UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the period ended June 30, 1998
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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
--------------- ---------------
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. Employer
incorporation or organization) Identification Number)
9025 North Lindbergh Drive, Peoria, IL 61615
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(Address of principal executive offices) (Zip Code)
(309) 692-1000
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(Registrant's telephone number, including area code)
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.
Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of August 4, 1998 the number of shares outstanding of the registrant's
Common Stock was 10,517,860.
Page 1 of 17
<PAGE>
PART I
Item 1. Financial Statements
RLI Corp. & Subsidiaries
Condensed Consolidated Statement of Earnings and Comprehensive Earnings
For the Three-Month Period Ended June 30,
(Unaudited) 1998 1997
------------ -----------
Net premiums earned $35,085,369 $35,974,352
Net investment income 5,741,858 5,999,346
Net realized investment gains 65,983 1,734,460
----------- -----------
40,893,210 43,708,158
----------- -----------
Losses and settlement expenses 15,139,615 15,650,578
Policy acquisition costs 9,880,536 10,931,140
Insurance operating expenses 4,459,423 4,762,090
Interest expense on debt 640,389 690,532
General corporate expenses 953,355 964,240
----------- -----------
31,073,318 32,998,580
----------- -----------
Equity in earnings of uncons. investee 573,321 296,783
----------- -----------
Earnings before income taxes 10,393,213 11,006,361
Income tax expense 2,768,225 3,022,692
----------- -----------
Net earnings $ 7,624,988 $ 7,983,669
============ ============
Other comprehensive earnings, net of tax 172,101 16,985,490
------------ ------------
Comprehensive Earnings $ 7,797,089 $24,969,159
============ ============
Earnings per share:
Basic:
Net earnings per share from operations $0.72 $0.72
Realized gains, net of tax $0.00 $0.12
------------ ------------
Basic net earnings per share $0.72 $0.84
============ ============
Basic comprehensive earnings per share $0.74 $2.62
============ ============
Diluted:
Net earnings per share from operations $0.71 $0.62
Realized gains, net of tax $0.00 $0.10
------------ ------------
Diluted net earnings per share $0.71 $0.72
============ ============
Diluted comprehensive earnings per share $0.73 $2.15
============ ============
Weighted average number of common shares outstanding
Basic 10,526,727 9,531,820
Diluted 10,663,068 11,804,475
Cash dividends declared per common share $0.13 $0.12
The accompanying notes are an integral part of the financial statements.
2
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RLI Corp. & Subsidiaries
Condensed Consolidated Statement of Earnings and Comprehensive Earnings
(Continued)
For the Six-Month Period Ended June 30,
(Unaudited) 1998 1997
----------- -----------
Net premiums earned $70,000,479 $69,039,987
Net investment income 11,686,378 12,020,897
Net realized investment gains 638,546 2,294,484
----------- -----------
82,325,403 83,355,368
----------- -----------
Losses and settlement expenses 27,562,696 31,353,740
Policy acquisition costs 23,897,741 20,894,159
Insurance operating expenses 8,822,780 8,546,493
Interest expense on debt 1,044,185 1,381,084
General corporate expenses 2,120,235 1,844,709
----------- -----------
63,447,637 64,020,185
----------- -----------
Equity in earnings of uncons. investee 937,275 540,456
----------- -----------
Earnings before income taxes 19,815,041 19,875,639
Income tax expense 5,214,025 5,336,185
----------- -----------
Net earnings $14,601,016 $14,539,454
============ ============
Other comprehensive earnings, net of tax 17,558,226 18,411,036
------------ ------------
Comprehensive Earnings $ 32,189,242 $32,950,490
============ ============
Earnings per share:
Basic:
Net earnings per share from operations $1.34 $1.36
Realized gains, net of tax $0.04 $0.16
------------ ------------
Basic net earnings per share $1.38 $1.52
============ ============
Basic comprehensive earnings per share $3.04 $3.44
============ ============
Diluted:
Net earnings per share from operations $1.32 $1.18
Realized gains, net of tax $0.04 $0.13
------------ ------------
Diluted net earnings per share $1.36 $1.31
============ ============
Diluted comprehensive earnings per share $3.00 $2.86
============ ============
Weighted average number of common shares outstanding
Basic 10,604,856 9,577,355
Diluted 10,739,120 11,851,311
Cash dividends declared per common share $0.25 $0.23
The accompanying notes are an integral part of the financial statements.
