13
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
(Mark One)
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended
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:
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |
(Address of principal executive offices) | (Zip Code) |
(
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol | Name of each exchange on which registered |
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.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Accelerated filer ☐ | Non-accelerated filer ☐ | Smaller reporting company | |
Emerging growth company |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of July 16, 2020, the number of shares outstanding of the registrant’s Common Stock was
Table of Contents
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
RLI Corp. and Subsidiaries
Condensed Consolidated Statements of Earnings and Comprehensive Earnings
(Unaudited)
For the Three-Month Periods | For the Six-Month Periods | |||||||||||
Ended June 30, | Ended June 30, | |||||||||||
(in thousands, except per share data) | 2020 | 2019 | 2020 | 2019 | ||||||||
Net premiums earned |
| $ | |
| $ | | $ | | $ | | ||
Net investment income |
| |
| |
| |
| | ||||
Net realized gains (losses) |
| ( |
| |
| |
| | ||||
Net unrealized gains (losses) on equity securities | | | ( | | ||||||||
Consolidated revenue | $ | | $ | | $ | | $ | | ||||
Losses and settlement expenses |
| |
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Policy acquisition costs |
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Insurance operating expenses |
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Interest expense on debt |
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General corporate expenses |
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Total expenses | $ | | $ | | $ | | $ | | ||||
Equity in earnings of unconsolidated investees |
| |
| |
| |
| | ||||
Earnings before income taxes | $ | | $ | | $ | | $ | | ||||
Income tax expense |
| |
| |
| |
| | ||||
Net earnings |
| $ | |
| $ | | $ | | $ | | ||
Other comprehensive earnings, net of tax |
| |
| |
| |
| | ||||
Comprehensive earnings |
| $ | |
| $ | | $ | | $ | | ||
Earnings per share: | ||||||||||||
Basic: | ||||||||||||
Basic net earnings per share |
| $ | |
| $ | | $ | | $ | | ||
Basic comprehensive earnings per share |
| $ | |
| $ | | $ | | $ | | ||
Diluted: | ||||||||||||
Diluted net earnings per share |
| $ | |
| $ | | $ | | $ | | ||
Diluted comprehensive earnings per share |
| $ | |
| $ | | $ | | $ | | ||
Weighted average number of common shares outstanding: | ||||||||||||
Basic |
| |
| |
| |
| | ||||
Diluted |
| |
| |
| |
| | ||||
See accompanying notes to the unaudited condensed consolidated interim financial statements.
3
RLI Corp. and Subsidiaries
Condensed Consolidated Balance Sheets
(Unaudited)
June 30, | December 31, | |||||
(in thousands, except share and per share data) |
| 2020 |
| 2019 | ||
ASSETS |
|
| ||||
Investments and cash: | ||||||
Fixed income: | ||||||
Available-for-sale, at fair value |
| $ | |
| $ | |
(amortized cost of $ | ||||||
(amortized cost of $ |
|
| ||||
Equity securities, at fair value (cost - $ |
| |
| | ||
Other invested assets | | | ||||
Cash |
| |
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Total investments and cash | $ | | $ | | ||
Accrued investment income |
| |
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Premiums and reinsurance balances receivable, net of allowances for uncollectible amounts of $ |
| |
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Ceded unearned premium |
| |
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Reinsurance balances recoverable on unpaid losses and settlement expenses, net of allowances for uncollectible amounts of $ |
| |
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Deferred policy acquisition costs |
| |
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Property and equipment, at cost, net of accumulated depreciation of $ |
| |
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Investment in unconsolidated investees |
| |
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Goodwill and intangibles |
| |
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Other assets |
| |
| | ||
TOTAL ASSETS |
| $ | |
| $ | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||
Liabilities | ||||||
Unpaid losses and settlement expenses |
| $ | |
| $ | |
Unearned premiums |
| |
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Reinsurance balances payable |
| |
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Funds held |
| |
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Income taxes-deferred |
| |
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Bonds payable, long-term debt |
| |
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Accrued expenses |
| |
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Other liabilities |
| |
| | ||
TOTAL LIABILITIES |
| $ | |
| $ | |
Shareholders’ Equity | ||||||
Common stock ($ | ||||||
(Shares authorized - | ||||||
( | ||||||
( | $ | | $ | | ||
Paid-in capital |
| |
| | ||
Accumulated other comprehensive earnings |
| |
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Retained earnings |
| |
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Deferred compensation |
| |
| | ||
Less: Treasury shares at cost | ||||||
( |
| ( |
| ( | ||
TOTAL SHAREHOLDERS’ EQUITY | $ | | $ | | ||
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY |
| $ | |
| $ | |
See accompanying notes to the unaudited condensed consolidated interim financial statements.
4
RLI Corp. and Subsidiaries
Condensed Consolidated Statements of Shareholders’ Equity
(Unaudited)
|
|
|
|
| Accumulated |
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| |||||||||||||||
Total | Other | |||||||||||||||||||||||
Common | Shareholders’ | Common | Paid-in | Comprehensive | Retained | Deferred | Treasury | |||||||||||||||||
(in thousands, except share and per share data) | Shares | Equity | Stock | Capital | Earnings (Loss) | Earnings | Compensation | Shares at Cost | ||||||||||||||||
Balance, January 1, 2019 |
| | $ | | $ | | $ | | $ | ( | $ | | $ | | $ | ( | ||||||||
Net earnings (loss) |
| — | | — | — | — | | — | — | |||||||||||||||
Other comprehensive earnings (loss), net of tax |
| — |
| |
| — |
| — |
| |
| — |
| — |
| — | ||||||||
Deferred compensation |
| — |
| — |
| — |
| — |
| — |
| — |
| ( |
| | ||||||||
Share-based compensation |
| |
| |
| |
| |
| — |
| — |
| — |
| — | ||||||||
Dividends and dividend equivalents ($ |
| — |
| ( |
| — |
| — |
| — |
| ( |
| — |
| — | ||||||||
Balance, March 31, 2019 |
| | $ | | $ | | $ | | $ | | $ | | $ | | $ | ( | ||||||||
Net earnings (loss) |
| — | | — | — | — | | — | — | |||||||||||||||
Other comprehensive earnings (loss), net of tax |
| — |
| |
| — |
| — |
| |
| — |
| — |
| — | ||||||||
Deferred compensation |
| — |
| — |
| — |
| — |
| — |
| — |
| |
| ( | ||||||||
Share-based compensation |
| |
| |
| |
| |
| — |
| — |
| — |
| — | ||||||||
Dividends and dividend equivalents ($ |
| — |
| ( |
| — |
| — |
| — |
| ( |
| — |
| — | ||||||||
Balance, June 30, 2019 |
| | $ | | $ | | $ | | $ | | $ | | $ | | $ | ( | ||||||||
|
|
|
|
| Accumulated |
|
|
| ||||||||||||||||
Total | Other |
| ||||||||||||||||||||||
Common | Shareholders’ | Common | Paid-in | Comprehensive | Retained | Deferred | Treasury |
| ||||||||||||||||
(in thousands, except share and per share data) | Shares | Equity | Stock | Capital | Earnings (Loss) | Earnings | Compensation | Shares at Cost |
| |||||||||||||||
Balance, January 1, 2020 |
| | $ | | $ | | $ | | $ | | $ | | $ | | $ | ( | ||||||||
Cumulative-effect adjustment from ASU 2016-13 | | | | |||||||||||||||||||||
Net earnings (loss) |
| — | ( | — | — | — | ( | — | — | |||||||||||||||
Other comprehensive earnings (loss), net of tax |
| — |
| ( |
| — |
| — |
| ( |
| — |
| — |
| — | ||||||||
Deferred compensation |
| — |
| — |
| — |
| — |
| — |
| — |
| ( |
| | ||||||||
Share-based compensation |
| |
| |
| |
| |
| — |
| — |
| — |
| — | ||||||||
Dividends and dividend equivalents ($ |
| — |
| ( |
| — |
| — |
| — |
| ( |
| — |
| — | ||||||||
Balance, March 31, 2020 |
| | $ | | $ | | $ | | $ | | $ | | $ | | $ | ( | ||||||||
Net earnings (loss) |
| — | | — | — | — | | — | — | |||||||||||||||
Other comprehensive earnings (loss), net of tax |
| — |
| |
| — |
| — |
| |
| — |
| — |
| — | ||||||||
Deferred compensation |
| — |
| — |
| — |
| — |
| — |
| — |
| |
| ( | ||||||||
Share-based compensation |
| |
| |
| — |
| |
| — |
| — |
| — |
| — | ||||||||
Dividends and dividend equivalents ($ |
| — |
| ( |
| — |
| — |
| — |
| ( |
| — |
| — | ||||||||
Balance, June 30, 2020 |
| | $ | | $ | | $ | | $ | | $ | | $ | | $ | ( | ||||||||
See accompanying notes to the unaudited condensed consolidated interim financial statements.
