<PAGE>
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 September 30, 1999
-------------------------------------------
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
--------------- ---------------
Commission File Number: 0-6612
-----------------------------------------
RLI Corp.
-----------------------------------------------------------------
(Exact name of registrant as specified in its charter)
ILLINOIS 37-0889946
-----------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
9025 North Lindbergh Drive, Peoria, IL 61615
-----------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(309) 692-1000
-----------------------------------------------------------------
(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 November 8, 1999 the number of shares outstanding of the registrant's
Common Stock was 9,923,787.
Page 1 of 21
<PAGE>
PART I
Item 1. Financial Statements
RLI Corp. & Subsidiaries
Condensed Consolidated Statement of Earnings and Comprehensive Earnings
For the Three-Month Period Ended September 30,
<TABLE>
<CAPTION>
(Unaudited) 1999 1998
----------- -----------
<S> <C> <C>
Net premiums earned $50,991,644 $35,950,695
Net investment income 6,737,007 6,179,146
Net realized investment gains 2,264,925 32,773
------------ -----------
59,993,576 42,162,614
------------ -----------
Losses and settlement expenses 27,104,767 20,242,656
Policy acquisition costs 15,304,061 10,513,079
Insurance operating expenses 4,097,696 3,501,110
Interest expense on debt 1,076,296 615,440
General corporate expenses 680,954 644,079
------------ -----------
48,263,774 35,516,364
------------ -----------
Equity in earnings of uncons. investee 210,771 490,968
------------ -----------
Earnings before income taxes 11,940,573 7,137,218
Income tax expense 3,469,082 1,558,720
------------ -----------
Net earnings $8,471,491 $5,578,498
============ ============
Other comp. earnings (loss), net of tax (21,189,824) (16,348,118)
------------ -----------
Comprehensive earnings (loss) ($12,718,333) ($10,769,620)
============ ============
Earnings per share:
Basic:
Net earnings per share from operations $0.70 $0.53
Realized gains, net of tax $0.15 $0.00
------------ -----------
Basic net earnings per share $0.85 $0.53
============ ===========
Basic comp. Earnings (loss) per share ($1.27) ($1.03)
============ ===========
Diluted:
Net earnings per share from operations $0.69 $0.53
Realized gains, net of tax $0.15 $0.00
------------ -----------
Diluted net earnings per share $0.84 $0.53
============ ===========
Diluted comp. Earnings (loss) per share ($1.26) ($1.02)
============ ===========
Weighted average number of common shares outstanding
Basic 10,015,096 10,477,837
Diluted 10,129,261 10,602,524
Cash dividends declared per common share $0.14 $0.13
</TABLE>
The accompanying notes are an integral part of the financial statements.
2
<PAGE>
RLI Corp. & Subsidiaries
Condensed Consolidated Statement of Earnings and Comprehensive Earnings
For the Nine-Month Period Ended September 30,
<TABLE>
<CAPTION>
(Unaudited) 1999 1998
------------ ------------
<S> <C> <C>
Net premiums earned $144,453,076 $105,951,174
Net investment income 19,165,187 17,865,524
Net realized investment gains 4,522,892 671,319
------------ ------------
168,141,155 124,488,017
------------ ------------
Losses and settlement expenses 70,203,818 47,805,352
Policy acquisition costs 48,938,152 34,410,820
Insurance operating expenses 12,253,391 12,323,890
Interest expense on debt 2,905,051 1,659,625
General corporate expenses 2,383,848 2,764,314
------------ ------------
136,684,260 98,964,001
------------ ------------
Equity in earnings of uncons. investee 1,428,151 1,428,243
------------ ------------
Earnings before income taxes 32,885,046 26,952,259
Income tax expense 8,814,982 6,772,745
------------ ------------
Net earnings $24,070,064 $20,179,514
============ ============
Other comp. earnings (loss), net of tax (13,577,938) 1,240,108
------------ ------------
Comprehensive earnings $10,492,126 $21,419,622
============ ============
Earnings per share:
Basic:
Net earnings per share from operations $2.07 $1.87
Realized gains, net of tax $0.29 $0.04
------------ ------------
Basic net earnings per share $2.36 $1.91
============ ===========
Basic comp. earnings per share $1.03 $2.03
============ ===========
Diluted:
Net earnings per share from operations $2.05 $1.85
Realized gains, net of tax $0.29 $0.04
------------ -----------
Diluted net earnings per share $2.34 $1.89
============ ===========
Diluted comp. earnings per share $1.02 $2.00
============ ===========
Weighted average number of common shares outstanding
Basic 10,193,015 10,562,051
Diluted 10,290,735 10,693,122
Cash dividends declared per common share $0.41 $0.38
</TABLE>
The accompanying notes are an integral part of the financial statements.