3
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RLI Corp. and Subsidiaries
Condensed Consolidated Balance Sheet
June 30, December 31,
ASSETS 1998 1997
(Unaudited)
Investments ------------ -------------
Fixed maturities
Held-to-maturity, at amortized cost $293,878,270 $290,034,309
Trading, at fair value 8,259,037 9,545,572
Available-for-sale, at fair value 34,902,580 34,120,202
Equity securities, at fair value 279,811,674 251,459,843
Short-term investments, at cost which
approximates fair value 13,419,374 18,696,896
----------- -------------
Total investments 630,270,935 603,856,822
Cash 0 0
Accrued investment income 6,213,983 6,348,257
Premiums and reinsurance balances receivable 53,252,984 30,719,768
Ceded unearned premiums 55,086,004 49,677,041
Reinsurance balances recoverable on unpaid losses 162,710,632 161,709,389
Deferred policy acquisition costs 21,938,754 21,984,585
Property and equipment 11,708,940 12,387,500
Investment in unconsolidated investee 13,057,602 13,615,577
Other assets 13,286,793 11,441,666
----------- ------------
TOTAL ASSETS $967,526,627 $911,740,605
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Unpaid losses and settlement expenses $401,825,809 $404,263,638
Unearned premiums 132,655,382 128,542,853
Reinsurance balances payable 41,247,517 24,390,338
Short-term debt:
LOC and notes payable 38,370,000 24,900,000
Income taxes-current 1,001,359 2,701,964
Income taxes-deferred 45,970,401 36,339,801
Other liabilities 21,744,147 24,049,571
----------- ------------
TOTAL LIABILITIES 682,814,615 645,188,165
----------- ------------
Shareholders' Equity:
Common stock ($1 par value, authorized
50,000,000 shares, issued 12,789,167 shares
at 6/30/98 and 10,229,673 at 12/31/97) 12,789,167 10,229,673
Accumulated other comprehensive earnings 104,440,889 86,852,663
Other shareholders' equity 224,051,941 215,019,386
Less: Treasury shares at cost
(2,263,002 shares at 6/30/98)
(1,595,419 shares at 12/31/97) (56,569,985) (45,549,282)
----------- ------------
TOTAL SHAREHOLDERS' EQUITY 284,712,012 266,552,440
----------- ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $967,526,627 $911,740,605
============ ============
The accompanying notes are an integral part of the financial statements.
4
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RLI Corp. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the Six-Month Period
Ended June 30,
--------------------------
1998 1997
------------ ------------
Net cash from (used in) operating activities $ 1,801,540 $ ( 5,983,352)
------------ ------------
Cash Flows from Investing Activities
Investments purchased (27,550,910) (42,608,387)
Investments sold 3,374,563 9,926,806
Investments called or matured 17,596,600 21,701,592
Net decrease in
short-term investments 5,277,522 27,182,573
Net property and equipment purchased ( 333,495) ( 1,296,163)
------------ ------------
Net cash from (used in) investing activities ( 1,635,720) 14,906,421
------------ ------------
Cash Flows from Financing Activities
Cash dividends paid ( 2,646,444) ( 2,211,382)
Proceeds from issuance of short-term debt 13,470,000 0
Fractional shares paid ( 16,109) 0
Change in contributed capital 47,436 236,665
Treasury shares purchased (11,020,703) ( 6,948,352)
------------ ------------
Net cash (used in) financing activities ( 165,820) ( 8,923,069)
------------ ------------
Net increase (decrease) in cash 0 0
------------ ------------
Cash at the beginning of the year 0 0
------------ ------------
Cash at June 30 $ 0 $ 0
============ ============
The accompanying notes are an integral part of the financial statements.
5
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - The financial information is
prepared in conformity with generally accepted accounting principles and
such principles are applied on a basis consistent with those reflected in
the 1997 annual report filed with the Securities and Exchange Commission.
The financial information included herein has been prepared by management
without audit by independent certified public accountants who do not
express an opinion thereon. The condensed consolidated balance sheet as
of December 31, 1997 has been derived from, and does not include all the
disclosures contained in the audited consolidated financial statements for
the year ended December 31, 1997.
The information furnished includes all adjustments and normal recurring
accrual adjustments which are, in the opinion of management, necessary for
a fair statement of results for the interim periods. Results of
operations for the six month periods ended June 30, 1998 and 1997 are not
necessarily indicative of the results of a full year.
The accompanying financial data should be read in conjunction with the
notes to the financial statements contained in the 1997 10-K Annual
Report.
Earnings Per Share: Basic earnings per share (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. 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.