5
RLI Corp. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the Six-Month Periods | ||||||
Ended June 30, | ||||||
(in thousands) | 2020 | 2019 | ||||
Net cash provided by operating activities |
| $ | |
| $ | |
Cash Flows from Investing Activities | ||||||
Purchase of: | ||||||
Fixed income securities, available-for-sale | $ | ( | $ | ( | ||
Equity securities | ( | ( | ||||
Property and equipment | ( | ( | ||||
Other | ( | ( | ||||
Proceeds from sale of: | ||||||
Fixed income securities, available-for-sale | | | ||||
Equity securities | | | ||||
Other | | | ||||
Proceeds from call or maturity of: | ||||||
Fixed income securities, available-for-sale | | | ||||
Net proceeds from sale (purchase) of short-term investments |
| - |
| ( | ||
Net cash used in investing activities |
| $ | ( |
| $ | ( |
Cash Flows from Financing Activities | ||||||
Cash dividends paid |
| $ | ( |
| $ | ( |
Proceeds from stock option exercises |
| |
| | ||
Net cash used in financing activities |
| $ | ( |
| $ | ( |
Net increase (decrease) in cash | $ | | $ | ( | ||
Cash at the beginning of the period | | | ||||
Cash at June 30 |
| $ | |
| $ | |
See accompanying notes to the unaudited condensed consolidated interim financial statements.
6
NOTES TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. BASIS OF PRESENTATION
The unaudited condensed consolidated interim financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (GAAP) for interim financial reporting and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the disclosures required by GAAP for complete financial statements. As such, these unaudited condensed consolidated interim financial statements should be read in conjunction with our 2019 Annual Report on Form 10-K. Management believes that the disclosures are adequate to make the information presented not misleading, and all normal and recurring adjustments necessary to present fairly the financial position at June 30, 2020 and the results of operations of RLI Corp. and subsidiaries for all periods presented have been made. The results of operations for any interim period are not necessarily indicative of the operating results for a full year. Certain reclassifications were made to 2019 to conform to the classifications used in the current year.
The preparation of the unaudited condensed consolidated interim financial statements requires management to make estimates and assumptions relating to the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated interim financial statements and the reported amounts of revenue and expenses during the period. These estimates are inherently subject to change and actual results could differ significantly from these estimates.
B. ADOPTED ACCOUNTING STANDARDS
ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
ASU 2016-13 was issued to provide more decision-useful information about the expected credit losses on financial instruments. Previous guidance delayed the recognition of credit losses until it was probable a loss had been incurred. This update requires a financial asset measured at amortized cost to be presented at the net amount expected to be collected by means of an allowance for credit losses that is included in net earnings. Credit losses relating to available-for-sale debt securities are also required to be recorded through a reversible allowance for credit losses, but is limited to the amount by which fair value is less than amortized cost.
We adopted ASU 2016-13 on January 1, 2020 using the modified-retrospective approach. The standard applied to three of the Company’s balance sheet accounts: available-for-sale fixed income securities, premiums receivable and reinsurance balances recoverable. The impact of this standard was and is expected to continue to be immaterial, as our fixed income portfolio is weighted towards higher rated bonds (
C. REINSURANCE
Ceded unearned premiums and reinsurance balances recoverable on paid and unpaid losses and settlement expenses are reported separately as assets, instead of being netted with the related liabilities, since reinsurance does not relieve the Company of our legal liability to our policyholders. Such balances are subject to the credit risk associated with the individual reinsurer. We continuously monitor the financial condition of our reinsurers and actively follow up on any past due or disputed amounts. As part of our monitoring efforts, we review their annual financial statements, quarterly disclosures and Securities and Exchange Commission (SEC) filings for those reinsurers that are publicly traded. We also review insurance industry developments that may impact the financial condition of our reinsurers. We analyze the credit risk associated with our reinsurance balances recoverable by monitoring the AM Best and Standard & Poor’s (S&P) ratings of our reinsurers. Additionally, we perform an in depth reinsurer financial condition analysis prior to the renewal of our reinsurance placements.
Once regulatory action (such as receivership, finding of insolvency, order of conservation or order of liquidation) is taken against a reinsurer, the paid and unpaid balances recoverable from the reinsurer are specifically identified and charged to earnings in the form of an allowance for uncollectible amounts. We subject our remaining reinsurance balances receivable to detailed recoverability tests, including a segment-based analysis using the average default rating percentage by S&P rating, and
7
record an additional allowance for unrecoverable amounts from reinsurers. This credit allowance is reviewed on an ongoing basis to ensure that the amount makes a reasonable provision for reinsurance balances that we may be unable to recover.
