UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 10-Q
(Mark One)
For the period ended June 30, 2001
or
For the transition period from _______________ to ________________
Commission File Number: 0-6612
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 ý No o
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of August 3, 2001 the number of shares outstanding of the registrant's Common Stock was 9,816,971.
PART I
Item 1. Financial Statements
RLI Corp. & SubsidiariesCondensed Consolidated Statement of Earnings and Comprehensive Earnings
The accompanying notes are an integral part of the financial statements.
RLI Corp. and Subsidiaries Condensed Consolidated Balance Sheet
RLI Corp. and SubsidiariesCondensed Consolidated Statements of Cash Flows(Unaudited)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Other Accounting Standards: In June 1998, the Financial Accounting Standards Board (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. Statement 133 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. Statement 133, as amended by FASB Statement No. 137, was effective for all fiscal quarters of fiscal years beginning after June 15, 2000.
In March 2001, the FASB adopted the guidance set forth in Derivatives Implementation Group (DIG) Issue A17, “Contracts That Provide for Net Share Settlement.” Based on this newly approved guidance, the Company has determined that stock warrants received in conjunction with the purchase of a note receivable qualify as derivatives under Statement 133. Therefore, in accordance with the transition provisions of Statement 133, the Company accounted for these warrants as derivatives effective April 1, 2001.
As no hedging relationship exists with respect to these instruments, they were marked to fair value with a cumulative-effect-type adjustment to net income as of April 1, 2001. This cumulative-effect adjustment totaled $800,415, net of tax. The change in fair value of this instrument from April 1 to June 30 has been recorded through the statement of earnings as net investment income and will be reported as such in all periods going forward.
In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141 “Business Combinations”, effective for all business combinations initiated after June 30, 2001, and No. 142 “Accounting for Goodwill and Other Intangible Assets”, effective for fiscal years beginning after December 15, 2001. SFAS 141 requires the purchase method of accounting be used for all business combinations. Goodwill and certain intangible assets will remain on the balance sheet and not be amortized. SFAS 142 establishes a new method of testing goodwill for impairment. On an annual basis, and when there is reason to suspect that their values may have been diminished or impaired, these assets must be tested for impairment. The amount of goodwill determined to be impaired will be expensed to current operations. The Company is currently evaluating what impact, if any, that these statements will have on our consolidated financial position or results of operations.
Amortization of goodwill was $1.1 million for both six-month periods ended June 30, 2001 and 2000. Total goodwill amortization for the year ended December 31, 2000 was $2.1 million.
"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, 2000.
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 88% of the Company's total revenue for the six months ended June 30, 2001.
SIX MONTHS ENDED JUNE 30, 2001, COMPARED TO SIX MONTHSENDED JUNE 30, 2000
Consolidated gross sales, which consist of gross premiums written, net investment income and realized investment gains (losses) totaled $271.2 million for the first six months of 2001 compared to $234.3 million for the same period in 2000. Gross premium writings of the Insurance Group improved 15.3% over 2000 levels, fueled by increases in the casualty and surety segments. Consolidated revenue for the first six months of 2001 increased $22.3 million or 17.9% from the same period in 2000. Net premiums earned alone increased 17.2%. Net investment income improved 8.1% to $15.2 million. Additionally, the sale of certain securities during the first six months of 2001 resulted in $1.9 million in realized gains, compared to $87,000 in realized losses for the same period last year.
The net after-tax earnings for the first six months of 2001 totaled $15.3 million, $1.53 per diluted share, compared to $13.5 million, $1.36 per share, for the same period in 2000. The cumulative-effect adjustment for the initial adoption of FASB Statement 133 totaled $800,415 ($0.08 per share) and is included in the 2001 net after-tax earnings number. Net operating earnings, which consist of the Company's net earnings reduced by after-tax realized investment gains/losses and cumulative-effect adjustment, totaled $13.3 million, $1.32 per share, compared to $13.6 million, $1.37 per share, for the same period in 2000. The small decline in operating earnings was the result of losses in the Company’s property book, including Seattle earthquake loss experience, which totaled just under $1.0 million ($0.06 per share).
Comprehensive earnings, which include net earnings plus unrealized gains/losses net of tax, were subject to the year’s volatility in the equity markets. Comprehensive earnings for the first six months totaled $4.1 million, $0.41 per share, compared to $9.5 million, $.96 per share, for the same period in 2000. Unrealized losses, net of tax, for the first six months of 2001 were $11.3 million, $1.12 per share compared to losses of $4.0 million, $0.40 per share, for the same period in 2000.
