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, 1997 ------------------------------------------- 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 August 8, 1997 the number of shares outstanding of the registrant's Common Stock was 9,394,655. Page 1 of 16
PART I Item 1. Financial Statements RLI Corp. and Subsidiaries Condensed Consolidated Statement Of Earnings (Unaudited) For the Three-Month Period Ended June 30, 1997 1996 (Restated) ----------- ----------- Net premiums earned $35,974,352 $32,390,263 Net investment income 5,999,346 6,091,854 Net realized investment gains(losses) 1,734,460 ( 36,190) ----------- ----------- 43,708,158 38,445,927 ----------- ----------- Losses and settlement expenses 15,650,578 16,907,372 Policy acquisition costs 10,931,140 7,505,677 Insurance operating expenses 4,762,090 3,862,271 Interest expense on debt 690,532 690,570 General corporate expenses 964,240 853,523 ----------- ----------- 32,998,580 29,819,413 ----------- ----------- Equity in earnings of unconsolidated investee 296,783 235,723 ----------- ----------- Earnings before income taxes 11,006,361 8,862,237 Income tax expense 3,022,692 2,481,575 ----------- ----------- Net earnings $ 7,983,669 $6,380,662 ============ ============= Net earnings per share: Primary $1.05 $0.80 Fully diluted $0.90 $0.71 Weighted average number of common shares outstanding Primary 7,625,456 7,935,776 Fully diluted 9,394,687 9,705,007 Cash dividends declared per common share $0.15 $0.14 The accompanying notes are an integral part of the financial statements. 2
RLI Corp. and Subsidiaries Condensed Consolidated Statement Of Earnings (Continued) (Unaudited) For the Six-Month Period Ended June 30, 1997 1996 (Restated) ----------- ----------- Net premiums earned $69,039,987 $64,557,241 Net investment income 12,020,897 11,819,299 Net realized investment gains 2,294,484 105,120 ----------- ----------- 83,355,368 76,481,660 ----------- ----------- Losses and settlement expenses 31,353,740 34,938,024 Policy acquisition costs 20,894,159 15,507,006 Insurance operating expenses 8,546,493 7,198,226 Interest expense on debt 1,381,084 1,411,914 General corporate expenses 1,844,709 1,588,565 ----------- ----------- 64,020,185 60,643,735 ----------- ----------- Equity in earnings of unconsolidated investee 540,456 360,411 ----------- ----------- Earnings before income taxes 19,875,639 16,198,336 Income tax expense 5,336,185 4,301,777 ----------- ----------- Net earnings $14,539,454 $11,896,559 ============ ============= Net earnings per share: Primary $1.90 $1.50 Fully diluted $1.64 $1.32 Weighted average number of common shares outstanding Primary 7,661,884 7,921,316 Fully diluted 9,431,115 9,690,547 Cash dividends declared per common share $0.29 $0.27 The accompanying notes are an integral part of the financial statements. 3
RLI Corp. and Subsidiaries Condensed Consolidated Balance Sheet June 30, December 31, ASSETS 1997 1996 Investments ------------ ------------- Fixed maturities (Unaudited) Held-to-maturity, at amortized cost $271,852,314 $263,282,430 Trading, at fair value 9,341,423 0 Available-for-sale, at fair value 35,871,552 44,904,303 Equity securities, at fair value 220,430,101 188,935,360 Short-term investments, at cost which approximates fair value 13,641,393 40,823,967 ----------- ------------- Total investments 551,136,783 537,946,060 Cash 0 0 Accrued investment income 5,921,377 5,835,885 Premiums and reinsurance balances receivable 56,229,272 37,166,516 Ceded unearned premiums 50,499,192 53,705,078 Reinsurance balances recoverable on unpaid losses 165,048,161 165,017,149 Deferred policy acquisition costs 24,484,881 16,663,603 Property and equipment 12,154,354 12,126,552 Investment in unconsolidated investee 13,205,265 8,970,691 Other assets 11,953,805 8,042,250 ----------- ------------ TOTAL ASSETS $890,633,090 $845,473,784 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Unpaid losses and settlement expenses $408,986,876 $405,801,220 Unearned premiums 135,435,750 129,781,639 Reinsurance balances payable 27,132,237 23,699,837 Long-term debt: Convertible debentures 46,000,000 46,000,000 Income taxes-current 3,096,541 2,134,692 Income taxes-deferred 29,430,287 17,170,687 Other liabilities 16,484,617 20,846,348 ----------- ------------ TOTAL LIABILITIES 666,566,308 645,434,423 ----------- ------------ Shareholders' Equity: Common stock ($1 par value, authorized 50,000,000 shares, issued 8,453,499 shares at 12/31/96 and 8,453,724 shares at 6/30/97) 8,453,724 8,453,449 Other shareholders' equity 228,440,402 197,464,904 Less: Treasury shares at cost (631,719 shares at 12/31/96) (828,268 shares at 6/30/97) (12,827,344) (5,878,992) ----------- ------------ TOTAL SHAREHOLDERS' EQUITY 224,066,782 200,039,361 ----------- ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $890,633,090 $845,473,784 ============ ============ The accompanying notes are an integral part of the financial statements. 4