The allowances for uncollectible amounts on paid and unpaid reinsurance recoverables were $
D. INTANGIBLE ASSETS
Goodwill and intangible assets totaled $
Goodwill and Intangible Assets | June 30, | December 31, | ||||
(in thousands) | 2020 | 2019 | ||||
Goodwill | ||||||
Energy surety | $ | | $ | | ||
Miscellaneous and contract surety | | | ||||
Small commercial | | | ||||
Total goodwill | $ | | $ | | ||
Intangibles | ||||||
Indefinite-lived intangibles - state insurance licenses | | | ||||
Definite-lived intangibles, net of accumulated amortization of $ | | | ||||
Total intangibles | $ | | $ | | ||
Total goodwill and intangibles | $ | | $ | |
All definite-lived intangible assets are amortized based on their estimated useful lives. Amortization of intangible assets was $
Annual impairment assessments were performed on our energy surety goodwill, miscellaneous and contract surety , small commercial and state insurance license indefinite-lived asset during the second quarter of 2020. Based upon these reviews,
E. EARNINGS PER SHARE
Basic earnings per share (EPS) excludes dilution and is computed by dividing income available to common shareholders 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 or 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 anti-dilutive. Under these circumstances, the diluted net earnings or net loss per share is computed excluding the common stock equivalents. The following represents a reconciliation of the numerator and denominator of the basic and diluted EPS computations contained in the unaudited condensed consolidated interim financial statements:
8
For the Three-Month Period | For the Three-Month Period | |||||||||||||||
Ended June 30, 2020 | Ended June 30, 2019 | |||||||||||||||
Income | Shares | Per Share | Income | Shares | Per Share | |||||||||||
(in thousands, except per share data) |
| (Numerator) |
| (Denominator) |
| Amount |
| (Numerator) |
| (Denominator) |
| Amount | ||||
Basic EPS | ||||||||||||||||
Earnings available to common shareholders |
| $ | |
| |
| $ | |
| $ | |
| |
| $ | |
Effect of Dilutive Securities | ||||||||||||||||
Stock options and restricted stock units |
| - |
| |
| - |
| | ||||||||
Diluted EPS | ||||||||||||||||
Earnings available to common shareholders |
| $ | |
| |
| $ | |
| $ | |
| |
| $ | |
Anti-dilutive options excluded from diluted EPS | | - | ||||||||||||||
For the Six-Month Period | For the Six-Month Period | |||||||||||||||
Ended June 30, 2020 | Ended June 30, 2019 | |||||||||||||||
Income | Shares | Per Share | Income | Shares | Per Share | |||||||||||
(in thousands, except per share data) |
| (Numerator) |
| (Denominator) |
| Amount |
| (Numerator) |
| (Denominator) |
| Amount | ||||
Basic EPS | ||||||||||||||||
Earnings available to common shareholders |
| $ | |
| |
| $ | |
| $ | |
| |
| $ | |
Effect of Dilutive Securities | ||||||||||||||||
Stock options and restricted stock units |
| - |
| |
| - |
| | ||||||||
Diluted EPS | ||||||||||||||||
Earnings available to common shareholders |
| $ | |
| |
| $ | |
| $ | |
| |
| $ | |
Anti-dilutive options excluded from diluted EPS | | | ||||||||||||||
F. COMPREHENSIVE EARNINGS
Our comprehensive earnings include net earnings plus after-tax unrealized gains and losses on our fixed income portfolio. In reporting other comprehensive earnings on a net basis in the statement of earnings, we used the federal statutory tax rate of
Unrealized gains, net of tax, on the fixed income portfolio were $
The following table illustrates the changes in the balance of each component of accumulated other comprehensive earnings for each period presented in the unaudited condensed consolidated interim financial statements:
(in thousands) | For the Three-Month Periods | For the Six-Month Periods | ||||||||||
Ended June 30, | Ended June 30, | |||||||||||
Unrealized Gains/Losses on Available-for-Sale Securities |
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||
Beginning balance |
| $ | |
| $ | |
| $ | |
| $ | ( |
Cumulative-effect adjustment of ASU 2016-13 (see note 1.B.) | - | - | | - | ||||||||
Adjusted beginning balance | $ | | $ | | $ | | $ | ( | ||||
Other comprehensive earnings before reclassifications |
| |
|
| |
| |
| | |||
Amounts reclassified from accumulated other comprehensive earnings |
| ( |
|
| ( |
| ( |
| ( | |||
Net current-period other comprehensive earnings (loss) |
| $ | |
| $ | |
| $ | |
| $ | |
Ending balance |
| $ | |
| $ | |
| $ | |
| $ | |
Balance of securities for which an allowance for credit losses has been recognized in net earnings | $ | |
| $ | - | |||||||
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Credit losses on or the sale of an available-for-sale security results in amounts being reclassified from accumulated other comprehensive earnings to current period net earnings. We recognized $
Amount Reclassified from Accumulated Other | ||||||||||||||
(in thousands) | Comprehensive Earnings | |||||||||||||
For the Three-Month | For the Six-Month | |||||||||||||
Component of Accumulated | Periods Ended June 30, | Periods Ended June 30, | Affected line item in the | |||||||||||
Other Comprehensive Earnings |
| 2020 |
| 2019 |
| 2020 |
| 2019 |
| Statement of Earnings | ||||
Unrealized gains and losses on available-for-sale securities | $ | | $ | | $ | | $ | | Net realized gains (losses) | |||||
( | - | ( | - | Credit losses presented within net realized gains | ||||||||||
$ | | $ | | $ | | $ | | Earnings before income taxes | ||||||
( | ( | ( | ( | Income tax expense | ||||||||||
$ | | $ | | $ | | $ | | Net earnings | ||||||
G. FAIR VALUE MEASUREMENTS
Fair value is defined as the price in the principal market that would be received for an asset to facilitate an orderly transaction between market participants on the measurement date. We determined the fair value of certain financial instruments based on their underlying characteristics and relevant transactions in the marketplace. We maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The following are the levels of the fair value hierarchy and a brief description of the type of valuation inputs that are used to establish each level. Financial assets are classified based upon the lowest level of significant input that is used to determine fair value.
Pricing Level 1 is applied to valuations based on readily available, unadjusted quoted prices in active markets for identical assets.
Pricing Level 2 is applied to valuations based upon quoted prices for similar assets in active markets, quoted prices for identical or similar assets in inactive markets; or valuations based on models where the significant inputs are observable (e.g. interest rates, yield curves, prepayment speeds, default rates, loss severities) or can be corroborated by observable market data.
Pricing Level 3 is applied to valuations that are derived from techniques in which one or more of the significant inputs are unobservable.
As a part of management’s process to determine fair value, we utilize widely recognized, third-party pricing sources to determine our fair values. We have obtained an understanding of the third-party pricing sources’ valuation methodologies and inputs. The following is a description of the valuation techniques used for financial assets that are measured at fair value, including the general classification of such assets pursuant to the fair value hierarchy.
Corporate, Agencies, Government and Municipal Bonds: The pricing vendor employs a multi-dimensional model which uses standard inputs including (listed in approximate order of priority for use) benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, market bids/offers and other reference data. The pricing vendor also monitors market indicators, as well as industry and economic events. All bonds valued using these techniques are classified as Level 2. All corporate, agency, government and municipal securities were deemed Level 2.
Mortgage-backed Securities (MBS)/Commercial Mortgage-backed Securities (CMBS) and Asset-backed Securities (ABS): The pricing vendor evaluation methodology includes principally interest rate movements and new issue data. Evaluations of the tranches (non-volatile, volatile or credit sensitivity) are based on the pricing vendors’ interpretation of accepted modeling and pricing conventions. This information is used to determine the cash flows for each tranche, benchmark yields, prepayment assumptions and to incorporate collateral performance. To evaluate MBS and CMBS volatility, an option
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adjusted spread model is used in combination with models that simulate interest rate paths to determine market price information. This process allows the pricing vendor to obtain evaluations of a broad universe of securities in a way that reflects changes in yield curve, index rates, implied volatility, mortgage rates and recent trade activity. MBS/CMBS and ABS with corroborated, observable inputs are classified as Level 2. All of our MBS/CMBS and ABS are deemed Level 2.
