earnings per share (1) $0.70 $0.80 $0.86 $0.89 $3.25
Basic operating earnings per share (1) (2) $0.69 $0.81 $0.86 $0.82 $3.17
Diluted earnings per share (1) $0.62 $0.71 $0.75 $0.77 $2.85
Diluted operating earnings per share (1) (2) $0.61 $0.71 $0.75 $0.72 $2.78
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) 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.
(2) Operating earnings per share is calculated by reducing net earnings by
the after-tax impact of net realized investment gains.
48
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The board of directors and shareholders
RLI Corp.
We have audited the accompanying consolidated balance sheets of RLI Corp. and
Subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of earnings and comprehensive earnings, shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
1997. 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, 1997 and 1996, and the results of their
operations and their cash flows for each of the years in the three-year
period ended December 31, 1997, in conformity with generally accepted
accounting principles.
January 21, 1998
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, 1997, the Company's system of internal controls was
adequate to accomplish the objectives described herein.
The audit committee is comprised solely of four non-employee directors and is
charged with general supervision of the audits, examinations and inspections
of the books and accounts of RLI Corp. and Subsidiaries. It also recommends
to the board of directors the firm of independent public accountants to be
engaged to audit the annual consolidated financial statements, and it meets
regularly with those independent public accountants and with management, both
separately and together. The independent public accountants and the internal
auditor have ready access to the audit committee.
Gerald D. Stephens, CPCU
President, RLI Corp.
Joseph E. Dondanville, CPA
Vice President, Chief Financial Officer, RLI Corp.
49
<PAGE>
INVESTOR INFORMATION
ANNUAL MEETING
The annual meeting of shareholders will be held at 2:00 p.m., local time, on
May 7, 1998, at the company's offices at 9025 N. Lindbergh Drive, Peoria, IL.
REQUESTS FOR ADDITIONAL INFORMATION
Additional copies of this report and the Annual Report to the Securities and
Exchange Commission, Form 10-K, are available without charge to any
shareholder. Additionally, "Street Name" shareholders can have their names
placed on a mailing list to receive copies of annual reports, quarterly
reports, and other shareholder materials. Simply contact the treasurer at our
corporate headquarters.
TRADING AND DIVIDEND INFORMATION
RLI common stock trades on the New York Stock Exchange under the symbol RLI.
The following table sets forth the high and low sale prices, as well as the
closing prices, for the common stock for the indicated periods as reported by
the NYSE. The table also indicates cash dividends as declared by the company.
<TABLE>
<CAPTION>
Stock Price Dividends
High Low Close Declared
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
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
- --------------------------------------------------------------------------------
1997
1st Quarter 36 5/8 31 7/8 31 7/8 $.14
2nd Quarter 36 3/4 30 1/2 36 7/16 .15
3rd Quarter 45 1/16 34 1/2 45 .15
4th Quarter 50 1/4 40 3/4 49 13/16 .15
- --------------------------------------------------------------------------------
</TABLE>
RLI Corp. normally pays dividends four times a year, usually on January 15,
April 15, July 15 and October 15. The company has paid and increased
dividends for 21 consecutive years. RLI dividends qualify for the enterprise
zone dividend subtraction modification for Illinois state income tax returns.
DIVIDEND REINVESTMENT PLANS
An Automatic Dividend Reinvestment and Stock Purchase Plan is offered to
shareholders of RLI on a voluntary basis. Shareholders may also have their
dividends deposited directly into their checking, savings or money market
accounts. If you wish to sign up for either Plan, send your request to
"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]
STOCK OWNERSHIP
At December 31, 1997, RLI stock ownership was as follows:
<TABLE>
<CAPTION>
Shares %
- -------------------------------------------------------------------
<S> <C> <C>
Insiders 699,847 8.1
ESOP 1,060,467 12.3
Institutions 5,093,075 59.0
Other public 1,780,865 20.6
- -------------------------------------------------------------------
8,634,254 100.0
</TABLE>
CONTACTING RLI
CORPORATE HEADQUARTERS
9025 N. 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.
FORWARD LOOKING STATEMENTS
Forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934
appear throughout this report. These statements relate to the company's
expectations, hopes, beliefs, intentions, goals or strategies regarding the
future and are based on certain underlying assumptions by the company. Such
assumptions are, in turn, based on information available and internal
estimates and analyses of general economic conditions, competitive factors,
conditions specific to the property and casualty insurance industry, claims
development and the impact thereof on the company's loss reserves, the
adequacy of the company's reinsurance programs, developments in the
securities markets and the impact on the company's investment portfolio,
regulatory changes and conditions, and other factors. Actual results could
differ materially from those in forward-looking statements. The company
assumes no obligation to update any such statements. You should review the
various risks, uncertainties and other factors listed from time to time in
the company's Securities and Exchange Commission filings.
53
<PAGE>
Exhibit 21.1
Subsidiaries of the Registrant
The following companies are subsidiaries of the Registrant as of December 31,
1997.
Jurisdiction of Percentage
Name Incorporation Ownership
- ---- ---------------- ----------
RLI Insurance Company Illinois 100%
RLI Aviation, Inc. Illinois 100%
Replacement Lens Inc. Illinois 100%
Mt. Hawley Insurance Company Kansas 100%
RLI Insurance Ltd. Bermuda 100%
RLI Insurance Agency Ltd. Canada 100%
35
<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) of RLI Corp. of our reports dated January 21, 1998,
relating to the consolidated balance sheets of RLI Corp. and subsidiaries as
of December 31, 1997 and 1996, and the related consolidated statements of
earnings and comprehensive earnings, shareholders' equity, and cash flows for
each of the years in the three-year period ended December 31, 1997, and all
related schedules, which reports are incorporated by reference in, or appear
in (with respect to the schedules), the 1997 annual report on Form 10-K of
RLI Corp.
KPMG Peat Marwick LLP
Chicago, Illinois
March 20, 1998
36
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<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, 1997, ATTACHED AS EXHIBIT 13 TO RLI CORP.'S
FORM 10-K 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-31-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 43,666
<DEBT-CARRYING-VALUE> 290,034
<DEBT-MARKET-VALUE> 296,808
<EQUITIES> 251,460
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 603,857
<CASH> 0
<RECOVER-REINSURE> 30,720