RLI Corp. and Subsidiaries Condensed Consolidated Statements of Cash Flows (Unaudited) For the Six-Month Period Ended June 30, -------------------------- 1997 1996 (Restated) ------------ ------------ Net cash used in operating activities ($ 5,983,352) ($ 5,054,319) ------------ ------------ Cash Flows from Investing Activities Investments purchased (42,608,387) (18,247,840) Investments sold 9,926,806 4,683,628 Investments called or matured 21,701,592 10,200,000 Net decrease in short-term investments 27,182,573 9,134,602 Net property and equipment purchased ( 1,296,163) ( 1,434,402) ------------ ------------ Net cash from investing activities 14,906,421 4,335,988 ------------ ------------ Cash Flows from Financing Activities Cash dividends paid (2,211,382) ( 2,142,799) Payments on debt 0 ( 2,800,000) Change in contributed capital 236,665 1,615,396 Treasury shares reissued 0 538,789 Treasury shares purchased (6,948,352) 0 ------------ ------------ Net cash (used in) financing activities (8,923,069) ( 2,788,614) ------------ ------------ Net increase (decrease) in cash 0 ( 3,506,945) ------------ ------------ Cash at the beginning of the year 0 3,506,945 ------------ ------------ Cash as of June 30 $ 0 $ 0 ============ ============ The accompanying notes are an integral part of the financial statements. 5
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 1996 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, 1996 has been derived from, and does not include all the disclosures contained in the audited consolidated financial statements for the year ended December 31, 1996. 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, 1997 and 1996 are not necessarily indicative of the results of a full year. Primary earnings per share are computed using the weighted average number of shares of common stock outstanding during the period. Fully diluted earnings per share calculations are based on the weighted average number of shares of common stock outstanding for the period, assuming full conversion of all Convertible Debentures into common stock. Net earnings are adjusted for purposes of this calculation to eliminate interest and amortization of debt issuance costs on the Convertible Debentures net of related taxes. When the conversion of Convertible Debentures increases the earnings per share or reduces the loss per share, the effect on earnings is antidilutive. Under these circumstances, the fully diluted net earnings or net loss per share is computed assuming no conversion of the Convertible Debentures. As previously reported in RLI Corp.'s Form 10-K filed for the period ended December 31, 1996, on December 1, 1996, RLI Vision Corp., the Company's wholly-owned optical goods distributor, merged with Hester Enterprises, Inc., the manufacturer of Maui Jim sunglasses. The Company retained a 34% minority interest in the combined entity, renamed Maui Jim, Inc. The Company accounted for this merger as a non-monetary exchange of ownership interests with no gain or loss recognized. As a result of the merger, the Company has presented its minority interest in Maui Jim, Inc. under the equity method of accounting beginning December 1, 1996. Additionally, for comparative purposes, the Company has restated prior period financial information to present its 100% ownership in RLI Vision Corp. under the equity method. This restatement is a change in presentation only and has no impact on earnings. In January 1997, the Company paid $3,694,119 for an additional 10% ownership interest in Maui Jim, Inc., bringing the Company's total minority interest in Maui Jim, Inc. to 44%. The accompanying financial data should be read in conjunction with the notes to the financial statements contained in the 1996 10-K Annual Report. 6
2. INDUSTRY SEGMENT INFORMATION - Selected information by industry segment for the six months ended June 30, 1997 and 1996 is presented below. SEGMENT DATA - (in thousands) EARNINGS (LOSS) BEFORE REV. TAXES ASSETS 1997 ------- -------- ------ RLI Insurance Group $ 69,040 $ 8,246 $849,128 Net investment income 12,021 12,021 Net realized investment gains 2,294 2,294 General corporate & interest expense -- (3,226) 41,505 Equity in earnings of unconsolidated investee -- 540 -------- --------- -------- Consolidated $ 83,355 $ 19,875 $890,633 ======== ========= ======== 1996 RLI Insurance Group $ 64,557 $ 6,914 $800,548 Net investment income 11,819 11,819 Net realized investment gains 105 105 General corporate & interest expense -- (3,000) 22,495 Equity in earnings of unconsolidated investee -- 360 -------- --------- -------- Consolidated $ 76,481 $ 16,198 $823,043 ======== ========= ======== 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. 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 83% of the Company's total revenue for the six months ended June 30, 1997. 7