RLI INSURANCE GROUP
Gross written premium for the Group increased to $254.1 million for the first six months of 2001 compared to $220.4 million for the same period in 2000. Much of this improvement came from the casualty segment where improved pricing and various growth initiatives have positively impacted the top-line. Underwriting income declined to a pre-tax profit of $3.7 million for the first six months of 2001 compared to $6.3 million for the same period in 2000. The GAAP combined ratio increased to 97.1 for the first six months of 2001 compared to 94.2 for the same period in 2000. Loss experience on the Company’s property book contributed to the higher combined ratio.
The Group’s property segment experienced an increase in gross writings of $1.8 million, or 2.3%, compared to first six months of 2000. For the first six months of 2001, property premiums totaled $82.3 million. Increased production was experienced on difference-in-conditions and construction business. Partially offsetting this increase, however, fire premium was down $5.4 million, as the Company has nonrenewed or exited from writing certain unprofitable products and accounts. Similarly, ocean marine writings declined $1.7 million, as the Company has discontinued this line of business. Underwriting profits for the property segment were $2.7 million for the first six months of 2001, compared to $5.6 million in 2000. The GAAP combined ratio increased to 92.3 from 80.0 for the same period last year. The Seattle earthquake, which registered 6.8 magnitude, resulted in just under $1.0 million in losses. Disciplined underwriting, coupled with the deep location of the quake’s epicenter, resulted in few claims reported from this event. In addition to the impact of the earthquake, losses on discontinued property classes have negatively impacted the year’s results. The construction book has also experienced higher than expected losses on builder’s risk business. Changes to underwriting standards and policy terms for this product were made late in 2000. Management will continue to carefully monitor the results of this product.
Gross written premiums for the casualty segment were $145.1 million for 2001, up $27.9 million, or 23.8%, from 2000. Increases in the following products contributed to this growth: general liability up $8.7 million, transportation up $6.2 million, program business up $4.6 million, executive products up $3.5 million, and employer’s indemnity up $2.7 million. Underwriting loss on the casualty book was $708,000, in line with the first six months of 2000. These results translated into a combined ratio of 101.0 for both six-month periods presented. The segment’s expense ratio at 35.0 has continued to show improvement, as premium volume has continued to increase, while the loss ratio at 66.0 remains in check.
Gross written premiums for the surety segment increased to $26.7 million for 2001, up $3.9 million, or 17.3%, from the same period in 2000. The recent expansion of the commercial surety product, with a focus on small- to middle-market accounts, resulted in $3.5 million of premium written during the first six months of 2001. The surety book reported underwriting income of $1.7 million, compared to $1.4 million for the first six months of 2000. The combined ratio for the surety segment totaled 91.8 in 2001 compared to 90.8 in 2000. The loss ratio component increased over last year due to several contract losses experienced during the first six months of 2001. Partially offsetting this increase, the expense ratio has shown improvement, as increased premium volume has driven a reduction in the expense ratio.
INVESTMENT INCOME
The Company's investment portfolio generated net dividends and interest income of $15.2 million during the first six months of 2001, an increase of 8.1% over that reported for the same period in 2000. Diversification of the fixed income portfolio and continued growth in operating cash flow has resulted in the rise in investment income. Additionally, pursuant to Statement 133 requirements, the Company recorded $374,000 in net investment income during 2001 to recognize the current period change in the fair value of stock warrants received in conjunction with the purchase of a note receivable. Further discussion of Statement 133 and its impact on the Company can be found in note 1, Other Accounting Standards.
The Company experienced a net realized gain from investments of $1.9 million in the first six months of 2001, compared to a net realized loss of $87,000 for the same period in 2000, which was impacted by the sale of certain fixed income and equity securities. For the six months ended June 30, 2001, the Company experienced a $17.3 million pre-tax unrealized loss on its investment portfolio.
Virtually all the Company's fixed income portfolio consists of securities rated A or better, with 91% rated AA or better. The year-to-date yields on the Company's fixed income investments for the six-month periods ended June 30, 2001 and 2000 are as follows:
For the first six months of 2001, yields on taxable bonds decreased slightly while those of non-taxable securities increased from the same period last year. The slight decline in taxable yields is attributable to both a decrease in treasury yields on the short and intermediate part of the yield curve and to the reinvestment of called and matured bonds at lower yields. Despite the lower treasury yields, the overall impact on the fixed income portfolio has been limited due to sector diversification and continued growth in operational cash flow. Non-taxable securities reflect a greater increase due to the purchase of longer dated securities.