For the Six-Month Period Ended June 30, 1998
Income Shares Per Share
(Numerator) (Denominator) Amount
- ------------------------------------------------------------------------------
Basic EPS
Income available to 14,601,016 10,604,856 1.38
common stockholders
Effect of Dilutive Securities
Incentive Stock Options -- 134,264
- ------------------------------------------------------------------------------
Diluted EPS
Income available to common 14,601,016 10,739,120 1.36
- ------------------------------------------------------------------------------
6
<PAGE>
For the Six-Month Period Ended June 30, 1997
Income Shares Per Share
(Numerator) (Denominator) Amount
- ------------------------------------------------------------------------------
Basic EPS
Income available to 14,539,454 9,577,355 1.52
common stockholders
Effect of Dilutive Securities
Convertible debentures 937,028 2,211,538
Incentive Stock Options -- 62,418
- ------------------------------------------------------------------------------
Diluted EPS
Income available to common 15,476,482 11,851,311 1.31
- ------------------------------------------------------------------------------
The comparison of Basic EPS between periods is impacted by the shares
associated with the Convertible debentures. In June 1997, the Company called
for redemption all of its outstanding convertible debentures. On July 24,
1997, the Company announced that all debentures had been converted. This
conversion resulted in an additional issuance of 2,211,538 shares of common
stock. Once converted, these shares became basic outstanding shares,
impacting both basic and diluted EPS. Prior to conversion, including the
first six months of 1997, these potentially dilutive shares were included in
calculating dilutive EPS but were excluded when computing basic EPS. For both
periods presented, dilutive EPS includes the impact of the shares associated
with the convertible debentures and provides a more accurate comparison of per
share earnings.
Note additionally, that 1997 share and per share data has been restated to
reflect the 5/4 stock split that occurred on June 19, 1998.
Comprehensive Earnings: Financial Accounting Standards Board (FASB) Statement
No. 130, "Reporting Comprehensive Income," was issued in June 1997 and became
effective for interim and annual periods beginning after December 15, 1997.
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.
Other Accounting Standards: In June 1997, the FASB 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. In the
initial year of application, this Statement need not be applied to interim
financial statements. The Company is currently evaluating its segment
disclosures with respect to this Statement.
7
<PAGE>
In February 1998, the FASB issued Statement No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits" (Statement 132). Statement
132 revises employers' disclosures about pension and other postretirement
benefit plans. It does not change the measurement or recognition of those
plans. Statement 132 standardizes the disclosure requirements for pensions
and other postretirement benefits to the extent practicable, requires
additional information on changes in the benefit obligations and fair values
of plan assets that will facilitate financial analysis, and eliminates certain
other disclosures that are no longer useful. This Statement is effective for
fiscal years beginning after December 15, 1997. The Company is currently
evaluating this recently issued Statement.
In June 1998, the FASB issued Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (Statement 133). Statement 133 addresses
the accounting for and disclosure of derivative instruments, including certain
derivative instruments embedded in other contracts, and hedging activities.
This Statement standardizes the accounting for derivative instruments by
requiring that an entity recognize those items as assets or liabilities in the
statement of financial position and measure them at fair value. This
Statement is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999. Although the Company does not currently invest in derivative
instruments, this recently issued Statement is under evaluation.
2. INDUSTRY SEGMENT INFORMATION - Selected information by industry segment
for the six months ended June 30, 1998 and 1997 is presented below.
SEGMENT DATA - (in thousands) EARNINGS
(LOSS)
BEFORE
REV. TAXES ASSETS*
1998 ------- -------- ------
RLI Insurance Group--Property $ 27,883 $ 10,607 $925,591
RLI Insurance Group--Casualty 33,906 ( 1,680)
RLI Insurance Group--Surety 8,211 790
Net investment income 11,686 11,686
Net realized investment gains 639 639
General corporate & interest expense -- (3,164) 28,878
Equity in Earnings of unconsolidated
investee -- 937 13,058
-------- --------- --------
Consolidated $ 82,325 $ 19,815 $967,527
======== ========= ========
1997
RLI Insurance Group--Property $ 28,590 $ 9,279 $844,321
RLI Insurance Group--Casualty 35,687 ( 1,311)
RLI Insurance Group--Surety 4,763 278
Net investment income 12,021 12,021
Net realized investment gains 2,294 2,294
General corporate & interest expense -- ( 3,225) 33,107
Equity in Earnings of unconsolidated
investee -- 540 13,205
-------- --------- --------
Consolidated $ 83,355 $ 19,876 $890,633
======== ========= ========
8
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*The Company does not evaluate assets on the basis of individual Insurance
Group segments. Insurance Group assets presented in the tables represent
total assets of RLI Insurance Group and are inclusive of all segments
contained therein.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995: This discussion and analysis may contain 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 which are not historical facts, and
involve risks and uncertainties that could cause actual results to differ
materially from those expected and projected. Various risk factors that could
affect future results are listed in the company's filings with the Securities
Exchange Commission, including the Form 10-K for the year ended December 31,
1997.