SIX MONTHS ENDED JUNE 30, 1997, COMPARED TO SIX MONTHS ENDED JUNE 30, 1996 Consolidated gross sales, which consist of gross premiums written, net investment income and realized investment gains (losses) totaled $160.9 million for the first six months of 1997, up 7.5% from the same period in 1996. This increase was the result of a 6.4% increase in gross sales of the insurance group, as detailed in the discussion of RLI Insurance Group that follows. Net investment income grew, as well, posting a 1.7% improvement over 1996 levels. Consolidated revenue increased $6.9 million, or 9.0%, from the same period in 1996. Net premiums earned for the first six months of 1997 were up $4.5 million, or 6.9%, compared to the same period in 1996, as surety writings showed marked improvement. Additionally, realized investment gains were $2.2 million higher than 1996. The sale of certain equity securities and real estate during the first six months of 1997 accounted for this increase. The net after-tax earnings for the first six months of 1997 totaled $14.5 million, $1.90 per share, compared to $11.9 million, $1.50 per share, for the same period in 1996. The increase in net earnings is attributable to continued strong property underwriting results and increased net investment income and investment gains. RLI INSURANCE GROUP Gross premiums written for the first six months of 1997 totaled $146.6 million, compared to $137.8 million reported for the same period in 1996. Property premiums increased to $78.8 million for the first six months of 1997 compared to $70.5 million for the same period in 1996. The addition of the Hawaiian Homeowners business in March of 1997 fueled this growth. As part of the purchase agreement with the Hawaii Property Insurance Association, RLI Insurance Group assumed $10.7 million in written premium. Since March, an additional $2.3 million in premium has been assumed and $1.4 million has been written directly by the Group, for total premium writings of $14.4 million from this book as of June 30, 1997. It is anticipated that the Hawaiian book will provide an additional $10.0 to $12.0 million in gross written premium on an annual basis. The Company's surety book also posted substantial growth in the first half of 1997. Direct writings for surety improved to $12.4 million versus $3.1 million for the same period in 1996. This increase is primarily the result of the implementation of two new contract surety programs in the second quarter of 1996. The increased writings on the property and surety books were partially offset by declines in the Company's casualty book. Gross written premium on the casualty book declined $8.8 million to $55.4 million when compared to the same period in 1996. General Liability, Employers Indemnity, and Directors and Officers Liability accounted for $5.4, $1.8 and $1.4 million, respectively, of this decline, as continued less favorable pricing and soft market conditions have resulted in the non-renewal of certain accounts which cannot be underwritten profitably. Net premiums written for the first six months of 1997 increased $10.1 million, or 14.9%, from the same period in 1996. Of this increase, $10.8 million was related to the property book. Net property writings increased $14.0 million with the addition of the Hawaiian Homeowners business. This increase, however, was offset by a $3.9 million decrease in Difference-In-Conditions net 8
writings. This decline was primarily due to the change in booking ceded premium from a written premium basis to an earned premium basis on California Excess of Loss treaties in 1996. Ceded premiums and unearned premiums were adjusted proportionally downward causing net premiums to be higher in 1996 compared to 1997. The Company's surety book posted net premium written of $6.9 million, a $4.5 million improvement over the same period in 1996. The improvements experienced in property and surety, however, were offset by a $5.2 million decline in net casualty writings related to the unfavorable pricing and market conditions as mentioned previously. Net premiums earned of $69.0 million in the first half of 1997 represents a 6.9% increase from the same period in 1996. Earned premiums associated with the Hawaiian Homeowners business caused property to improve $4.5 million over first half 1996 levels. With the addition of the two new programs, as mentioned previously, the surety book improved, as well, posting a $3.1 million increase over 1996 levels. Earned premiums on the casualty book, however, declined by $3.2 million due to the decline in writings as mentioned previously. The Group's pretax earnings totaled $8.2 million for the first six months of 1997 compared to pretax earnings of $6.9 million for the same period in 1996. The property book contributed to this improvement posting $9.3 million in pretax earnings in 1997 compared to $8.5 million for the first half of 1996. 