3
<PAGE>
RLI Corp. and Subsidiaries Condensed Consolidated Balance Sheet
September 30, 1999 December 31, 1998
<TABLE>
<CAPTION>
ASSETS (Unaudited)
-------------- --------------
<S> <C> <C>
Investments
Fixed maturities
Held-to-maturity, at amortized cost $305,645,516 $283,991,524
Trading, at market value 7,701,741 8,348,141
Available-for-sale, at market value 40,557,934 36,516,393
Equity securities, at fair value 277,838,043 296,520,399
Short-term investments, at cost 43,971,127 51,917,333
-------------- --------------
Total investments 675,714,361 677,293,790
Accrued investment income 6,368,529 6,457,473
Premiums and reinsurance balances receivable 94,861,750 46,666,743
Ceded unearned premium 45,053,773 59,779,814
Reinsurance balances recoverable on unpaid losses 254,256,868 168,260,816
Income taxes-current 2,443,816 0
Deferred policy acquisition costs 34,805,430 22,510,141
Property and equipment 14,962,471 12,199,800
Investment in unconsolidated investee 14,885,395 13,457,367
Goodwill 34,530,391 4,127,586
Other assets 8,416,364 1,931,507
-------------- --------------
TOTAL ASSETS $1,186,299,148 $1,012,685,037
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Unpaid losses and settlement expenses $532,148,836 $415,523,392
Unearned premiums 165,676,663 142,022,972
Reinsurance balances payable 35,124,141 32,160,867
Short-term debt and notes payable 79,539,568 39,643,965
Income taxes-current 0 2,124,460
Income taxes-deferred 41,671,965 48,420,667
Other liabilities 45,354,237 38,830,060
-------------- --------------
TOTAL LIABILITIES 899,515,410 718,726,383
-------------- --------------
Shareholders' Equity:
Common stock ($1 par value, authorized)
(12,804,558 shares issued at 9/30/99)
(12,789,935 shares issued at 12/31/98) 12,804,558 12,789,935
Paid-In Capital 70,743,700 71,093,124
Accumulated other comprehensive earnings 96,793,523 110,371,461
Retained Earnings 183,182,037 163,324,161
Deferred compensation 4,510,704 3,460,606
Less: Unearned ESOP shares at cost
(70,400 shares at 12/31/98) 0 ( 2,500,999)
Less: Treasury shares at cost
(2,854,941 shares at 9/30/99)
(2,384,736 shares at 12/31/98) (81,250,784) ( 64,579,634)
-------------- --------------
TOTAL SHAREHOLDERS' EQUITY 286,783,738 293,958,654
-------------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,186,299,148 $1,012,685,037
============== ==============
</TABLE>
The accompanying notes are an integral part of the financial statements.
4
<PAGE>
RLI Corp. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
For the Nine-Month Period
Ended September 30,
--------------------------
1999 1998
----------- -----------
<S> <C> <C>
Net cash provided by
operating activities $34,627,063 $26,454,635
----------- -----------
Cash Flows from Investing Activities
Investments purchased (54,251,597) (37,826,525)
Investments sold 18,629,145 3,885,579
Investments called or matured 23,650,563 24,616,600
Net (increase) decrease in
short-term investments 2,858,716 (10,243,864)
Net property and equipment purchased (4,154,528) (1,081,714)
Investment in Underwriters Indemnity Holdings (40,700,000) 0
----------- -----------
Net cash (used in)
investing activities (53,967,701) (20,649,924)
----------- -----------
Cash Flows from Financing Activities
Cash dividends paid (4,172,608) (3,993,547)
Proceeds from issuance of notes payable 36,330,603 13,891,250
Change in contributed capital 302,696 60,639
Fractional shares paid -- (16,099)
Treasury shares purchased (15,621,052) (13,288,543)
Unearned ESOP shares purchased 2,500,999 (2,458,411)
----------- -----------
Net cash provided by (used in)
financing activities 19,340,638 (5,804,711)
----------- -----------
Net increase in cash 0 0
----------- -----------
Cash at the beginning of the year 0 0
----------- -----------
Cash at September 30 $ 0 $ 0
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
5
<PAGE>
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 1998 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, 1998 has been derived
from, and does not include all the disclosures contained in the audited
consolidated financial statements for the year ended December 31, 1998.
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 nine-month periods ended September 30, 1999 and 1998
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 1998 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.
<TABLE>
<CAPTION>
For the Nine-Month Period Ended September 30, 1999
Income Shares Per Share
(Numerator) (Denominator) Amount
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
BASIC EPS
Income available to $24,070,064 10,193,015 2.36
common stockholders
EFFECT OF DILUTIVE SECURITIES
Incentive Stock Options -- 97,720
- ------------------------------------------------------------------------------
DILUTED EPS
Income available to common $24,070,064 10,290,735 2.34
- ------------------------------------------------------------------------------
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
For the Nine-Month Period Ended September 30, 1998
Income Shares Per Share
(Numerator) (Denominator) Amount
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
BASIC EPS
Income available to $20,179,514 10,562,051 1.91
common stockholders
EFFECT OF DILUTIVE SECURITIES
Incentive Stock Options -- 131,071
- ------------------------------------------------------------------------------
DILUTED EPS
Income available to common $20,179,514 10,693,122 1.89
- ------------------------------------------------------------------------------
</TABLE>
OTHER ACCOUNTING STANDARDS: 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, as amended by FASB Statement No. 137, is effective
for all fiscal quarters of fiscal years beginning after June 15, 2000. Although
the Company does not currently invest in derivative instruments, this recently
issued Statement is under evaluation.
In October 1998, the AICPA issued Statement of Position (SOP) 98-7, "Deposit
Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not
Transfer Insurance Risk." SOP 98-7 provides guidance on how to account for
insurance and reinsurance contracts that do not transfer insurance risk. The
method used for these contracts is referred to as deposit accounting. This SOP
specifies that at inception, a deposit asset or liability should be recognized
for insurance and reinsurance contracts accounted for under deposit accounting
and should be measured based on the consideration paid or received, less any
explicitly identified premiums or fees to be retained by the insurer or
reinsurer, irrespective of the experience of the contract. This SOP is effective
for financial statements for fiscal years beginning after June 15, 1999. The
Company does not have any insurance or reinsurance contracts that are required
to be accounted for under the deposit method as of September 30, 1999.