OVERVIEW
RLI Corp. (the Company) is a holding company that, through its subsidiaries,
underwrites selected property and casualty insurance products.
The most significant operation is RLI Insurance Group (the Group), which
provides specialty property and casualty coverages for primarily commercial
risks. The Group accounted for 85% of the Company's total revenue for the six
months ended June 30, 1998.
SIX MONTHS ENDED JUNE 30, 1998, COMPARED TO SIX MONTHS
ENDED JUNE 30, 1997
Consolidated gross sales, which consist of gross premiums written, net
investment income and realized investment gains (losses) totaled $153.1
million for the first six months of 1998, down 4.8% from the same period in
1997. This decrease was primarily the result of a 4.0% decrease in gross
writings of the insurance group. As detailed in the discussion of RLI
Insurance Group that follows, first half 1997 results included $10.7 million
of non-recurring premiums associated with the Company's purchase of the Hawaii
Residential Insurance program. Consolidated revenue for the first six months
of 1998 decreased $1.0 million from the same period in 1997 to $82.3 million.
Net premiums earned in the first six months of 1998 were up $1.0 million, or
1.4%, compared to the same period in 1997, as casualty and surety revenue
showed improvement. Net investment income declined $300,000 to $11.7 million
for the first half of 1998. Additionally, realized investment gains are
tracking $1.7 million below 1997 levels. The sale of certain equity
securities and real estate during the first six months of 1997 accounted for
this decrease between periods.
The net after-tax earnings for the first six months of 1998 totaled $14.6
million, $1.36 per diluted share, compared to $14.5 million, $1.31 per share,
for the same period in 1997. Net operating earnings, which consist of the
Company's net earnings reduced by after-tax realized investment gains,
improved to $14.2 million, $1.32 per share, compared to $13.0 million, $1.18
per share, for the same period in 1997.
9
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Comprehensive earnings, which includes net earnings plus unrealized
gains/losses net of tax, totaled $32.2 million, $3.00 per share, compared to
$33.0 million, $2.86 per share, for the same period in 1997. Unrealized
gains, net of tax, for the first half of 1998 were $17.6 million, $1.64 per
share compared to $18.4 million, $1.55 per share, for the same period in 1997.
RLI INSURANCE GROUP
Gross premiums written for the first six months of 1998 totaled $140.8
million, compared to $146.6 million reported for the same period in 1997.
Property premiums decreased $22.2 million to $56.6 million for the first half
of 1998. Non-recurring premiums associated with the acquisition of the
Hawaiian Homeowners business in March of 1997 account for half of this
decline. As part of the purchase agreement with the Hawaii Property Insurance
Association, RLI Insurance Group assumed, on a one-time basis, $10.7 million
in unearned premium. Additionally, rate reductions experienced on property's
Difference-In-Condition product have resulted in a decline of $10.3 million
compared to 1997 levels. The Company's surety book, on the other hand, grew
its top line by 31.3% during the first half of 1998. Direct writings for
surety improved $3.9 million to $16.3 million versus $12.4 million for the
same period in 1997. This increase is primarily the result of the continued
growth of the Universal Bonding and Surety America programs. Gross writings
on the casualty book improved, as well, up $12.5 million over the first half
of 1997 to $67.9 million. Commercial Umbrella improved $9.4 million to $22.6
million for the first half of 1998. The Company's expansion into the West
Coast market, through its relationship with the general agency ALCO, accounted
for $6.2 million of this growth, while an additional $4.5 million in
production came from the Company's newly opened office in Dallas, Texas.
Additionally, the Transportation program launched in November of 1997 added
$7.7 million in writings during its first six months of production. It is
anticipated that this program will add $17.0 million in annual written
premiums during 1998. Partially offsetting the growth in the Commercial
Umbrella and Transportation programs, Employer's Excess Indemnity experienced
a decline of $4.9 million, as the Company discontinued its relationship with
its primary brokerage firm for this program.
Net premiums written for the first six months of 1998 decreased $9.2 million
or 11.8% from the same period in 1997. Net property writings decreased $15.9
million from 1997 levels, due to the non-recurring premiums associated with
the assumption of the Hawaiian Homeowners business and difference-in-condition
pricing, as mentioned previously. The surety book posted net premium written
of $10.0 million, a $3.1 million improvement over the same period in 1997,
while net casualty writings improved $3.5 million to $36.5 million.