1996 property earnings were reduced by $2.2 million, or $.18 per share, due to winter storm losses on the east coast. For the first quarter of 1997, however, only $300,000, or $.03 per share, were reported from eastern winter storm losses. Surety showed improvement, as well, reporting a pretax profit of $278,000 compared to a pretax loss of $365,000 for the same period in 1996. This translates into surety's second consecutive quarter of operating profits and is directly in line with the original business plan for this division. The improvement experienced in property and surety was partially offset by a decline in earnings on the casualty book. Casualty posted a pretax loss of $1.3 million for the first half of 1997 compared to a pretax loss of $1.2 million for the same period in 1996. The GAAP combined ratio through the first six months of 1997 was 88.0 compared to 89.3 for the same period in 1996. The loss ratio decreased from 54.1 for the first half of 1996 to 45.4 in the first half of 1997. This decrease was mainly the result of the improved property and casualty loss ratios. The property book reported a loss ratio of 19.2 for the first half of 1997 compared to 25.0 for the same period in 1996. The decline in losses reported from eastern winter storms, as mentioned previously, was the primary driver of this improvement. The casualty book reported a loss ratio of 69.7 in 1997 compared to 73.2 in 1996. The higher loss ratio in 1996 was the result of $2.2 million in General Liability reserve strengthening on the 1994 through 1996 accident years. The Company's expense ratio increased from 35.2 for the first half of 1996 to 42.6 for the first half of 1997. This increase was primarily related to commissions associated with the acquisition of the Hawaiian Homeowners business. The $13.0 million in assumed premium on the Hawaiian book was purchased at a commission rate of 65.4. New business, directly written by the Company, however, will carry a commission rate between 17% and 20%. These two items contributed to the increase in property's expense ratio from 39.8 in the first half of 1996 to 48.4 in the first half of 1997. The casualty book, as well, showed an increase in expense ratio from 9
29.9 in 1996 to 34.0 in 1997. Despite only a $533,000 increase in total expense between periods, the $3.2 million decline in earned premiums in 1997 compared to 1996 contributed to the increase in casualty's expense ratio. The surety book, however, posted a significant improvement in expense ratio, decreasing from 93.8 in 1996 to 72.7 in 1997. The tremendous growth in surety earned premiums, as discussed previously, coupled with expense control measures, contributed to this improvement. INVESTMENT INCOME The Company's investment portfolio generated net dividends and interest income of $12.0 million during the first six months of 1997, an increase of 1.7% over that reported for the same period in 1996. This increase is the result of a higher invested asset base for the six months ended June 30, 1997 compared to the same period in 1996. Invested assets at June 30, 1997 increased by $13.2 million, or 2.5%, from December 31, 1996. Short-term investments, however, declined by $27.2 million from December 31, 1996 due primarily to the funding of reinsurance obligations and other operating needs. In addition, the Company recognized realized investment gains of $2.3 million in the first six months of 1997 compared to $105,000 in the first six months of 1996. Capital gains have increased over 1996 levels due to the sale of real estate and certain equity securities. Capital gains associated with sale of real estate amounted to $775,000. The remaining gains related to the sale of certain equity securities deemed to have reached their full potential. The Company's fixed income portfolio consisted entirely 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, 1997 and 1996 have remained relatively flat and are as follows: 1997 1996 ---- ---- Taxable 6.92% 6.94% Non-taxable 5.03% 5.00% The Company's available-for-sale portfolio of debt and equity securities had net unrealized gains before tax of $28.3 million in the first six months of 1997 compared to net unrealized gains before tax of $9.0 million for the same period in 1996. During the second quarter of 1997, the stock market rallied from the correction experienced in March of 1997. This rally resulted in the Company recording $26.1 million in net unrealized gains before tax for the three months ended June 30, 1997. Unrealized appreciation on securities, net of tax is reflected in a separate component of shareholders' equity. The Company's net unrealized gain before tax was $105.9 million and $77.5 million at June 30, 1997 and December 31, 1996, respectively. Interest expense on debt obligations remained flat at $1.4 million for the first six months of 1997 and 1996. 10