The Company's available-for-sale portfolio of debt and equity securities had a net unrealized loss before tax of $17.3 million for the first six months of 2001, compared with a $6.1 million loss for the same period in 2000. The 2001 year-to-date loss reflects largely stock market fluctuations experienced during the first six months of the year. The Company's net cumulative unrealized gain before tax was $156.5 million, down from $173.8 million at December 31, 2000. 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 $2.0 million for the first six months of 2001, a $520,000 decrease from the same period in 2000. This change is related to decreased debt costs resulting from falling interest rates, as well as principal payments made in late February and March 2001 that decreased the average outstanding debt balance by $8.1 million over the same period last year. Interest expense has been incurred at a rate of 5.74% for the first six months of 2001 compared to a rate of 6.49% for the same period last year. At June 30, 2001, outstanding short-term balances totaled $65.9 million, compared to $78.1 million at June 30, 2000.
INCOME TAXES
The Company's effective tax rate for the first six months of 2001 and 2000 was 26%. 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 2001 and 2000 as a result of the following:
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, the sale of convertible debentures, and short-term borrowings.
During the first six months of 2001, the Company retired 1,272 outstanding shares at a cost of $57,000. During the same period in 2000, the Company repurchased 71,272 of its outstanding shares at a cost of $2.1 million. All repurchase activity for 2000 occurred in the first quarter and was funded through operating cash flow.
Invested assets at June 30, 2001 decreased by $24.1 million, or 3.2%, from December 31, 2000. Contributing to this decline, unrealized losses on the investment portfolio totaled $17.3 million. Additionally, proceeds from the sales and maturities of certain debt securities were used to extinguish $12.8 million in short-term debt, during February and March 2001.
At June 30, 2001 the Company had short-term investments, cash and other investments maturing within one year, of approximately $30.7 million and additional investments of $144.4 million maturing within five years. The Company maintains one primary source of credit, a $30.0 million line of credit that cannot be canceled during its annual term. As of June 30, 2001, the Company had $19.6 million in outstanding short-term borrowings on this facility. Additionally, the Company was party to four reverse repurchase transactions totaling $46.3 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.
THREE MONTHS ENDED JUNE 30, 2001, COMPARED TO THREE MONTHSENDED JUNE 30, 2000
Consolidated gross sales, which consist of gross premiums written, net investment income and realized investment gains totaled $142.2 million for the second quarter of 2001 compared to $125.1 million for the same period in 2000. Gross writings of the Insurance Group improved 13.6% over 2000 levels fueled by increases in the casualty and surety segments. Consolidated revenue for the second quarter of 2001 increased $10.1 million or 15.6% from the same period in 2000. Net premiums earned alone increased 15.6%. Net investment income improved 8.8% to $7.7 million. Additionally, the sale of certain securities during the second quarter of 2001 resulted in $517,000 in realized gains, compared to $34,000 for the same period last year.
The net after-tax earnings for the second quarter of 2001 totaled $8.2 million, $0.82 per diluted share, compared to $7.0 million, $0.70 per share, for the same period in 2000. As mentioned previously, the cumulative-effect adjustment for the initial adoption of FASB Statement 133 totaled $800,415 ($0.08 per share) and is included in the second quarter 2001 net after-tax earnings number. Net operating earnings, which consist of the Company's net earnings reduced by after-tax realized investment gains/losses and cumulative-effect adjustment, totaled $7.1 million, $0.71 per share, compared to $6.9 million, $0.70 per share, for the same period in 2000.
Comprehensive earnings, which include net earnings plus unrealized gains/losses net of tax, showed improvement for the second quarter of 2001. Comprehensive earnings for the quarter totaled $11.2 million, $1.12 per share, compared to $7.9 million, $0.80 per share, for the same period in 2000. Unrealized gains, net of tax, for the second quarter of 2001 were $3.0 million, $0.30 per share compared to $1.0 million, $0.10 per share, for the same period in 2000.
Gross written premium for the Group increased to $134.0 million for the second quarter of 2001 compared to $118.0 million for the same period in 2000. Much of this improvement came from the casualty segment where improved pricing and various growth initiatives have positively impacted the top-line. Additionally, the expansion of the commercial surety book has added to top line growth. Underwriting income declined to a pre-tax profit of $1.6 million for the second quarter of 2001 compared to $2.6 million for the same period in 2000. The GAAP combined ratio increased to 97.6 for the second quarter of 2001 compared to 95.5 for the second quarter of 2000. Loss experience in property classes the Company began exiting late last year contributed to the quarter’s higher combined ratio.