7
<PAGE>
2. INDUSTRY SEGMENT INFORMATION - Selected information by industry segment
for the nine months ended September 30, 1999 and 1998 is presented
below.
<TABLE>
<CAPTION>
SEGMENT DATA--(in thousands) EARNINGS REVENUES
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Property 12,963 14,540 37,902 40,196
Casualty (1,711) (2,068) 87,473 52,629
Surety 1,806 (1,061) 19,078 13,126
Net investment income 19,165 17,866 19,165 17,866
Realized gains 4,523 671 4,523 671
General corporate expense
and interest on debt (5,289) (4,424)
Equity in earnings of
unconsolidated investee 1,428 1,428
------ ------
Total segment earnings before
income taxes 32,885 26,952
------ ------
Income taxes 8,815 6,773
------ ------
Total 24,070 20,179 168,141 124,488
------ ------ ------- -------
</TABLE>
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, 1998.
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 86% of the Company's total revenue for the nine
months ended September 30, 1999.
8
<PAGE>
BUSINESS COMBINATION - PURCHASE ACCOUNTING
On January 29, 1999, RLI Insurance Company purchased Underwriters Indemnity
Holdings (UIH) for $40.7 million. The purchase was financed entirely through
short-term debt. UIH is the insurance holding company for Planet Indemnity
Company and Underwriters Indemnity Company. As a property/casualty insurance
group these companies have combined to offer primarily surety and inland marine
coverages on commercial risks relating to the exploration, drilling, producing
and gathering activities of the oil and gas industry. Also provided to a lesser
degree were control of well and general liability insurance. The genuine value
of this operation was found almost exclusively in the surety operations, which
approximated $35 million. The casualty book was considered incidental to the
overall business while the property business contained deficient premiums to an
unknown extent. All property coverages are being non-renewed in accordance with
allowable policy provisions.
The acquisition is being accounted for under the purchase method of accounting
for business combinations. Accounting guidance derived primarily from APB 16
regarding business combinations dictates that the purchase price be allocated to
the assets acquired less liabilities assumed with any excess being recorded as
goodwill. The allocation of the purchase price results in goodwill of $31.8
million that will be amortized over 20 years.
NINE MONTHS ENDED SEPTEMBER 30, 1999, COMPARED TO NINE MONTHS
ENDED SEPTEMBER 30, 1998
Consolidated gross sales, which consist of gross premiums written, net
investment income and realized investment gains totaled $278.4 million for the
first nine months of 1999 compared to $233.1 million for the same period in
1998. Gross writings of the Insurance Group improved 18.7% over 1998 levels
fueled by a $30 million increase in casualty premiums. Consolidated revenue for
the first nine months of 1999 increased $43.7 million or 35.1% from the same
period in 1998. Net premiums earned alone increased 36.3% due to the Group's
implementation of a combined casualty reinsurance contract, which resulted in
increased retentions of premium while eliminating ceding commissions. Net
investment income improved 7.3% to $19.2 million. Realized investment gains
totaled $4.5 million for the first nine months of 1999 compared to $700,000 for
the same period in 1998 due to the strategic sale of several equity positions in
the second and third quarters.
The net after-tax earnings for the first nine months of 1999 totaled $24.1
million, $2.34 per diluted share, compared to $20.2 million, $1.89 per share,
for the same period in 1998. Net operating earnings, which consist of the
Company's net earnings reduced by after-tax realized investment gains, totaled
$21.1 million, $2.05 per share, compared to $19.7 million, $1.85 per share, for
the same period in 1998.
Comprehensive earnings, which includes net earnings plus unrealized gains/losses
net of tax, totaled $10.5 million, $1.02 per share, compared to $21.4 million,
$2.00 per share, for the same period in 1998. Unrealized losses, net of tax, for
the first nine months of 1999 were $13.6 million, $1.32 per share compared to
unrealized gains of $1.2 million, $0.11 per share, for the same period in 1998.
The decline in the stock market in the first and third quarters of 1999
accounted for the decrease in unrealized gains.
9
<PAGE>
RLI INSURANCE GROUP
Gross written premium for the Group increased by $40.1 million to $254.7 million
for the first nine months of 1999 compared to $214.6 million for the same period
in 1998. This 18.7% improvement came from the casualty and property segments
where various growth initiatives are taking effect. Profitability increased with
$13.1 million in pretax underwriting profit compared to $11.4 million last year.
The GAAP combined ratio was 91.0 for the first nine months of 1999 compared to
89.2 for the first nine months of 1998. This increase is the result of an
increase in the loss ratio to 48.6 for the first nine months of 1999 from 45.1
for the same period in 1998. Partially offsetting this increase was a decrease
in the expense ratio to 42.4 through September 30, 1999, compared to 44.1
through September 30, 1998.
The Group's property segment increased premium writings by 11.8% in the first
nine months of 1999. Difference in conditions (DIC) premiums continue to decline
as a result of rate reductions. This trend was offset by a 37% increase in fire
premiums in the first nine months along with some production from new product
lines. The property segment generated pre-tax underwriting profits of $13.0
million for the first nine months of the year compared to $14.5 million last
year. This decline in profitability reflects the increasing mix of fire lines
with higher loss ratios relative to the DIC book with lower loss ratios. This is
also reflected in the 1999 combined ratio of 65.8 compared to 63.8 a year ago.