Net premiums earned of $70.0 million in the first half of 1998 represents a
$1.0 million improvement from the same period in 1997. Earned premiums
associated with the Hawaiian Homeowners business helped offset declines
experienced on the Property-Fire program, as property experienced only a
$700,000 decline over first half 1997 levels. With the continued growth of
Universal Bonding and Surety America, as mentioned previously, the surety book
improved to $8.2 million, a $3.4 million increase over 1997 levels. Earned
premiums on the casualty book, however, declined by $1.8 million, due to the
decline in writings experienced throughout 1997. As the year progresses,
growth initiatives which have served to improve casualty's gross and net
10
<PAGE>
writings should additionally help to offset this decline in earned premiums.
The Group's pretax earnings totaled $9.7 million for the first six months of
1998 compared to $8.2 million for the same period in 1997. The property book
was responsible for the majority of this improvement posting $10.6 million in
pretax earnings compared to $9.3 million for the first half of 1997. Costs
associated with the acquisition of the Hawaiian book caused 1997 earnings to
be lower. Surety showed improvement, as well, reporting a pretax profit of
$790,000, up from $278,000 reported for the same period in 1997. The
improvement experienced in property and surety was partially offset by a
decline in earnings on the casualty book. The casualty book posted a pretax
loss of $1.7 million for the first half of 1998 compared to a pretax loss of
$1.3 million for the same period in 1997.
The GAAP combined ratio through the first six months of 1998 was 86.1 compared
to 88.0 for the same period in 1997. The loss ratio decreased from 45.4 for
the first half of 1997 to 39.4 in the first half of 1998. This decrease was
the result of a decline in casualty's loss ratio, coupled with a shift in
earned premiums to the lower loss ratio surety book. The casualty book's loss
ratio decreased from 69.7 for the first half of 1997 to 60.0 thus far in 1998.
Based on loss experience-to-date, first quarter 1998 casualty results
contained a $3.0 million reclass between losses incurred and operating
expenses (decreasing losses incurred and increasing contingent commissions) on
the Company's deductible buy-back program, an experience-based program. This
reclass has no impact on bottom line net earnings, but does affect the
comparison of loss and expense ratios between periods. Net of this reclass,
casualty's loss ratio is 68.8, more in line with 1997. Additionally, despite
El Nino-related weather patterns across the nation during the year, the
property book's loss ratio, at 19.4, compares favorably with 1997's 19.2.
Winter storm losses impacted the first half of 1998 by $1.4 million compared
to $300,000 for the same period in 1997. Surety's loss ratio remained flat at
22.1 compared to 21.4 for the same period in 1997. The Company's expense
ratio increased from 42.6 for the first half of 1997 to 46.7 for the first
half of 1998. This increase was primarily related to increases experienced on
the casualty book. The casualty book's expense ratio increased from 34.0 in
1997 to 45.0 in 1998. The aforementioned reclass on the Company's deductible
buy-back program accounted for 8.8 of the 11.0 point increase. Net of this
reclass, the casualty books expense ratio was 36.2, up 2.2 points from 1997's
34.0. Start-up costs associated with the Company's Transportation program, as
well as the expansion of casualty operations in Dallas, San Francisco, and Los
Angeles, have caused expenses to trend upward. Partially offsetting this
increase, the Company's property and surety books showed improvements in
expense ratio for the first half 1998. Property's expense ratio decreased
from 48.4 in 1997 to 42.5 in 1998. Commissions associated with the Hawaiian
Homeowner's acquisition caused first half 1997's expense ratio to be higher.
Additionally, the surety book posted an improvement in expense ratio,
decreasing from 72.7 in 1997 to 68.3 in 1998.
11
<PAGE>
INVESTMENT INCOME
The Company's investment portfolio generated net dividends and interest income
of $11.7 million during the first six months of 1998, a decrease of 2.8% over
that reported for the same period in 1997. This decrease is the result of a
drop in fixed income yields, an increase in tax exempt securities, and
increasing asset management fees on the appreciated common stock portfolio.
Invested assets at June 30, 1998 increased by $26.4 million, or 4.4%, from
December 31, 1997, primarily driven by unrealized gains on the Company's
investment portfolio. For the six months ended June 30, 1998, the Company
experienced $27.1 million in pre-tax unrealized gains on its investment
portfolio. Short-term investments, however, declined by $5.3 million from
December 31, 1997 due primarily to the funding of reinsurance obligations and
other first half operating needs.
Virtually all the Company's fixed income portfolio consists of securities
rated A or better and 98% were rated AA or better. The year-to-date yields
on the Company's fixed income investments for the six month periods ended
June 30, 1998 and 1997 are as follows:
1998 1997
---- ----
Taxable 6.58% 6.92%
Non-taxable 4.98% 5.03%
Yields on taxable and non-taxable securities declined through the first six
months of 1998 due to the maturity of higher yielding securities from the
portfolio. In a period of declining interest rates, these securities were
replaced with lower yielding securities. Additionally, during the second
quarter of 1998, a one-time adjustment to the premium amortization on callable
bonds has negatively impacted yields on the taxable bond portfolio.