<DEFERRED-ACQUISITION> 21,985
<TOTAL-ASSETS> 911,741
<POLICY-LOSSES> 242,554
<UNEARNED-PREMIUMS> 128,543
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 24,900
0
0
<COMMON> 10,229
<OTHER-SE> 256,322
<TOTAL-LIABILITY-AND-EQUITY> 911,741
141,884
<INVESTMENT-INCOME> 24,558
<INVESTMENT-GAINS> 2,982
<OTHER-INCOME> 951
<BENEFITS> 61,251
<UNDERWRITING-AMORTIZATION> 43,140
<UNDERWRITING-OTHER> 18,741
<INCOME-PRETAX> 41,522
<INCOME-TAX> 11,351
<INCOME-CONTINUING> 30,171
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 30,171
<EPS-PRIMARY> 3.63
<EPS-DILUTED> 3.33
<RESERVE-OPEN> 240,784
<PROVISION-CURRENT> 61,771
<PROVISION-PRIOR> (520)
<PAYMENTS-CURRENT> 11,284
<PAYMENTS-PRIOR> 47,999
<RESERVE-CLOSE> 242,554
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<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, 1997, ATTACHED AS EXHIBIT 13 TO
RLI CORP.'S FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1995
<PERIOD-END> DEC-31-1996 DEC-31-1995
<DEBT-HELD-FOR-SALE> 44,904 45,120
<DEBT-CARRYING-VALUE> 263,282 251,638
<DEBT-MARKET-VALUE> 266,025 260,958
<EQUITIES> 188,935 153,958
<MORTGAGE> 0 0
<REAL-ESTATE> 0 0
<TOTAL-INVEST> 537,946 471,599
<CASH> 0 0
<RECOVER-REINSURE> 37,167 36,447
<DEFERRED-ACQUISITION> 16,664 15,807
<TOTAL-ASSETS> 845,474 810,200
<POLICY-LOSSES> 240,784 221,649
<UNEARNED-PREMIUMS> 129,782 126,014
<POLICY-OTHER> 0 0
<POLICY-HOLDER-FUNDS> 0 0
<NOTES-PAYABLE> 46,000 48,800
0 0
0 0
<COMMON> 8,453 8,453
<OTHER-SE> 191,586 150,155
<TOTAL-LIABILITY-AND-EQUITY> 845,474 810,200
130,656 133,468
<INVESTMENT-INCOME> 23,681 22,029
<INVESTMENT-GAINS> 1,018 457
<OTHER-INCOME> 231 715
<BENEFITS> 68,261 85,890
<UNDERWRITING-AMORTIZATION> 29,556 43,042
<UNDERWRITING-OTHER> 16,441 14,470
<INCOME-PRETAX> 35,240 7,826
<INCOME-TAX> 9,544 (123)
<INCOME-CONTINUING> 25,696 7,950
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 25,696 7,950
<EPS-PRIMARY> 3.25 1.01
<EPS-DILUTED> 2.85 1.01
<RESERVE-OPEN> 221,648 195,229
<PROVISION-CURRENT> 69,724 62,619
<PROVISION-PRIOR> (1,463) 23,271
<PAYMENTS-CURRENT> 11,026 10,586
<PAYMENTS-PRIOR> 37,505 48,023
<RESERVE-CLOSE> 240,784 221,784
<CUMULATIVE-DEFICIENCY> 0 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
PERIODS PRESENTED HAVE BEEN STATED IN ACCORDANCE WITH FASB 128, EARNINGS PER
SHARE.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997
<PERIOD-END> MAR-31-1997 JUN-30-1997 SEP-30-1997
<DEBT-HELD-FOR-SALE> 44,810 42,213 47,301
<DEBT-CARRYING-VALUE> 270,406 271,852 286,558
<DEBT-MARKET-VALUE> 268,589 273,591 291,161
<EQUITIES> 192,129 220,430 233,780
<MORTGAGE> 0 0 0
<REAL-ESTATE> 0 0 0
<TOTAL-INVEST> 513,664 551,137 572,223
<CASH> 0 0 0
<RECOVER-REINSURE> 51,686 56,229 43,060
<DEFERRED-ACQUISITION> 22,498 24,485 22,831
<TOTAL-ASSETS> 839,015 890,633 898,496
<POLICY-LOSSES> 243,006 243,939 245,660
<UNEARNED-PREMIUMS> 130,273 135,436 129,964
<POLICY-OTHER> 0 0 0
<POLICY-HOLDER-FUNDS> 0 0 0
<NOTES-PAYABLE> 46,000 46,000 0
0 0 0
0 0 0
<COMMON> 8,454 8,454 10,224
<OTHER-SE> 191,557 215,613 269,489