The Group’s property segment experienced an increase in gross writings of $3.5 million, or 8.3%, compared to second quarter 2000. For the second quarter of 2001, property premiums totaled $45.3 million. Difference-in-condition and construction writings advanced a combined $5.5 million and served to partially offset the reduction in writings from property classes that have been exited or nonrenewed. Underwriting profits for the property segment were $1.1 million for second quarter of 2001, compared to $2.3 million in 2000. The GAAP combined ratio increased to 93.7 compared to 84.1 for the same period last year. Loss experience in property classes the Company began exiting late last year contributed to the segment’s higher combined ratio.
Gross written premiums for the casualty segment were $73.3 million for the second quarter of 2001, up $9.5 million, or 15.0%, from the same period in 2000. Increases in the following products contributed to this growth: general liability up $4.8 million, executive products up $2.5 million, commercial umbrella up $1.2 million, and personal umbrella up $1.0 million. Underwriting loss on the casualty book was $94,000, in line with second quarter 2000. These results translate into a combined ratio of 100.2 in 2001 versus 100.1 for the same period in 2000. The segment’s expense ratio at 34.2 has continued to show improvement, as premium volume has continued to increase, while the loss ratio at 66.0 remains in check.
Gross written premiums for the surety segment increased to $15.5 million for the second quarter of 2001, up $3.0 million, or 24.1%, from the same period in 2000. The 2001 expansion of the commercial surety product, with a focus on small- to middle-market accounts, resulted in $2.4 million of premium written during the second quarter of 2001. The surety book reported underwriting income of $564,000, compared to $328,000 for the second quarter of 2000. The combined ratio for the surety segment totaled 94.9 in 2001 compared to 96.1 in 2000. Both quarter’s loss ratio’s were impacted by contract losses. The loss ratio for second quarter 2001 totaled 32.1, compared to 31.6 for the same period in 2000. The expense ratio, however, has continued to show improvement at 62.8 for the quarter, compared to 64.5 for the same period in 2000. Increased premium volume has continued to drive a reduction in the expense ratio.
The Company's investment portfolio generated net dividends and interest income of $7.7 million during the second quarter of 2001, an increase of 8.8% over that reported for the same period in 2000. Diversification of the fixed income portfolio and positive operating cash flow has resulted in the rise in investment income. Additionally, pursuant to Statement 133 requirements, the Company recorded $374,000 in net investment income during the second quarter of 2001 to recognize the current period change in the fair value of stock warrants received in conjunction with the purchase of a note receivable. Further discussion of Statement 133 and its impact on the Company can be found in note 1, Other Accounting Standards.
The Company experienced a net realized gain from investments of $517,000 in the second quarter of 2001, compared to a net realized gain of $34,000 for the same period in 2000. The majority of gains realized in the second quarter of 2001 were the result of the sale of certain fixed income and equity securities.
The Company's effective tax rate for the second quarter of 2001 was 27% compared to 25% reported for the same period in 2000. 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 2000 and 1999 as a result of the following:
ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141 “Business Combinations”, effective for all business combinations initiated after June 30, 2001, and No. 142 “Accounting for Goodwill and Other Intangible Assets”, effective for fiscal years beginning after December 15, 2001. SFAS 141 requires the purchase method of accounting be used for all business combinations. Goodwill and certain intangible assets will remain on the balance sheet and not be amortized. SFAS 142 establishes a new method of testing goodwill for impairment. On an annual basis, and when there is reason to suspect that their values may have been diminished or impaired, these assets must be tested for impairment. The amount of goodwill determined to be impaired will be expensed to current operations. The Company is currently evaluating what impact, if any, that these statements will have on our consolidated financial position or results of operations. Amortization of goodwill was $1.1 million for both six-month periods ended June 30, 2001 and 2000. Total goodwill amortization for the year ended December 31, 2000 was $2.1 million.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of economic losses due to adverse changes in the estimated fair value of a financial instrument as the result of changes in equity prices, interest rates, foreign exchange rates and commodity prices. The Company's consolidated balance sheets include assets and liabilities whose estimated fair values are subject to market risk. The primary market risks to the Company are equity price risk associated with investments in equity securities and interest rate risk associated with investments in fixed maturities. From time to time, equity prices and interest rates fluctuate causing an effect on the Company's investment portfolio. The Company has a small exposure to foreign exchange risk arising from a limited number of policies whose resulting claims would be payable in foreign currencies. All such policies will have expired by September 30, 2001. The company has no direct commodity risk.
The Company's market risk exposures at June 30, 2001, have not materially changed from those identified at December 31, 2000.
PART II - OTHER INFORMATION
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.
Date: August 7, 2001