The Company's available-for-sale portfolio of debt and equity securities had
net unrealized gains before tax of $27.1 million for the first six months of
1998 compared to net unrealized gains before tax of $28.3 million for the same
period in 1997. The Company's net unrealized gain before tax was $160.4
million and $133.3 million at June 30, 1998 and December 31, 1997,
respectively. Unrealized appreciation on securities, net of tax is reflected
in accumulated other comprehensive earnings, a component of shareholders'
equity.
Interest expense on debt obligations decreased to $1.0 million for the first
six months of 1998, a $300,000 drop from the same period in 1997. This
decrease is related to a reduction in outstanding debt balances. Conversion
of the $46.0 million convertible debt into common equity occurred in July
1997. Short-term debt accumulated in conjunction with the Company's stock
repurchase program began the year at $24.9 million and has increased to $38.4
million at June 30, 1998.
12
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INCOME TAXES
The Company's effective tax rate for the first six months of 1998 was 26%
compared to 27% for the same period in 1997. Income tax expense attributable
to income from operations differed from the amounts computed by applying the
U.S. federal tax rate of 35% to pretax income for the first six months of 1998
and 1997 as a result of the following:
1998 1997
Amount % Amount %
------ --- ------ ---
Provision for income taxes at
the statutory rate of 35% $ 6,935,264 35% $ 6,956,474 35%
Increase (reduction) in taxes
resulting from:
Tax exempt interest income (1,083,591) ( 5%) ( 891,015) ( 4%)
Dividends received deduction ( 699,597) ( 4%) ( 661,571) ( 3%)
Dividends paid deduction ( 112,151) ( 1%) ( 119,497) ( 1%)
Other items, net 174,100 1% 51,794 --
---------- ---- ---------- ----
Total tax expense $ 5,214,025 26% $ 5,336,185 27%
LIQUIDITY AND CAPITAL RESOURCES
Historically, the primary sources of the Company's liquidity have been funds
generated from insurance premiums and investment income (operating activities)
and maturing investments (investing activities). In addition, the Company has
occasionally received proceeds from financing activities such as the sale of
common stock to the employee stock ownership plan, sale of convertible
debentures, and small, short-term borrowings.
During the first half of 1998, the Company repurchased 268,730 of its
outstanding shares at a cost of $11.0 million. This repurchase program has
been funded through the issuance of short-term debt. These treasury shares
are reflected as a separate component of shareholders' equity.
At June 30, 1998 the Company had short-term investments, cash and other
investments maturing within one year, of approximately $33.9 million and
additional investments of $136.5 million maturing within five years. The
Company maintains one source of credit, a $30.0 million unsecured line of
credit that cannot be canceled during its annual term. As of June 30, 1998,
the Company had $17.7 million in outstanding short-term borrowings.
Additionally, the Company was party to three reverse repurchase transactions
totaling $20.6 million.
Management believes that cash generated by operations, cash generated by
investments and cash available from financing activities will provide
sufficient sources of liquidity to meet its anticipated needs over the next
twelve to twenty-four months.
13
<PAGE>
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.
Year 2000 issues impact the Company's business in various ways, including
internal systems for processing policies, vendor systems which interact with
the Company's systems, and insurance coverage exposures which may impact the
Company's insureds.
The Company is utilizing both internal and external resources to identify,
correct or modify, and test the systems for the Year 2000 compliance.
Internal systems are in the testing process for Year 2000 compliance.
The Company's critical business systems will be Year 2000 compliant by
December 31, 1998, which should allow for ample time and manpower to identify,
and modify as needed, non-core systems so that the Company will be compliant
prior to January 1, 2000.
The Company continues to contact its vendors for confirmation of compliance
efforts. Key system vendors have responded either that their systems are
compliant, or that activities are in place so that systems will be compliant
prior to January 1, 2000. Progress is monitored so that the Company may
review alternatives in the event there is an indication that certain vendors
may not meet their goal of compliance.
The Company continues to monitor the insurance industry with respect to Year
2000 coverage issues. The Insurance Services Office (ISO) has created such
endorsements for its members' use. The Company will consider the feasibility
of insuring or excluding coverage on an individual basis, utilizing the
underwriting discipline to which we adhere for all aspects of coverage for our
insureds.
The Company has formed a Year 2000 task force team which meets on a regular
basis to review the Company's progress in resolving these issues. Year 2000
compliance is an on-going situation that the Company will continue to monitor
and re-evaluate.