<TOTAL-LIABILITY-AND-EQUITY> 839,015 890,633 898,496
33,066 69,040 104,935
<INVESTMENT-INCOME> 6,022 12,021 18,268
<INVESTMENT-GAINS> 560 2,294 2,839
<OTHER-INCOME> 244 540 860
<BENEFITS> 15,703 31,354 46,578
<UNDERWRITING-AMORTIZATION> 9,963 20,894 32,213
<UNDERWRITING-OTHER> 3,784 8,546 13,069
<INCOME-PRETAX> 8,869 19,876 30,724
<INCOME-TAX> 2,313 5,336 8,288
<INCOME-CONTINUING> 6,556 14,540 22,436
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 6,556 14,540 22,436
<EPS-PRIMARY> 0.85 1.90 2.77
<EPS-DILUTED> .74 1.63 2.48
<RESERVE-OPEN> 240,784 240,784 240,784
<PROVISION-CURRENT> 16,276 31,514 46,744
<PROVISION-PRIOR> (572) (160) (165)
<PAYMENTS-CURRENT> 585 2,803 6,516
<PAYMENTS-PRIOR> 13,135 25,606 35,570
<RESERVE-CLOSE> 243,006 243,939 245,660
<CUMULATIVE-DEFICIENCY> 0 0 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
PERIODS PRESENTED HAVE BEEN STATED IN ACCORDANCE WITH FASB 128, EARNINGS PER
SHARE.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996 DEC-31-1996
<PERIOD-END> MAR-31-1996 JUN-30-1996 SEP-30-1996
<DEBT-HELD-FOR-SALE> 44,821 44,133 46,395
<DEBT-CARRYING-VALUE> 248,249 250,781 262,340
<DEBT-MARKET-VALUE> 250,719 251,062 262,634
<EQUITIES> 162,362 167,737 175,340
<MORTGAGE> 0 0 0
<REAL-ESTATE> 0 0 0
<TOTAL-INVEST> 455,432 474,401 493,656
<CASH> 3,923 0 777
<RECOVER-REINSURE> 66,870 67,653 63,858
<DEFERRED-ACQUISITION> 15,199 15,823 16,565
<TOTAL-ASSETS> 809,124 823,043 831,873
<POLICY-LOSSES> 225,135 226,403 238,084
<UNEARNED-PREMIUMS> 122,572 129,659 129,844
<POLICY-OTHER> 0 0 0
<POLICY-HOLDER-FUNDS> 0 0 0
<NOTES-PAYABLE> 46,000 46,000 47,600
0 0 0
0 0 0
<COMMON> 8,453 8,453 8,453
<OTHER-SE> 161,270 167,910 173,780
<TOTAL-LIABILITY-AND-EQUITY> 809,124 823,043 831,873
32,167 64,557 96,852
<INVESTMENT-INCOME> 5,727 11,819 17,639
<INVESTMENT-GAINS> 141 105 142
<OTHER-INCOME> 125 360 715
<BENEFITS> 18,031 34,938 51,244
<UNDERWRITING-AMORTIZATION> 8,001 15,507 22,953
<UNDERWRITING-OTHER> 3,336 7,198 11,143
<INCOME-PRETAX> 7,336 16,198 25,605
<INCOME-TAX> 1,820 4,301 6,909
<INCOME-CONTINUING> 5,516 11,897 18,695
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 5,516 11,897 18,695
<EPS-PRIMARY> 0.70 1.50 2.36
<EPS-DILUTED> 0.62 1.32 2.07
<RESERVE-OPEN> 221,648 221,648 221,648
<PROVISION-CURRENT> 19,010 35,580 52,391
<PROVISION-PRIOR> (976) (642) (1,148)
<PAYMENTS-CURRENT> 993 3,387 6,907
<PAYMENTS-PRIOR> 13,164 26,302 27,458
<RESERVE-CLOSE> 225,135 226,403 238,084
<CUMULATIVE-DEFICIENCY> 0 0 0
</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:
<TABLE>
<CAPTION>
At December 31, 1997
(In thousands)
--------------
<S> <C>
Net liability reported on a statutory basis $242,812
Adjustments:
Interest imputed on commutation settlements (258)
----
Net liability reported on a GAAP basis $242,554
--------
Reconciliation of the GAAP net liability:
Gross unpaid losses and settlement expenses $404,264
Reinsurance balances recoverable on unpaid losses
and settlement expenses (161,710)
--------
Net liability reported on a GAAP basis $242,554
--------
</TABLE>
37