INCOME TAXES The Company's effective tax rate for the first six months of 1997 and 1996 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 first six months of 1997 and 1996 as a result of the following: 1997 1996 Amount % Amount % ------ --- ------ --- Provision for income taxes at the statutory rate of 35% $ 6,956,474 35% $ 5,669,418 35% Increase (reduction) in taxes resulting from: Tax exempt interest income ( 891,015) ( 4%) ( 750,458) ( 4%) Dividends received deduction ( 661,571) ( 3%) ( 592,993) ( 4%) Dividends paid deduction ( 119,497) ( 1%) ( 128,844) ( 1%) Other items, net 51,794 -- 104,654 1% ---------- ---- ---------- ---- Total tax expense $ 5,336,185 27% $ 4,301,777 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 1997, the Company repurchased 196,549 of its outstanding shares at a cost of $6.9 million. These treasury shares are reflected as a separate component of equity. On June 20, 1997, the Company announced that it was calling for redemption all of its outstanding 6% convertible debentures that were to mature July 15, 2003. The $46.0 million bond issue was to be redeemed for cash on July 22, 1997 at 103% of its principal amount, plus accrued interest. Holders of the debenture had the option to convert, at any time prior to the close of business on July 21, 1997, the debentures at an exchange rate of 38.4615 shares of RLI common stock for each $1,000 principal amount of convertible debt ($26.00 per share conversion price). On July 24, 1997, the Company announced that the entire $46.0 million had been converted into RLI common stock. This conversion created an additional 1,769,199 new shares of RLI common stock. At June 30, 1997 the Company had short-term investments, cash and other investments maturing within one year, of approximately $31.6 million and additional investments of $122.7 million maturing within five years. The Company maintains three sources of credit from two financial institutions: one $10.0 million secured and committed line of credit that cannot be canceled during its annual term; a $30.0 million secured line of credit that cannot be canceled during its annual term; and a $3.0 million secured line of credit 11
available for the issuance of letters of credit. All lines were unused at June 30, 1997. 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. THREE MONTHS ENDED JUNE 30, 1997, COMPARED TO THREE MONTHS ENDED JUNE 30, 1996 Consolidated gross sales, totaled $84.0 million for the second quarter of 1997, up 4.5% from the same period in 1996. This increase was the result of a 2.6% increase in gross sales of the insurance group, as well as a $1.8 million increase in realized capital gains. Consolidated revenue for the second quarter of 1997 increased $7.2 million, or 13.7%, from the same period in 1996. Net premiums earned in the second quarter of 1997 were up 11.1% compared to 1996, as surety writings showed marked improvement, and the Hawaiian homeowner's book provided additional earned premium. The net after-tax earnings for the second quarter of 1997 totaled $8.0 million, $1.05 per share, compared to $6.4 million, $.80 per share, for the same period in 1996. The increase in net earnings is attributable to continued strong property and surety underwriting results and increased net investment gains. RLI INSURANCE GROUP Gross premiums written in the second quarter of 1997 totaled $76.3 million, compared to $74.4 million reported for the same period in 1996. Property premiums remained flat at $39.8 million for the second quarter of 1997 and 1996. Hawaiian Homeowners business added $3.7 million in written premium. This increase, however, was offset by modest declines in both Difference-In- Condition and Property-Fire. The Company's surety book posted substantial growth in the second quarter of 1997. Direct writings for surety improved to $7.5 million compared to $2.1 million for the same period in 1996. The Company's casualty book, however, posted a $3.4 million decline in writings, as soft market conditions have resulted in the non-renewal of certain accounts which cannot be underwritten profitably. Net premiums written for the second quarter of 1997 increased $7.0 million or 20.6% from the same period in 1996. Of this increase, $6.4 million was related to the property book. Net property writings increased $3.4 million with the addition of the Hawaiian Homeowners business. The Company's surety book posted net premium written of $4.1 million, a $2.5 million improvement over the same period in 1996. The improvements experienced in property and surety, however, were offset by a $1.9 million decline in net casualty writings related to the less favorable pricing and market conditions mentioned previously. Net premiums earned of $36.0 million in the second quarter of 1997 represents a $3.6 million, or 11.0%, increase over the same period in 1996. Earned 12