Casualty segment gross written premiums were $137.0 million for the first nine
months of 1999 compared to $107.0 million for the prior year. The driving forces
behind this improvement were increases in the commercial umbrella product of
$10.8 million and the transportation product of $9.7 million. At the beginning
of 1999 a combined casualty reinsurance contract was implemented to take
advantage of the growth in premiums and improved economies of scale. This
arrangement will result in assuming less exposure per risk while improving the
overall combined ratio of this segment. Although there are no ceding commissions
recognized with this agreement, the Group retains more premium. This was
evidenced by the GAAP combined ratio falling to 102.0 for the first nine months
compared to 104.0 last year. This new reinsurance contract will also improve
cash flow and thereby generate additional investment income in the future. Even
at a combined ratio of 102.0, the management of the Company believes reserves to
be adequate and a significant source of future earnings potential from
investment income.
Surety segment gross written premiums stayed steady at $23.5 million for the
first nine months of 1999 compared to $23.4 million for the same period in 1998.
This stable trend was the result of the Company's disassociation with a
particular producer late in 1998, offset by $5.7 million in premium for the
period from the newly acquired surety operation in Houston - Underwriters'
Indemnity. The GAAP combined ratio for the surety segment has dropped sharply to
90.5 in the first nine months from 108.1 a year ago. A charge of $2.6 million
related to unfavorable loss development late in the third quarter of 1998 on the
contract surety book caused the loss ratio to increase to 40.8. Without the
effect of this charge the loss ratio would have been 20.9, which is more in line
with the loss ratio of 19.3 experienced through the first nine months of 1999.
10
<PAGE>
INVESTMENT INCOME
The Company's investment portfolio generated net dividends and interest income
of $19.2 million during the first nine months of 1999, an increase of 7.3% over
that reported for the same period in 1998. The increase is primarily due to the
company's overall premium growth as well as the impact of the first quarter
acquisition of Underwriters Indemnity Holdings, Inc.
Invested assets at September 30, 1999 decreased by $1.6 million, or 0.2%, and
are relatively unchanged from December 31, 1998. For the nine months ended
September 30, 1999, the Company experienced a $20.9 million pre-tax unrealized
loss on its investment portfolio. Short-term investments decreased to $44.0
million down $8.0 million from December 31, 1998.
Virtually all the Company's fixed income portfolio consists of securities rated
A or better and 95% were rated AA or better. The year-to-date yields on the
Company's fixed income investments for the nine-month periods ended September
30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Taxable 6.55% 6.54%
Non-taxable 4.76% 4.96%
</TABLE>
Yields on taxable securities are relatively unchanged from the same period last
year as maturity proceeds have been reinvested with similarly yielding
securities. A decrease in non-taxable yields resulted from proceeds of numerous
calls on higher yielding holdings being replaced with lower yielding municipals.
The Company's available-for-sale portfolio of debt and equity securities had a
net unrealized loss before tax of $20.9 million for the first nine months of
1999 compared to net unrealized gains before tax of $1.9 million for the same
period in 1998. The 1999 year-to-date loss reflects stock market fluctuations
and the impact of an increasing interest rate environment. Net unrealized gains
before tax were $148.6 million and $169.5 million at September 30, 1999 and
December 31, 1998, 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 increased to $2.9 million for the first
nine months of 1999, a $1.2 million increase from the same period in 1998. This
change is related to an increase in outstanding debt balances, primarily due to
the January 1999 acquisition of Underwriters Indemnity Holdings, Inc. At
September 30, 1999, outstanding short-term debt totaled $79.5 million.
11
<PAGE>
INCOME TAXES
The Company's effective tax rate for the first nine months of 1999 was 27%
compared to 25% for the same period in 1998. This increase is primarily due to
goodwill amortization from the acquisition of Underwriters' Indemnity in 1999
not being deductible for tax purposes. 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 nine months of 1999 and 1998 as a
result of the following:
<TABLE>
<CAPTION>
1999 1998
Amount % Amount %
------ --- ------ ---
<S> <C> <C> <C> <C>
Provision for income taxes at
the statutory rate of 35% $11,509,766 35% $ 9,433,291 35%
Increase (reduction) in taxes
resulting from:
Tax exempt interest income (1,916,438) ( 6%) (1,661,771) (6%)
Dividends received deduction (1,120,546) ( 3%) (1,048,852) (4%)
Dividends paid deduction (183,071) ( 1%) (172,078) (1%)
Goodwill amortization 280,707 1% -- -
Other items, net 244,564 1% 222,155 1%
----------- ---- ----------- ---
Total tax expense $ 8,814,982 27% $ 6,772,745 25%
</TABLE>
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, the sale of public debt, and short-term borrowings.
During the first nine months of 1999, the Company repurchased 470,200 of its
outstanding shares at a cost of $15.6 million. This repurchase program has been
funded through operating cash flow and short-term borrowings. These treasury
shares are reflected as a separate component of shareholders' equity.
Third quarter 1999 operating cash flow continues to show improvement over the
same period in 1998. The Company's premium growth along with the impact of the
new global casualty reinsurance treaty contributed to this increase.