THREE MONTHS ENDED JUNE 30, 1998, COMPARED TO
THREE MONTHS ENDED JUNE 30, 1997
Consolidated gross sales totaled $84.0 million for the second quarter of 1998,
equal to that reported for the same period in 1997. As detailed in the
discussion of RLI Insurance Group that follows, second quarter 1998 gross
premiums improved $1.8 million, or 2.4%, over second quarter 1997 levels.
This improvement, however, was offset by a $1.7 million decline in realized
investment gains. Consolidated revenue for the second quarter of 1998
decreased $2.8 million, or 6.4%, from the same period in 1997. Net premiums
earned in the second quarter of 1998 declined $900,000 compared to 1997, and
investment income and investment gains declined $1.9 million over second
quarter 1997 levels.
14
<PAGE>
The net after-tax earnings for the second quarter of 1998 totaled $7.6
million, $0.71 per diluted share, compared to $8.0 million, $0.72 per share,
for the same period in 1997. Net earnings for the second quarter of 1997
include $1.1 million, $0.10 per share, in after-tax realized investment gains.
Net operating earnings, which consist of the Company's net earnings reduced by
after-tax realized investment gains, improved to $7.6 million, $0.71 per
share, compared to $6.9 million, $0.62 per share, for the same period in 1997.
The increase in net earnings is attributable to continued strong property and
surety underwriting results.
Comprehensive earnings, which includes net earnings plus unrealized
gains/losses net of tax, was $7.8 million, $0.73 per share, compared to $25.0
million, $2.15 per share for the same period in 1997. Unrealized gains, net
of tax, for the second quarter of 1998 were $172,000, $0.02 per share,
compared to $17.0 million, $1.43 per share, for the same period in 1997. The
tremendous rise in the stock market during the second quarter of 1997
accounted for this difference.
RLI INSURANCE GROUP
Gross premiums written for the second quarter of 1998 totaled $78.1 million,
compared to $76.3 million reported for the same period in 1997. Property
premiums decreased $8.2 million to $31.5 million for the second quarter of
1998, primarily due to a decline in Difference-In-Conditions writings as
mentioned previously. The Company's surety book, on the other hand, grew its
top line by 29.3% during the second quarter of 1998. Direct writings for
surety improved $2.2 million to $9.7 million versus $7.5 million for the same
period in 1997. This increase is primarily the result of the continued growth
of the Universal Bonding and Surety America programs. Gross writings on the
casualty book improved, as well, up $7.9 million over second quarter 1997 to
$37.0 million. Commercial Umbrella improved $5.0 million to $12.1 million for
the second quarter of 1998. As mentioned previously, the Company's expansion
into the West Coast market, coupled with the newly opened office in Dallas,
Texas accounted for this improvement. Additionally, the Transportation
program launched in November of 1997 added $5.3 million in writings during its
second quarter of production. Partially offsetting the growth in the
Commercial Umbrella and Transportation programs, Employer's Excess Indemnity
experienced a decline of $1.9 million, as the Company discontinued its
relationship with its primary brokerage firm for this program.
Net premiums written for the second quarter of 1998 decreased $2.4 million or
6.0% from the same period in 1997. Net property writings decreased $6.9
million over second quarter 1997, primarily due to the decline in Difference-
In-Condition writings, as mentioned previously. The surety book posted net
premium written of $5.7 million, a $1.6 million improvement over the same
period in 1997. On the strength of Commercial Umbrella and Transportation
production, net casualty writings improved $2.8 million to $19.5 million.
Net premiums earned of $35.1 million in the second quarter of 1998 represents
a $900,000, or 2.5%, decline over the same period in 1997. Earned premiums on
the property book declined $2.7 million, due to the reduction in writings as
previously detailed. Surety, however, posted growth, improving $1.7 million,
or 64.8%, over the same period in 1997. Continued growth in the Universal
Bonding and Surety America programs fueled this improvement. Additionally,
top-line growth initiatives on the casualty book have begun to translate into
15
<PAGE>
earned premium. Commercial Umbrella and Transportation improved $1.3 and $1.0
million, respectively, and served to offset declines experienced on the
General Liability and Employer's Excess Indemnity.
The Group's pretax earnings totaled $5.6 million for the second quarter of
1998 compared to $4.6 million for the same period in 1997, as property,
surety, and casualty have shown improvement. The GAAP combined ratio for the
second quarter of 1998 was 84.1 compared to 87.1 for the same period in 1997.