Regulation D Private Placement Securities: All Regulation D privately placed bonds are classified as corporate securities and deemed Level 3. The pricing vendor evaluation methodology for these securities includes a combination of observable and unobservable inputs. Observable inputs include public corporate spread matrices classified by sector, rating and average life, as well as investment and non-investment grade matrices created from fixed income indices. Unobservable inputs include a liquidity spread premium calculated based on public corporate spread and private corporate spread matrices. The quantitative detail of the liquidity spread premium is neither provided nor reasonably available to the Company. An increase to the credit spread assumptions would result in a lower fair value measurement.
For all of our fixed income securities classified as Level 2, as described above, we periodically conduct a review to assess the reasonableness of the fair values provided by our pricing services. Our review consists of a two-pronged approach. First, we compare prices provided by our pricing services to those provided by an additional source. In some cases, we obtain prices from securities brokers and compare them to the prices provided by our pricing services. In both comparisons, if discrepancies are found, we compare our prices to actual reported trade data for like securities. No changes to the fair values supplied by our pricing services have occurred as a result of our reviews. Based on these assessments, we have determined that the fair values of our Level 2 securities provided by our pricing services are reasonable.
Common Stock: As of June 30, 2020, all of our common stock holdings are traded on an exchange. Exchange traded equities have readily observable price levels and are classified as Level 1 (fair value based on quoted market prices).
Due to the relatively short-term nature of cash, short-term investments, accounts receivable and accounts payable, their carrying amounts are reasonable estimates of fair value. Our investments in private funds, classified as other invested assets, are measured using the investments’ net asset value per share and are not categorized within the fair value hierarchy.
H. RISKS AND UNCERTAINTIES
Certain risks and uncertainties are inherent to our day-to-day operations. Adverse changes in the economy could lower demand for our insurance products or negatively impact our investment results, both of which could have an adverse effect on the revenue and profitability of our operations. The COVID-19 pandemic has resulted in and is expected to continue to result in significant disruptions in economic activity and financial markets. The cumulative effects of COVID-19 on the Company, and the effect of any other public health outbreak, cannot be predicted at this time, but could reduce demand for our insurance policies, result in increased level of losses, settlement expenses or other operating costs, reduce the market value of invested assets held by the Company or negatively impact the fair value of our goodwill.
Catastrophe Exposures
Our catastrophe reinsurance treaty renewed on January 1, 2020. We purchased limits of $
2. INVESTMENTS
Our investments are primarily composed of fixed income debt securities and common stock equity securities. We carry our equity securities at fair value and categorize all of our debt securities as available-for-sale, which are carried at fair value.
Realized gains and losses on disposition of investments are based on specific identification of the investments sold on the settlement date. The following is a summary of the disposition of fixed income and equity securities for the six-month periods ended June 30, 2020 and 2019:
11
SALES | Proceeds | Gross Realized | Net Realized | |||||||||
(in thousands) |
| From Sales |
| Gains |
| Losses |
| Gain (Loss) | ||||
2020 | ||||||||||||
Available-for-sale | $ | | $ | | $ | ( | $ | | ||||
Equities |
| |
| |
| ( |
| | ||||
2019 | ||||||||||||
Available-for-sale | $ | | $ | | $ | ( | $ | | ||||
Equities |
| |
| |
| ( |
| | ||||
CALLS/MATURITIES | Gross Realized | Net Realized | ||||||||||
(in thousands) |
| Proceeds |
| Gains |
| Losses |
| Gain (Loss) | ||||
2020 | ||||||||||||
Available-for-sale | $ | | $ | | $ | ( | $ | | ||||
2019 | ||||||||||||
Available-for-sale | $ | | $ | | $ | ( | $ | | ||||
FAIR VALUE MEASUREMENTS
Assets measured at fair value on a recurring basis as of June 30, 2020 and December 31, 2019 are summarized below:
As of June 30, 2020 | ||||||||||||
Fair Value Measurements Using | ||||||||||||
| Quoted Prices in |
| Significant Other |
| Significant |
|
| |||||
Active Markets for | Observable | Unobservable | ||||||||||
Identical Assets | Inputs | Inputs | ||||||||||
(in thousands) |
| (Level 1) |
| (Level 2) |
| (Level 3) |
| Total | ||||
Fixed income securities - available-for-sale | ||||||||||||
U.S. government | $ | — | $ | | $ | — | $ | | ||||
U.S. agency | — | | — | | ||||||||
Non-U.S. govt. & agency | — | | — | | ||||||||
Agency MBS | — | | — | | ||||||||
ABS/CMBS* | — | | — | | ||||||||
Corporate | — | | | | ||||||||
Municipal | — | | — | | ||||||||
Total fixed income securities - available-for-sale | $ | — | $ | | $ | | $ | | ||||
Equity securities | | — | — | | ||||||||
Other invested assets | | — | — | | ||||||||
Total | $ | | $ | | $ | | $ | | ||||
As of December 31, 2019 | ||||||||||||
Fair Value Measurements Using | ||||||||||||
Quoted Prices in |
| Significant Other |
| Significant |
|
| ||||||
Active Markets for | Observable | Unobservable | ||||||||||
Identical Assets | Inputs | Inputs | ||||||||||
(in thousands) |
| (Level 1) |
| (Level 2) |
| (Level 3) |
| Total | ||||
Fixed income securities - available-for-sale | ||||||||||||
U.S. government | $ | — | $ | | $ | — | $ | | ||||
U.S. agency | — | | — | | ||||||||
Non-U.S. govt. & agency | — | | — | | ||||||||
Agency MBS | — | | — | | ||||||||
ABS/CMBS* | — | | — | | ||||||||
Corporate | — | | | | ||||||||
Municipal | — | | — | | ||||||||
Total fixed income securities - available-for-sale | $ | — | $ | | $ | | $ | | ||||
Equity securities | | — | — | | ||||||||
Total | $ | | $ | | $ | | $ | | ||||
* Non-agency asset-backed and commercial mortgage-backed
12
As of June 30, 2020, we had $
Level 3 | |||
(in thousands) | Securities | ||
Balance as of January 1, 2020 | $ | | |
Net realized and unrealized gains (losses) |
| ||
Included in net earnings as a part of: | |||
Net investment income | ( | ||
Net realized gains (losses) | ( | ||
Included in other comprehensive earnings |
| ( | |
Total net realized and unrealized gains (losses) | $ | ( | |
Purchases | | ||
Balance as of June 30, 2020 | $ | | |
Change in unrealized gains (losses) during the period for Level 3 assets held at period-end - | $ | ( | |
Change in unrealized gains (losses) during the period for Level 3 assets held at period-end - | $ | ( | |