At September 30, 1999 the Company had short-term investments, cash and other
investments maturing within one year, of approximately $79.0 million and
additional investments of $130.3 million maturing within five years. The Company
maintains one source of credit, a $30.0 million line of credit, available on a
secured or unsecured basis that cannot be canceled during its annual term. As of
September 30, 1999, the Company had $19.6 million in outstanding short-term
borrowings on this facility. Additionally, the Company was party to five reverse
repurchase transactions totaling $59.4 million and other miscellaneous
short-term debt of $500,000.
12
<PAGE>
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.
OTHER MATTERS
The Year 2000 (Y2K) issue is a result of computerized systems, including both
hardware and software systems, using a two-digit format, as opposed to four
digits, to indicate the year in date fields. Such computer systems may be unable
to interpret dates beyond the year 1999, which could cause a system failure or
other computer errors, leading to disruptions in operations.
In 1997, the Company began work on a five-phase program for Y2K compliance.
Phase I was to identify those primary and mission-critical business systems,
those essential to continuing operations, which presented Y2K issues. This phase
was a four-month process beginning in August of 1997. Phase II was to form a
committee by business unit to identify all secondary and general infrastructure
issues which would need to be addressed for Y2K compliance. This phase began in
December of 1997 and was completed in April of 1998, with the evaluation and
initial identification of secondary Y2K exposures, which needed attention. Phase
III was the modification and testing of mission-critical systems identified in
Phase I. Phase III included changes to the Company's property and casualty
systems, accounts receivable, custom business processing, general ledger,
accounts payable, external business interfaces, digital image processing and
accounting interface systems. The status of completion of Phase III is discussed
below. Phase IV, which began in May 1998, included the development of plans to
address secondary infrastructure issues, line of business strategies to address
exposures associated with the Company's insurance products and a process to
survey key vendors and business partners. This phase has extended into the third
quarter of 1999 and is targeted for completion in November of 1999. Phase V is
designed to refine operational and contingency plans for Y2K cut-over. This
phase began in the first quarter of 1999 and carries through the first quarter
of the year 2000. Items carried through the first quarter of the year 2000 are
considered non-critical and incidental to the Company's operations.
The Company has identified three major areas determined to be critical for
successful Y2K compliance: (1) accounting and premium processing systems, (2)
terms and conditions of existing insurance contracts, and (3) third-party
relationships. The Company's MIS Steering Committee, Audit Committee and the
Board of Directors regularly review Y2K compliance and progress.
13
<PAGE>
In accordance with Phase I of the program, the Company completed an internal
review of all primary and mission-critical systems and contacted related
software suppliers to determine major areas of exposure by December of 1997. As
an element of Phase III, in November of 1998 the Company successfully completed
the modification, testing and implementation of Y2K-compliant core property and
casualty systems, accounts receivable, custom business processing, general
ledger, accounts payable and accounting interfaces. The Company's new
reinsurance system, implemented in early 1998, was already identified as Y2K
compliant. Business transactions are presently being processed and premiums are
being earned on in-force policies with Y2K expiration dates. Digital image
processing upgrades were completed in January of 1999. External business
interfaces have been addressed within core systems efforts but may require
additional modifications for any subsequent changes implemented by external
parties. These activities concluded the successful completion of Phase III
efforts.
As a component of Phase IV, the Company completed the development of strategies
by line of business, which it feels will effectively manage Y2K related
exposures and coverages. This exposure is divided into two distinct areas:
business partners and insurance coverage issues for our policyholders/customers.
In August of 1998, all significant vendors and business partners were surveyed
for compliance efforts and the Company's internal audit and compliance unit has
reviewed responses for further steps and action. Efforts have been made to
evaluate the individual responses and follow up with those business partners who
did not respond to the initial request for information. Of the responses
received from vendors and business partners, a significant number state that
they are Y2K compliant or intend to be Y2K compliant by December 31, 1999.
Additionally, in April of 1999 the Company took action to evaluate and assess
the preparedness of the physical branch locations managed by external entities.
The Company will continue to make efforts to ensure its business partners and
vendors are Y2K compliant; however, the ultimate state of compliance of these
providers is beyond the Company's control and could impact the Company's
operations and financial results in future periods.
The types of insurance that may be the subject of claims arising from Y2K losses
include property, directors & officers' liability, miscellaneous professional
liability, and other casualty. Although uncertainty exists with respect to legal
interpretations of Y2K liability, it is anticipated that if Y2K claims are
received, the majority will stem from directors & officers, miscellaneous
professional liability and property policies, in terms of both frequency and
severity. The Company has formulated a Y2K questionnaire to be completed at the
time of initial policy application and renewal. Each application is individually
underwritten, and responses on the Y2K questionnaire are a component of the
underwriter's determination whether to offer coverage and if so, to what extent.
A Y2K exclusion has been drafted and is available for underwriters' use if
needed. Additionally, a Y2K team of underwriters and claims personnel have been
assembled to prepare for the proper handling of Y2K claims. All claims are
handled on an individual basis in accordance with policy terms and conditions.
The Company has developed an insurance coverage position statement, which is
being sent out to inquiries from producers and insureds. Individuals or entities
requiring information on the Company's position with Y2K matters may reference
the current statement on the Company's Internet site at www.rlicorp.com.
14
<PAGE>
As an element of Phase V, the Company has system contingency services contracted
through a major third-party provider and successfully conducted a Y2K test for
critical systems in June of 1999. The Company continues to enhance and update
the present business contingency plan to address specific Y2K related exposures.