The loss ratio declined from 43.5 for the second quarter of 1997 to 43.2 in
the second quarter of 1998, as both property and casualty showed slight
improvements. The Company's expense ratio decreased from 43.6 for the second
quarter of 1997 to 40.9 for the second quarter of 1998, as property, surety
and casualty have shown improvement. Property's expense ratio declined from
47.7 in 1997 to 40.8 in 1998. Commissions associated with the acquisition and
assumption of the Hawaiian Homeowners business accounted for the higher
expense ratio in 1997. The surety book posted a 64.2 expense ratio in 1998
compared to 70.9 in 1997. The tremendous growth in surety earned premiums,
coupled with expense control measures, contributed to this improvement. The
casualty book has shown a slight improvement, as well, declining from 35.7 in
1997 to 35.0 in 1998.
INVESTMENT INCOME
The Company's investment portfolio generated net dividends and interest income
of $5.7 million during the second quarter of 1998, a decrease of 4.3% over
that reported for the same period in 1997. This decrease is the result of a
drop in fixed income yields, an increase in tax exempt securities, and
increasing asset management fees on the appreciated common stock portfolio.
In addition, the Company recognized realized investment gains of $66,000 in
the second quarter of 1998 compared to $1.7 million in the second quarter of
1997. Second quarter of 1997 includes the sale of real estate and certain
equity securities, as discussed previously.
INCOME TAXES
The Company's effective tax rate for the second quarter of 1998 and 1997 was
27%. Income tax expense attributable to income from operations differed from
the amounts computed by applying the U.S. federal tax rate of 35% to pretax
income for the second quarter of 1998 and 1997 as a result of the following:
1998 1997
Amount % Amount %
------ --- ------ ---
Provision for income taxes at
the statutory rate of 35% $ 3,637,625 35% $ 3,852,226 35%
Increase (reduction) in taxes
resulting from:
Tax exempt interest income ( 553,818) ( 5%) ( 447,978) ( 4%)
Dividends received deduction ( 345,745) ( 3%) ( 329,798) ( 3%)
Dividends paid deduction ( 56,477) ( 1%) ( 56,819) ( 1%)
Other items, net 86,640 1% 5,061 --
---------- ---- ---------- ----
Total tax expense $ 2,768,225 27% $ 3,022,692 27%
16
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings - Not Applicable
Item 2. Change in Securities - Not Applicable
Item 3. Defaults Upon Senior Securities - Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
On May 7, 1998, at the Company's Annual Meeting of Shareholders, the following
members were elected to the Board of Directors:
Richard J. Haayen Robert O. Viets Gerald D. Stephens
The following proposal was approved at the Company's Annual Meeting:
Affirmative Negative Votes
Votes Votes Withheld
----------- -------- --------
Approve an arrangement with 5,639,549 332,475 90,266
Centre Reinsurance (U.S.) Limited
under which the Company would
issue convertible preferred stock
in the event of a qualifying
catastrophic event.
Item 5. Other Information - Not Applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Not Applicable
(b) The Company did not file any reports on Form 8-K during the three
months ended June 30, 1998.
SIGNATURES
Pursuant to the requirements 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.
/s/Joseph E. Dondanville
Joseph E. Dondanville
Vice President, Chief Financial Officer
(Duly authorized and Principal
Financial and Accounting Officer)
Date: August 11, 1998
17<PAGE>
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE FINANCIAL STATEMENTS IN THE RLI CORP. FORM 10Q FOR THE PERIOD
ENDED JUNE 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<DEBT-HELD-FOR-SALE> 43,162
<DEBT-CARRYING-VALUE> 293,878
<DEBT-MARKET-VALUE> 300,802
<EQUITIES> 279,812
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 630,271
<CASH> 0
<RECOVER-REINSURE> 53,253
<DEFERRED-ACQUISITION> 21,939
<TOTAL-ASSETS> 967,527
<POLICY-LOSSES> 239,115
<UNEARNED-PREMIUMS> 132,655
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 38,370
0
0
<COMMON> 12,789
<OTHER-SE> 271,923
<TOTAL-LIABILITY-AND-EQUITY> 967,527
70,000
<INVESTMENT-INCOME> 11,686
<INVESTMENT-GAINS> 639
<OTHER-INCOME> 937
<BENEFITS> 27,563
<UNDERWRITING-AMORTIZATION> 23,898
<UNDERWRITING-OTHER> 8,823
<INCOME-PRETAX> 19,815
<INCOME-TAX> 5,214
<INCOME-CONTINUING> 14,601
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 14,601
<EPS-PRIMARY> 0.82
<EPS-DILUTED> 0.81
<RESERVE-OPEN> 242,554
<PROVISION-CURRENT> 31,713
<PROVISION-PRIOR> (4,150)
<PAYMENTS-CURRENT> 3,987
<PAYMENTS-PRIOR> 27,015
<RESERVE-CLOSE> 239,115
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