The amortized cost and fair value of available-for-sale fixed income securities by contractual maturity as of June 30, 2020 were as follows:
June 30, 2020 | ||||||
Available-for-sale | Amortized | Fair | ||||
(in thousands) |
| Cost |
| Value | ||
Due in one year or less | $ | | $ | | ||
Due after one year through five years | | | ||||
Due after five years through 10 years | | | ||||
Due after 10 years | | | ||||
Mtge/ABS/CMBS* | | | ||||
Total available-for-sale | $ | | $ | | ||
*Mortgage-backed, asset-backed and commercial mortgage-backed
The amortized cost and fair value of available-for-sale securities at June 30, 2020 and December 31, 2019 are presented in the tables below. Amortized cost does not include the $
Available-for-sale | June 30, 2020 | ||||||||||||||
(in thousands) |
| Cost or | Allowance |
| Gross |
| Gross |
|
| ||||||
Amortized | for Credit | Unrealized | Unrealized | Fair | |||||||||||
Asset Class |
| Cost | Losses | Gains |
| Losses |
| Value | |||||||
U.S. government | $ | | $ | - | $ | | $ | - | $ | | |||||
U.S. agency | | - | | - | | ||||||||||
Non-U.S. govt. & agency | | - | | ( | | ||||||||||
Agency MBS | | - | | ( | | ||||||||||
ABS/CMBS* | | ( | | ( | | ||||||||||
Corporate | | ( | | ( | | ||||||||||
Municipal | | - | | ( | | ||||||||||
Total Fixed Income | $ | | $ | ( | $ | | $ | ( | $ | | |||||
*Non-agency asset-backed and commercial mortgage-backed
13
Available-for-sale | December 31, 2019 | ||||||||||||||
(in thousands) |
| Cost or | Allowance |
| Gross |
| Gross |
|
| ||||||
Amortized | for Credit | Unrealized | Unrealized | Fair | |||||||||||
Asset Class |
| Cost | Losses |
| Gains |
| Losses |
| Value | ||||||
U.S. government | $ | | $ | - | $ | | $ | ( | $ | | |||||
U.S. agency | | - | | ( | | ||||||||||
Non-U.S. govt. & agency | | - | | - | | ||||||||||
Agency MBS | | - | | ( | | ||||||||||
ABS/CMBS* | | - | | ( | | ||||||||||
Corporate | | - | | ( | | ||||||||||
Municipal | | - | | ( | | ||||||||||
Total Fixed Income | $ | | $ | - | $ | | $ | ( | $ | | |||||
*Non-agency asset-backed and commercial mortgage-backed
Allowance for Credit Losses and Unrealized Losses on Fixed Income Securities
We adopted ASU 2016-13, Financial Instruments – Credit Losses, on January 1, 2020, which required the recognition of a reversible allowance for credit losses on available-for-sale fixed income securities. See note 1. B. for more information on the adoption of the ASU. Available-for-sale securities in the fixed income portfolio are subjected to several criteria to determine if those securities should be included in the allowance for expected credit loss evaluation, including:
| ● | Changes in technology that may impair the earnings potential of the investment, |
| ● | The discontinuance of a segment of business that may affect future earnings potential, |
| ● | Reduction of or non-payment of interest and/or principal, |
| ● | Specific concerns related to the issuer’s industry or geographic area of operation, |
| ● | Significant or recurring operating losses, poor cash flows and/or deteriorating liquidity ratios and |
| ● | Downgrades in credit quality by a major rating agency. |
If changes in interest rates and credit spreads do not reasonably explain the unrealized loss for an available-for-sale security or if any of the criteria above indicate a potential credit loss, the security is subjected to a discounted cash flow analysis. Inputs into the discounted cash flow analysis include prepayment assumptions for structured securities, default rates and recoverability rates based on credit rating. The allowance for any security is limited to the amount that the securities fair value is below amortized cost.
As of June 30, 2020, the discounted cash flow analysis resulted in an allowance for credit losses on
Prior to the adoption of ASU 2016-13, we conducted reviews of fixed income securities with unrealized losses to evaluate whether an impairment was other-than-temporary. Any credit-related impairment on fixed income securities we did not plan to sell and for which we were not more likely than not to be required to sell were recognized in net earnings, with the non-credit related impairment recognized in comprehensive earnings. We did recognize any other-than-temporary impairment losses in earnings on the fixed income portfolio in the first six months of 2019.
As of June 30, 2020, in addition to the securities included in the allowance for credit losses, the fixed income portfolio contained
14
spreads more than offset declines in interest rates during the period, primarily in the corporate portfolio. Of the total
June 30, 2020 | December 31, 2019 | |||||||||||||||||
(in thousands) |
| < 12 Mos. |
| 12 Mos. & |
| Total |
| < 12 Mos. |
| 12 Mos. & |
| Total | ||||||
U.S. government | ||||||||||||||||||
Fair value | $ | — | $ | — | $ | — | $ | | $ | | $ | | ||||||
Amortized cost | — | — | — | | | | ||||||||||||
Unrealized Loss | $ | — | $ | — | $ | — | $ | ( | $ | ( | $ | ( | ||||||
U.S. agency | ||||||||||||||||||
Fair value | $ | — | $ | — | $ | — | $ | | $ | — | $ | | ||||||
Amortized cost | — | — | — | | — | | ||||||||||||
Unrealized Loss | $ | — | $ | — | $ | — | $ | ( | $ | — | $ | ( | ||||||
Non-U.S. government | ||||||||||||||||||
Fair value | $ | | $ | — | $ | | $ | — | $ | — | $ | — | ||||||
Amortized cost | | — | | — | — | — | ||||||||||||
Unrealized Loss | $ | ( | $ | — | $ | ( | $ | — | $ | — | $ | — | ||||||
Agency MBS | ||||||||||||||||||
Fair value | $ | | $ | | $ | | $ | | $ | | $ | | ||||||
Amortized cost | | | | | | | ||||||||||||
Unrealized Loss | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | ||||||
ABS/CMBS* | ||||||||||||||||||
Fair value | $ | | $ | | $ | | $ | | $ | | $ | | ||||||
Amortized cost | | | | | | | ||||||||||||
Unrealized Loss | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | ||||||
Corporate | ||||||||||||||||||
Fair value | $ | | $ | | $ | | $ | | $ | | $ | | ||||||
Amortized cost | | | | | | | ||||||||||||
Unrealized Loss | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | ||||||
Municipal | ||||||||||||||||||
Fair value | $ | | $ | — | $ | | $ | | $ | — | $ | | ||||||
Amortized cost | | — | | | — | | ||||||||||||
Unrealized Loss | $ | ( | $ | — | $ | ( | $ | ( | $ | — | $ | ( | ||||||
Total fixed income | ||||||||||||||||||
Fair value | $ | | $ | | $ | | $ | | $ | | $ | | ||||||
Amortized cost | | | | | | | ||||||||||||
Unrealized Loss | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | ||||||
* Non-agency asset-backed and commercial mortgage-backed
The following table shows the composition of the fixed income securities in unrealized loss positions, after factoring in the allowance for credit losses, at June 30, 2020 by the National Association of Insurance Commissioners (NAIC) rating and the generally equivalent Standard & Poor’s (S&P) and Moody’s ratings. The vast majority of the securities are rated by S&P and/or Moody’s.