The specific requirements associated with a Y2K operational support plan for the
millennium weekend, including on-site staff and on-call support will be
communicated in a detailed plan by mid-November of 1999. Management and control
of new or developing Y2K exposures will continue through the first quarter of
2000.
The Company has incurred $1.2 million in expenses to complete the core system
modifications for Y2K. It required over 26,000 hours of technical staff effort
and changes to systems representing 12.5 million lines of program code. It was
originally estimated that the Company would incur an additional $300,000 of
expenses in 1999 to upgrade telephone systems, corporate e-mail solutions, and
to ensure the necessary services are in place for contingency efforts. The
Company implemented new e-mail solutions in April of 1999 and new corporate
phone system and switch in May of 1999. As of this date the company has incurred
approximately $250,000 of the estimated additional expenses with a remaining
estimated $80,000 to be incurred late in 1999 and early 2000. Actual expenses
are not significantly greater than those originally forecasted for 1999.
A re-evaluation of all personal computer hardware, network components and
software began in May of 1999 and was completed by the end of October 1999.
Presently, all network servers are Y2K compliant and 75% of personal computer
workstations have been evaluated and remedied. The Company conducted a
successful Y2K simulation, cutover and operation of core business systems during
a disaster recovery test in June of 1999.
Executive management is continuing to place focus and emphasis on eliminating
major issues associated with potential Y2K related failures and as of this date
has not experienced Y2K related problems.
THREE MONTHS ENDED SEPTEMBER 30, 1999, COMPARED TO THREE MONTHS
ENDED SEPTEMBER 30, 1998
Consolidated gross sales totaled $100.1 million for the third quarter of 1999
compared to $80.0 million for the same period in 1998. As detailed in the
discussion of RLI Insurance Group that follows, third quarter 1999 gross
premiums improved $17.3 million, or 23.4%, over third quarter 1998 levels.
Consolidated revenue for the third quarter of 1999 increased $17.8 million, or
42.3%, from the same period in 1998. Net premiums earned in the third quarter of
1999 improved $15.0 million compared to 1998, and investment income and
investment gains improved $2.8 million over third quarter 1998 levels.
The net after-tax earnings for the third quarter of 1999 totaled $8.5 million,
$0.84 per diluted share, compared to $5.6 million, $0.53 per share, for the same
period in 1998. Net operating earnings, which consist of the Company's net
earnings reduced by after-tax realized investment gains, improved to $7.0
million, $0.69 per share, compared to $5.6 million, $0.53 per share, for the
same period in 1998.
15
<PAGE>
Comprehensive losses, which includes net earnings plus unrealized losses net of
tax, totaled $12.7 million, $1.26 per share, compared to $10.8 million, $1.02
per share, for the same period in 1998. Unrealized losses, net of tax, for the
third quarter of 1999 were $21.2 million, $2.10 per share compared to $16.3
million, $1.55 per share, for the same period in 1998. This increase in losses
is attributable to the stock market declines of August and September, 1999.
RLI INSURANCE GROUP
Gross written premium for the third quarter of 1999 totaled $91.1 million,
compared to $73.8 million reported for the same period in 1998. Much of this
improvement came from the casualty segment as mentioned previously. Pretax
underwriting profit increased to $4.5 million in the third quarter of 1999
compared to $1.7 million for the same period last year. This equates to GAAP
combined ratios of 91.2 for the third quarter of 1999 compared to 95.3 for the
third quarter of 1998.
Property segment gross written premiums increased by 19.9% to $33.1 million in
the third quarter of 1999. This is due to a 43% increase in fire premiums to
$10.7 million for the third quarter of 1999, compared to $7.5 million for the
same period in 1998, as well as some production from new product lines. Property
segment underwriting profits were $4.0 million for the third quarter of the year
compared to $3.9 million last year. The GAAP combined ratio for the property
segment increased to 69.3 for the third quarter of 1999 compared to 68.0 for the
same period last year. This increase was due to the increasing mix of fire lines
with higher loss ratios, as mentioned previously.
Gross written premiums for the casualty segment were $48.1 million for the third
quarter of 1999 compared to $39.1 million for the prior year. This is primarily
due to the increases in the commercial umbrella and the transportation products
mentioned previously. Commercial umbrella gross written premium increased by
$2.4 million and the transportation product by $4.0 million from the third
quarter of 1998. The GAAP combined ratio fell slightly to 101.6 for the third
quarter compared to 102.1 last year.
The Group's surety segment gross written premiums increased by 40.0% to $9.9
million for the third quarter of 1999 compared to $7.1 million for the same
period in 1998. This increase was primarily due to $2.4 million in premium for
the quarter from Underwriters' Indemnity in Houston. The GAAP combined ratio for
the surety segment fell to 85.6 in the third quarter from 137.7 a year ago. This
was the result of the charge to reserves late in the third quarter of 1998, as
mentioned previously. Without the effect of this charge, the GAAP combined ratio
would have been 84.8, which is more in line with the 85.6 combined ratio
realized for the third quarter of 1999.
16
<PAGE>
INVESTMENT INCOME
The Company's investment portfolio generated net dividends and interest income
of $6.7 million during the third quarter of 1999, an increase of 9.0% over that
reported for the same period in 1998. This is the result of an increase in cash
flow due to the Company's premium growth and the impact of the new global
casualty reinsurance treaty.
In addition, the Company recognized realized investment gains of $2.3 million in
the third quarter of 1999 compared to $32,000 in the third quarter of 1998.