premiums associated with the Hawaiian Homeowners business caused property to improve $3.4 million over second quarter 1996 levels. The surety book improved, as well, posting a $1.9 million increase over 1996 levels. Earned premiums on the casualty book, however, declined by $1.7 million due to the decline in writings mentioned previously. The Group's pretax earnings totaled $4.6 million for the second quarter of 1997 compared to pretax earnings of $4.1 million for the same period in 1996. The GAAP combined ratio for the second quarter of 1997 was 87.1 compared to 87.3 for the same period in 1996. The loss ratio decreased from 52.2 for the second quarter of 1996 to 43.5 in the second quarter of 1997. The casualty book accounted for the majority of this improvement as the loss ratio declined to 68.8 in second quarter 1997 compared to 77.6 for the same period in 1996. Second quarter 1996 included $2.2 million in General Liability reserve strengthening. The Company's expense ratio increased from 35.1 for the second quarter of 1996 to 43.6 for the second quarter of 1997. This increase was primarily related to commissions associated with the acquisition of the Hawaiian Homeowners business. These commissions contributed to the increase in property's expense ratio from 38.4 in the second quarter of 1996 to 47.7 in the second quarter of 1997. The casualty book, as well, showed an increase in expense ratio from 30.5 in 1996 to 35.7 in 1997. Despite only a $390,000 increase in total expense between periods, the $1.7 million decline in earned premiums in 1997 compared to 1996 contributed to the increase in the expense ratio. The surety book, however, posted a significant improvement in expense ratio, decreasing from 89.8 in 1996 to 70.9 in 1997. The tremendous growth in surety earned premiums, as discussed previously, coupled with expense control measures, contributed to this improvement. INVESTMENT INCOME The Company's investment portfolio generated net dividends and interest income of $6.0 million during the second quarter of 1997, compared to $6.1 million reported for the same period in 1996. Second quarter 1996 included a $300,000, one-time, increase to investment income from the booking of interest income on funds held. Net of this one-time adjustment, investment income tracks favorably in 1997 compared to 1996. In addition, the Company recognized realized investment gains of $1.7 million in the second quarter of 1997 compared to a realized loss of $36,000 in the second quarter of 1996. Second quarter 1997 included the sale of real estate and certain equity securities, as discussed previously. 13
INCOME TAXES The Company's effective tax rate for the second quarter of 1997 and 1996 was 27% and 28%, respectively. 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 three months of 1997 and 1996 as a result of the following: 1997 1996 Amount % Amount % ------ --- ------ --- Provision for income taxes at the statutory rate of 35% $ 3,852,226 35% $ 3,102,147 35% Increase (reduction) in taxes resulting from: Tax exempt interest income ( 447,978) ( 4%) ( 370,244) ( 4%) Dividends received deduction ( 329,798) ( 3%) ( 293,844) ( 3%) Dividends paid deduction ( 56,819) ( 1%) ( 64,676) ( 1%) Other items, net 5,061 -- 108,192 1% ---------- ---- ---------- ---- Total tax expense $ 3,022,692 27% $ 2,481,575 28% 14
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 1, 1997, at the Company's Annual Meeting of Shareholders, the following members were elected to the Board of Directors: Bernard J. Daenzer Jonathan E. Michael Richard J. Haayen Edward F. Sutkowski The following proposals were approved at the Company's Annual Meeting: Affirmative Negative Votes Votes Votes Withheld 1. Amendment to the Articles of 5,905,473 707,122 38,736 Incorporation to authorize a new class of preferred stock. 2. Amendment to the Articles of 6,503,291 125,716 22,324 Incorporation to reqiure affirmative vote of at least a majority of the outstanding shares entitled to vote on subsequent amendments to the Articles. 3. Approve the Market Value Potential 6,654,695 548,138 72,959 Performance Incentive Plan. 4. Approve the Stock Option Plan for 5,471,215 1,523,274 281,303 Outside Directors. 5. Ratify the action of the Board of 7,110,409 145,350 20,033 Directors appointing KPMG Peat Marwick LLP as independent public accountants for 1997. 15
PART II - OTHER INFORMATION (Continued) Item 5. Other Information - Not Applicable Item 6. Exhibits and Reports on Form 8-K (a) Exhibit 3.1 Amended Articles of Incorporation Exhibit 3.2 By-Laws Exhibit 10.1 Market Value Potential Performance Incentive Plan Exhibit 10.6 RLI Corp. Director's Option Plan (b) The Company did not file any reports on Form 8-K during the six months ended June 30, 1997. 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 8, 1997 16