15
Equivalent | Equivalent | (dollars in thousands) | ||||||||||||||
NAIC |
| S&P |
| Moody’s | Amortized |
|
|
| Unrealized | Percent | ||||||
Rating |
| Rating |
| Rating |
| Cost |
| Fair Value |
| Loss |
| to Total | ||||
1 | AAA/AA/A | Aaa/Aa/A | $ | | $ | | $ | ( | % | |||||||
2 | BBB | Baa | | | ( | % | ||||||||||
3 | BB | Ba | | | ( | % | ||||||||||
4 | B | B | | | ( | % | ||||||||||
5 | CCC | Caa | | | ( | % | ||||||||||
6 | CC or lower | Ca or lower | | | ( | | % | |||||||||
Total | $ | | $ | | $ | ( | % | |||||||||
Unrealized Gains and Losses on Equity Securities
Unrealized gains recognized on equity securities still held as of June 30, 2020 were $
Other Invested Assets
We had $
Our LIHTC interests had a balance of $
As of June 30, 2020, $
Our investments in private funds totaled $
Cash
Cash consists of uninvested balances in bank accounts. We had a cash balance of $
16
3. HISTORICAL LOSS AND LAE DEVELOPMENT
The following table is a reconciliation of our unpaid losses and settlement expenses (LAE) for the first six months of 2020 and 2019:
For the Six-Month Periods | ||||||
Ended June 30, | ||||||
(in thousands) |
| 2020 |
| 2019 | ||
Unpaid losses and LAE at beginning of year | ||||||
Gross | $ | | $ | | ||
Ceded |
| ( |
| ( | ||
Net | $ | | $ | | ||
Adoption impact of ASU 2016-13 on reinsurance balances recoverable | $ | ( | $ | — | ||
Increase (decrease) in incurred losses and LAE | ||||||
Current accident year | $ | | $ | | ||
Prior accident years |
| ( |
| ( | ||
Total incurred | $ | | $ | | ||
Loss and LAE payments for claims incurred | ||||||
Current accident year | $ | ( | $ | ( | ||
Prior accident years |
| ( |
| ( | ||
Total paid | $ | ( | $ | ( | ||
Net unpaid losses and LAE at June 30 | $ | | $ | | ||
Unpaid losses and LAE at June 30 | ||||||
Gross | $ | | $ | | ||
Ceded |
| ( |
| ( | ||
Net | $ | | $ | | ||
We adopted ASU 2016-13, Financial Instruments – Credit Losses, on January 1, 2020, which required financial assets, including reinsurance balances recoverable, to be presented at the net amount expected to be collected. We previously maintained an allowance for uncollectible reinsurance balances prior to the adoption of this update. However, in order to comply with the updated requirements, we released $
For the first six months of 2020, incurred losses and LAE included $
For the first six months of 2019, incurred losses and LAE included $
Actuarial models base future emergence on historic experience, with adjustments for current trends, and the appropriateness of these assumptions involved more uncertainty as of June 30, 2020. We expect there will be impacts to the timing of loss emergence and ultimate loss ratios for certain coverages we underwrite as a result of the spread of COVID-19 and the related economic shutdown. The industry is experiencing new issues, including the postponement of civil court cases, the extension of various statutes of limitations, changes in settlement trends and a significant reduction in economic activity and insured exposure in some classes. Our booked reserves include consideration of these factors, but the duration and degree to which these issues persist, along with potential legislative, regulatory or judicial actions, could result in loss reserve deficiencies and reduce earnings in future periods.
17
4. INCOME TAXES
Our effective tax rate for the three and six-month periods ended June 30, 2020 was
Income tax expense (benefit) attributable to income from operations for the three and six-month periods ended June 30, 2020 and 2019 differed from the amounts computed by applying the U.S. federal tax rate of
For the Three-Month Periods Ended June 30, |
| For the Six-Month Periods Ended June 30, | ||||||||||||||||||||||
2020 | 2019 | 2020 | 2019 | |||||||||||||||||||||
(in thousands) |
| Amount |
| % |
|
| Amount |
| % |
| Amount |
| % |
|
| Amount |
| % | ||||||
Provision for income taxes at the statutory rate of 21% | $ | | % | $ | | % | $ | | % | $ | | % | ||||||||||||
Increase (reduction) in taxes resulting from: | ||||||||||||||||||||||||
Excess tax benefit on share-based compensation | ( | ( | % | ( | ( | % | ( | ( | % | ( | ( | % | ||||||||||||
Tax exempt interest income | ( | ( | % | ( | ( | % | ( | ( | % | ( | ( | % | ||||||||||||
Dividends received deduction | ( | ( | % | ( | ( | % | ( | ( | % | ( | ( | % | ||||||||||||
ESOP dividends paid deduction | ( | ( | % | ( | ( | % | ( | ( | % | ( | ( | % | ||||||||||||
Nondeductible expenses | | % | | % | | % | | % | ||||||||||||||||
Other items, net | ( | ( | % | | % | ( | ( | % | | % | ||||||||||||||
Total tax expense (benefit) | $ | | % | $ | | % | $ | | % | $ | | % | ||||||||||||
5. STOCK BASED COMPENSATION
Our RLI Corp. Long-Term Incentive Plan (2010 LTIP) was in place from 2010 to 2015. The 2010 LTIP provided for equity-based compensation, including stock options, up to a maximum of
In 2015, our shareholders approved the 2015 RLI Corp. Long-Term Incentive Plan (2015 LTIP), which provides for equity-based compensation and replaced the 2010 LTIP. In conjunction with the adoption of the 2015 LTIP, effective May 7, 2015, options were no longer granted under the 2010 LTIP. Awards under the 2015 LTIP may be in the form of restricted stock, restricted stock units, stock options (non-qualified only), stock appreciation rights, performance units as well as other stock-based awards. Eligibility under the 2015 LTIP is limited to employees and directors of the Company or any affiliate. The granting of awards under the 2015 LTIP is solely at the discretion of the board of directors. The maximum number of shares of common stock available for distribution under the 2015 LTIP is
Stock Options
Under the 2015 LTIP, as under the 2010 LTIP, we grant stock options for shares with an exercise price equal to the fair market value of the shares at the date of grant (subject to adjustments for changes in our capitalization, special dividends and other events as set forth in such plans). Options generally vest and become exercisable ratably over a
For most participants, the requisite service period and vesting period will be the same. For participants who are retirement eligible, defined by the plan as those individuals whose age and years of service equals
18
The following tables summarize option activity for the six-month periods ended June 30, 2020 and 2019:
Through 2019, the majority of our annual stock option grants were authorized at our regular board meeting in May. In addition, quarterly grants to certain retirement eligible employees were historically authorized at the May meeting. Since stock option grants to retirement eligible employees are fully expensed when issued, the approach allowed for a more even expense distribution throughout the year. In 2020, the COVID-19 pandemic created economic uncertainty and the Company deemed it prudent to defer any decision on whether to grant stock options until a later date. The options granted in the six-month period ended June 30, 2020 related to the quarterly grants authorized at the May 2019 board meeting.
In the first six months of 2020,
The fair value of options was estimated using a Black-Scholes based option pricing model with the following weighted average grant-date assumptions and weighted average fair values as of June 30:
| 2020 |
| 2019 |
| ||||
Weighted-average fair value of grants | $ | | $ | |||||
Risk-free interest rates | % | % | ||||||
Dividend yield | % | % | ||||||
Expected volatility | % | % | ||||||
Expected option life | years | years | ||||||
The risk-free rate was determined based on U.S. treasury yields that most closely approximated the option’s expected life. The dividend yield was determined based on the average annualized quarterly dividends paid during the most recent five-year period and incorporated a consideration for special dividends paid in recent history. The expected volatility was calculated based
19
on the median of the rolling volatilities for the expected life of the options. The expected option life was determined based on historical exercise behavior and the assumption that all outstanding options will be exercised at the midpoint of the current date and remaining contractual term, adjusted for the demographics of the current year’s grant.