Third quarter of 1999 includes the sale of certain equity securities, as
discussed previously.
INCOME TAXES
The Company's effective tax rate for the third quarter of 1999 was 29% compared
to 22% for the same period in 1998. This increase is due to goodwill
amortization from the acquisition of Underwriters' Indemnity in 1999 not being
deductible for tax purposes, as well as an increase in underwriting income for
the quarter, which is taxed at 35%. 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 third quarter of 1999 and 1998 as a
result of the following:
<TABLE>
<CAPTION>
1999 1998
Amount % Amount %
------ --- ------ ---
<S> <C> <C> <C> <C>
Provision for income taxes at
the statutory rate of 35% $ 4,179,201 35% $ 2,498,026 35%
Increase (reduction) in taxes
resulting from:
Tax exempt interest income (652,423) (5%) (578,181) (8%)
Dividends received deduction (368,891) (3%) (349,255) (5%)
Dividends paid deduction (62,533) (1%) (59,927) (1%)
Goodwill amortization 280,707 2% -- -
Other items, net 93,021 1% 48,057 1%
----------- ---- ----------- ---
Total tax expense $ 3,469,082 29% $ 1,558,720 22%
</TABLE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is a general term describing the potential economic loss associated
with adverse changes in the fair market value of financial instruments.
Management of market risk is a critical component of RLI Corp.'s investment
decisions and objectives. The Company manages its exposure to market risk by
using the following:
1. Monitoring on a constant basis the fair market value of all financial assets;
2. Changing the character of future investments purchases; and
3. Re-balancing its existing asset and liability portfolios.
17
<PAGE>
The Company's primary risk exposures are to changes in interest rates and equity
prices, as it has no derivatives or foreign exchange risk as of September 30,
1999.
INTEREST RATE RISK
The Company's primary exposure to interest rate risk is with its fixed income
investment portfolio, but on a smaller scale, it also incurs similar risk with
its short-term debt instruments.
Modified duration analysis is used to measure the sensitivity of the fixed
income investment portfolio to changes in interest rates, providing a measure of
price percentage volatility. The Company attempts to minimize interest rate risk
by matching the duration of its assets to that of its liabilities. The Company
limits the impact of changes in interest rates on its financial statements by
designating a majority of the fixed income holdings as held-to-maturity. This
designation is chosen for the securities for which the Company has the intent
and ability to hold to stated maturity. These securities are carried at
amortized cost and, except for declines that are other than temporary, changes
in fair market value are not reflected on the financial statements. As of
September 30, 1999, the Company had classified 86% of its fixed income
securities portfolio as held-to-maturity. The balance of the Company's fixed
income portfolio is classified as either available-for-sale or trading.
Interest rate risk could also impact the Company's income statement due to its
impact on interest expense. The Company's current debt obligations are short
term in nature with no long-term debt outstanding as of September 30, 1999. As a
result, the Company assumes interest rate risk in its ability to refinance these
short-term debt obligations. Any rise in interest rates will cause interest
expense to increase, assuming debt is maintained at current levels.
EQUITY PRICE RISK
Equity price risk is the potential that the Company will incur economic loss due
to the decline of common stock prices. Beta analysis is used to measure the
sensitivity of the Company's equity portfolio to changes in the value of the S&P
500 index (an index representative of the broad equity market). As measured from
December 31, 1981 to September 30, 1999, the Company's equity portfolio has a
beta of 0.68 in comparison to the S&P 500. This low beta statistic reflects the
Company's long term emphasis on maintaining a conservative, value oriented,
dividend-driven equity investment philosophy. Historically, dividend-paying
common stocks have demonstrated superior down-market performance
characteristics.
Additional risk management techniques include:
1. Restricting individual security weightings to less than 3% of the equity
portfolio's market value; and
2. Reducing the exposure to sector risk by limiting the market value
invested in any one particular industry sector to 25% of the equity
portfolio.
18
<PAGE>
Equity securities are classified as available-for-sale, with unrealized gains
and losses excluded from net earnings but recorded as a component of
comprehensive earnings and shareholders' equity, net of deferred income taxes.
SENSITIVITY ANALYSIS
The tables below detail information on the market risk exposure for the
Company's financial investments as of September 30, 1999. Listed on each
table is the September 30, 1999 market value for the Company's assets and the
expected reduction in market value, given the stated hypothetical events.
This sensitivity analysis assumes that the composition of the Company's
assets remains constant over the period being measured and that interest rate
changes are reflected uniformly across the yield curve. The analysis does not
consider any action the Company would undertake in response to changes in
market conditions. For purposes of this disclosure, securities are divided
into two categories: those held for trading purposes and those held for
non-trading purposes. The examples given are not predictions of future market
events, but rather illustrations of the impact such events may have on the
market value of the Company's investment portfolio.
As of September 30, 1999, the Company's fixed income portfolio had a market
value of $353.7 million. This sensitivity analysis uses scenarios of interest
rates increasing 100 and 200 basis points from their September 30, 1999
levels, with all other variables held constant. Such scenarios would result
in decreases in the market value of the fixed income portfolio of $14.2
million and $27.7 million, respectively. Due to the Company's use of the
held-to maturity designation for a majority of the fixed income portfolio,
the balance sheet impact of these scenarios would be much lower. The income
statement would only be affected by holdings designated as trading.