Restricted Stock Units
In addition to stock options, restricted stock units (RSUs) are granted with a value equal to the closing stock price of the Company’s stock on the dates the units are granted. These units generally have a
As of June 30, 2020,
In 2019, each outside director received RSUs with a fair market value that approximated $
6. OPERATING SEGMENT INFORMATION
Selected information by operating segment is presented in the table below. Additionally, the table reconciles segment totals to total earnings and total revenues.
For the Three-Month Periods | For the Six-Month Periods | |||||||||||
REVENUES | Ended June 30, | Ended June 30, | ||||||||||
(in thousands) |
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||
Casualty | $ | | $ | | $ | | $ | | ||||
Property | | | | | ||||||||
Surety | | | | | ||||||||
Net premiums earned | $ | | $ | | $ | | $ | | ||||
Net investment income | | | | | ||||||||
Net realized gains (losses) | ( | | | | ||||||||
Net unrealized gains (losses) on equity securities | | | ( | | ||||||||
Total consolidated revenue | $ | | $ | | $ | | $ | | ||||
NET EARNINGS (LOSS) | ||||||||||||
(in thousands) |
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||
Casualty | $ | | $ | | $ | | $ | | ||||
Property | | ( | | | ||||||||
Surety | | | | | ||||||||
Net underwriting income | $ | | $ | | $ | | $ | | ||||
Net investment income | | | | | ||||||||
Net realized gains (losses) | ( | | | | ||||||||
Net unrealized gains (losses) on equity securities | | | ( | | ||||||||
General corporate expense and interest on debt | ( | ( | ( | ( | ||||||||
Equity in earnings of unconsolidated investees | | | | | ||||||||
Earnings before income taxes | $ | | $ | | $ | | $ | | ||||
Income tax expense | | | | | ||||||||
Net earnings | $ | | $ | | $ | | $ | | ||||
20
The following table further summarizes revenues by major product type within each operating segment:
For the Three-Month Periods | For the Six-Month Periods | |||||||||||
NET PREMIUMS EARNED | Ended June 30, | Ended June 30, | ||||||||||
(in thousands) |
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||
Casualty | ||||||||||||
Commercial excess and personal umbrella | $ | | $ | | $ | | $ | | ||||
General liability | | | | | ||||||||
Professional services | | | | | ||||||||
Commercial transportation | | | | | ||||||||
Small commercial | | | | | ||||||||
Executive products | | | | | ||||||||
Other casualty | | | | | ||||||||
Total | $ | | $ | | $ | | $ | | ||||
Property | ||||||||||||
Marine | $ | | $ | | $ | | $ | | ||||
Commercial property | | | | | ||||||||
Specialty personal | | | | | ||||||||
Other property | | | | | ||||||||
Total | $ | | $ | | $ | | $ | | ||||
Surety | ||||||||||||
Commercial | $ | | $ | | $ | | $ | | ||||
Miscellaneous | | | | | ||||||||
Contract | | | | | ||||||||
Total | $ | | $ | | $ | | $ | | ||||
Grand Total | $ | | $ | | $ | | $ | | ||||
7. LEASES
Right-of-use (ROU) assets are included in the line item and lease liabilities are included in the line item of the consolidated balance sheet. We determine if a contract contains a lease at inception and recognize operating lease ROU assets and operating lease liabilities based on the present value of the future minimum lease payments at the commencement date. As our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments. Lease agreements may include options to extend or terminate. The options are exercised at our discretion and are included in operating lease liabilities if it is reasonably certain the option will be exercised. Lease agreements have lease and non-lease components, which are accounted for as a single lease component. Operating lease cost for future minimum lease payments is recognized on a straight-line basis over the lease term. Variable lease cost is expensed in the period in which the obligation is incurred. Sublease income is recognized on a straight-line basis over the sublease term.
The Company’s operating lease obligations are for branch office facilities. Our leases have remaining lease terms of
21
For the Three-Month Periods | For the Six-Month Periods | |||||||||||
Ended June 30, | Ended June 30, | |||||||||||
(in thousands) | 2020 |
| 2019 |
| 2020 |
| 2019 | |||||
Operating lease cost | $ | | $ | | $ | | $ | | ||||
Variable lease cost | | | | | ||||||||
Sublease income | ( | - | ( | - | ||||||||
Total lease cost | $ | | $ | | $ | | $ | | ||||
Cash paid for amounts included in measurement of lease liabilities | ||||||||||||
Operating cash outflows from operating leases | $ | | $ | | $ | | $ | | ||||
ROU assets obtained in exchange for new operating lease liabilities | $ | - | $ | | $ | | $ | | ||||
Reduction to ROU assets resulting from reduction to lease liabilities | $ | - | $ | | $ | - | $ | | ||||
Other non-cash reductions to ROU assets | $ | - | $ | - | $ | | $ | - | ||||
(in thousands) |
| June 30, 2020 |
| December 31, 2019 | ||||
Operating lease ROU assets |
| $ | | $ | | |||
| ||||||||
Operating lease liabilities |
| $ | | $ | | |||
| ||||||||
Weighted-average remaining lease term - operating leases |
| years | years | |||||
| ||||||||
Weighted-average discount rate - operating leases |
| % | % | |||||
Future minimum lease payments under non-cancellable leases as of June 30, 2020 were as follows:
(in thousands) | June 30, 2020 | ||
2020 | $ | | |
2021 | | ||
2022 | | ||
2023 | | ||
2024 | | ||
Thereafter | | ||
Total future minimum lease payments | $ | | |
Less imputed interest | ( | ||
Total operating lease liability | $ | | |
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 appear throughout this report. These statements relate to our current expectations, beliefs, intentions, goals or strategies regarding the future and are based on certain underlying assumptions by the Company. These forward looking statements generally include words such as “expect,” “predict,” “estimate,” “will,” “should,” “anticipate,” “believe” and similar expressions. Such assumptions are, in turn, based on information available and internal estimates and analyses of general economic conditions, competitive factors, conditions specific to the property and casualty insurance and reinsurance industries, claims development and the impact thereof on our loss reserves, the adequacy and financial security of our reinsurance programs, developments in the securities market and the impact on our investment portfolio, regulatory changes and conditions and other factors and are subject to various risks, uncertainties and other factors, including, without limitation those set forth in “Item 1A. Risk Factors” within the Annual Report on Form 10-K for the year ended December 31, 2019 and Part II within this report. Actual results could differ materially from those expressed in, or implied by, these forward looking statements. We assume no obligation to update any such statements. You should review the various risks, uncertainties and other factors listed from time to time in our Securities and Exchange Commission filings.
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OVERVIEW
RLI Corp. is a U.S.-based, specialty insurance company that underwrites select property and casualty insurance through major subsidiaries collectively known as RLI Insurance Group (Group). Our focus is on niche markets and developing unique products that are tailored to customers’ needs. We hire underwriters and claim examiners with deep expertise and provide exceptional customer service and support. We maintain a highly diverse product portfolio and underwrite for profit in all market conditions. In 2019, we achieved our 24th consecutive year of underwriting profitability. Over the 24 year period, we averaged an 88.3 combined ratio. This drives our ability to provide shareholder returns in three different ways: the underwriting income itself, net investment income from our investment portfolio and long-term appreciation in our equity portfolio.