As of September 30, 1999, the Company's equity portfolio had a market value
of $277.8 million. This base sensitivity analysis uses market scenarios of
the S&P 500 index declining both 10 percent and 20 percent. These scenarios
would result in approximate decreases in the market value of the equity
portfolio of $18.9 million and $37.8 million, respectively. As the Company
designates all common stocks as available-for-sale, these market value
declines would impact the Company's balance sheet.
Counter to the base scenarios shown in Tables 1 and 2, Tables 3 and 4
quantify the opposite impact. Under the assumptions of falling interest rates
and an increasing S&P 500 index, the market value of the Company's assets
will increase from their present levels by the indicated amounts.
The income statement will also be impacted by interest expense. As of
September 30, 1999, the Company had $79.5 million in short term debt
obligations. Assuming this debt level remains constant, a hypothetical 100
basis point increase in interest rates would increase the Company's annual
interest expense by $800,000 and a 200 basis point increase would increase
annual interest expense by $1.6 million. Conversely, falling interest rates
would result in equivalent reductions in interest expense. These numbers are
not included in the following tables.
19
<PAGE>
TABLE 1 (IN THOUSANDS)
Effect of a 100 basis point increase in interest rates and a 10% decline in the
S&P 500:
<TABLE>
<CAPTION>
9/30/99 Interest Equity
MKT. VALUE RATE RISK RISK
---------- --------- ------
<S> <C> <C> <C>
Held for Trading Purposes
Fixed Maturity Securities $ 7,702 ($ 253) --
Total Trading $ 7,702 ($ 253) --
Held for Non-Trading Purposes
Fixed Maturity Securities $345,951 ($13,934) --
Equity Securities $277,838 -- ($18,893)
Total Non-Trading $623,789 ($13,934) ($18,893)
Total Trading & Non-Trading $631,491 ($14,187) ($18,893)
</TABLE>
TABLE 2 (IN THOUSANDS)
Effect of a 200 basis point increase in interest rates and a 20% decline in the
S&P 500:
<TABLE>
<CAPTION>
9/30/99 Interest Equity
MKT. VALUE RATE RISK RISK
---------- --------- ------
<S> <C> <C> <C>
Held for Trading Purposes
Fixed Maturity Securities $ 7,702 ($ 492) --
Total Trading $ 7,702 ($ 492) --
Held for Non-Trading Purposes
Fixed Maturity Securities $345,951 ($27,177) --
Equity Securities $277,838 -- ($37,786)
Total Non-Trading $623,789 ($27,177) ($37,786)
Total Trading & Non-Trading $631,491 ($27,669) ($37,786)
</TABLE>
TABLE 3 (IN THOUSANDS)
Effect of a 100 basis point decrease in interest rates and a 10% increase in the
S&P 500:
<TABLE>
<CAPTION>
9/30/99 Interest Equity
Mkt. Value Rate Risk Risk
---------- --------- ------
<S> <C> <C> <C>
Held for Trading Purposes
Fixed Maturity Securities $ 7,702 $ 261 --
Total Trading $ 7,702 $ 261 --
Held for Non-Trading Purposes
Fixed Maturity Securities $345,951 $ 13,008 --
Equity Securities $277,838 -- $ 18,893
Total Non-Trading $623,789 $ 13,008 $ 18,893
Total Trading & Non-Trading $631,491 $ 13,269 $ 18,893
</TABLE>
20
<PAGE>
TABLE 4 (IN THOUSANDS)
Effect of a 200 basis point decrease in interest rates and a 20% increase in the
S&P 500:
<TABLE>
<CAPTION>
9/30/99 Interest Equity
Mkt. Value Rate Risk Risk
---------- --------- ------
<S> <C> <C> <C>
Held for Trading Purposes
Fixed Maturity Securities $7,702 $513 --
Total Trading $7,702 $513 --
Held for Non-Trading Purposes
Fixed Maturity Securities $345,951 $25,479 --
Equity Securities $277,838 -- $37,786
Total Non-Trading $623,789 $25,479 $37,786
Total Trading & Non-Trading $631,491 $25,992 $37,786
</TABLE>
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 - Not Applicable
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
nine months ended September 30, 1999.
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: November 11, 1999
21
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<CIK> 0000084246
<NAME> RLI CORP.
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<DEBT-HELD-FOR-SALE> 40,557,934
<DEBT-CARRYING-VALUE> 305,645,516
<DEBT-MARKET-VALUE> 305,393,269
<EQUITIES> 277,838,043
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 675,714,361
<CASH> 0
<RECOVER-REINSURE> 94,861,750
<DEFERRED-ACQUISITION> 34,805,430
<TOTAL-ASSETS> 1,186,299,148
<POLICY-LOSSES> 532,148,836
<UNEARNED-PREMIUMS> 165,676,663
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 79,539,568
0
0
<COMMON> 12,804,558
<OTHER-SE> 273,979,180
<TOTAL-LIABILITY-AND-EQUITY> 1,186,299,148
144,453,076
<INVESTMENT-INCOME> 19,165,187
<INVESTMENT-GAINS> 4,522,892
<OTHER-INCOME> 0
<BENEFITS> 70,203,818
<UNDERWRITING-AMORTIZATION> 48,938,152
<UNDERWRITING-OTHER> 12,253,391
<INCOME-PRETAX> 32,885,046
<INCOME-TAX> 8,814,982
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 24,070,064
<EPS-BASIC> 2.36
<EPS-DILUTED> 2.34
<RESERVE-OPEN> 415,523,392
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 532,148,836
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