We measure the results of our insurance operations by monitoring growth and profitability across three distinct business segments: casualty, property and surety. Growth is measured in terms of gross premiums written, and profitability is analyzed through combined ratios, which are further subdivided into their respective loss and expense components.
The property and casualty insurance business is cyclical and influenced by many factors, including price competition, economic conditions, natural or man-made disasters (for example, earthquakes, hurricanes, pandemics and terrorism), interest rates, state regulations, court decisions and changes in the law. One of the unique and challenging features of the property and casualty insurance business is that coverages must be priced before costs have fully developed, because premiums are charged before claims are incurred. This requires that liabilities be estimated and recorded in recognition of future loss and settlement obligations. Due to the inherent uncertainty in estimating these liabilities, there can be no assurance that actual liabilities will not be more or less than recorded amounts; if actual liabilities differ from recorded amounts, there will be an adverse or favorable effect on net earnings.
The casualty portion of our business consists largely of commercial excess, personal umbrella, general liability, transportation and executive products coverages, as well as package business and other specialty coverages, such as professional liability and workers’ compensation for office-based professionals. We also assume a limited amount of hard-to-place risks through a quota share reinsurance agreement. The casualty business is subject to the risk of estimating losses and related loss reserves because the ultimate settlement of a casualty claim may take several years to fully develop. The casualty segment is also subject to inflation risk and may be affected by evolving legislation and court decisions that define the extent of coverage and the amount of compensation due for injuries or losses.
Our property segment is comprised primarily of commercial fire, earthquake, difference in conditions and marine coverages. We also offer select personal lines policies, including homeowners’ coverages. Property insurance results are subject to the variability introduced by perils such as earthquakes, fires, hurricanes and other storms. Our major catastrophe exposure is to losses caused by earthquakes, primarily on the West Coast. Our second largest catastrophe exposure is to losses caused by wind storms to commercial properties throughout the Gulf and East Coast, as well as to homes we insure in Hawaii. We seek to limit our net aggregate exposure to a catastrophic event by minimizing the total policy limits written in a particular region, purchasing reinsurance and maintaining consistent policy terms and conditions throughout insurance cycles. We also use computer-assisted modeling techniques to provide estimates that help the Company carefully manage the concentration of risks exposed to catastrophic events.
The surety segment specializes in writing small to large-sized commercial and contract surety coverages, including payment and performance bonds. We also offer miscellaneous bonds including license and permit, notary and court bonds. Often, our surety coverages involve a statutory requirement for bonds. While these bonds typically maintain a relatively low loss ratio, losses may fluctuate due to adverse economic conditions affecting the financial viability of our principals. The contract surety product guarantees the construction work of a commercial contractor for a specific project. Generally, losses occur due to the deterioration of a contractor’s financial condition. This line has historically produced marginally higher loss ratios than other surety lines during economic downturns.
The insurance marketplace is intensely competitive across all of our segments. However, we believe that our business model is built to create underwriting income by focusing on sound risk selection and discipline. Our primary focus will continue to be on underwriting profitability, with a secondary focus on premium growth where we believe underwriting profit exists, as opposed to general premium growth or market share measurements.
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GAAP, non-GAAP and Performance Measures
Throughout this quarterly report, we include certain non-generally accepted accounting principles (non-GAAP) financial measures. Management believes that these non-GAAP measures further explain the Company’s results of operations and allow for a more complete understanding of the underlying trends in the Company’s business. These measures should not be viewed as a substitute for those determined in accordance with generally accepted accounting principles in the United States of America (GAAP). In addition, our definitions of these items may not be comparable to the definitions used by other companies.
The following is a list of non-GAAP measures found throughout this report with their definitions, relationships to GAAP measures and explanations of their importance to our operations.
Underwriting Income
Underwriting income or profit represents one measure of the pretax profitability of our insurance operations and is derived by subtracting losses and settlement expenses, policy acquisition costs and insurance operating expenses from net premiums earned, which are all GAAP financial measures. Each of these captions is presented in the statements of earnings but is not subtotaled. However, this information is available in total and by segment in note 6 to the unaudited condensed consolidated interim financial statements in this quarterly report on Form 10-Q and in note 12 to the consolidated financial statements in our 2019 Annual Report on Form 10-K, regarding operating segment information. The nearest comparable GAAP measure is earnings before income taxes which, in addition to underwriting income, includes net investment income, net realized gains or losses, net unrealized gain or losses on equity securities, general corporate expenses, debt costs and our portion of earnings from unconsolidated investees. A reconciliation of net earnings to underwriting income follows:
For the Three-Month Periods | For the Six-Month Periods | |||||||||||
Ended June 30, | Ended June 30, | |||||||||||
(in thousands) |
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||
Net earnings | $ | 92,166 | $ | 40,467 | $ | 30,899 | $ | 105,940 | ||||
Income tax expense | 22,713 | 8,361 | 4,616 | 24,629 | ||||||||
Earnings before income taxes | $ | 114,879 | $ | 48,828 | $ | 35,515 | $ | 130,569 | ||||
Equity in earnings of unconsolidated investees | (5,100) | (8,468) | (9,614) | (13,782) | ||||||||
General corporate expenses | 1,994 | 3,283 | 3,749 | 6,559 | ||||||||
Interest expense on debt | 1,903 | 1,861 | 3,800 | 3,722 | ||||||||
Net unrealized (gains) losses on equity securities | (74,705) | (8,810) | 55,690 | (42,308) | ||||||||
Net realized (gains) losses | 2,109 | (4,764) | (13,043) | (13,832) | ||||||||
Net investment income | (16,917) | (16,998) | (34,695) | (33,563) | ||||||||
Net underwriting income | $ | 24,163 | $ | 14,932 | $ | 41,402 | $ | 37,365 | ||||
Combined Ratio
The combined ratio, which is derived from components of underwriting income, is a common industry performance measure of profitability for underwriting operations and is calculated in two components. First, the loss ratio is losses and settlement expenses divided by net premiums earned. The second component, the expense ratio, reflects the sum of policy acquisition costs and insurance operating expenses divided by net premiums earned. All items included in these components of the combined ratio are presented in our GAAP consolidated financial statements. The sum of the loss and expense ratios is the combined ratio. The difference between the combined ratio and 100 reflects the per-dollar rate of underwriting income or loss.
Critical Accounting Policies
In preparing the unaudited condensed consolidated interim financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses for the reporting period. Actual results could differ significantly from those estimates.
The most critical accounting policies involve significant estimates and include those used in determining the liability for unpaid losses and settlement expenses, investment valuation, recoverability of reinsurance balances, deferred policy acquisition costs and deferred taxes. For a detailed discussion of each of these policies, refer to our 2019 Annual Report on Form 10-K.
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We adopted ASU 2016-13, Financial Instruments – Credit Losses, on January 1, 2020, which eliminated the concept of other-than-temporary impairment and required the recognition of a reversible allowance for credit losses on available-for-sale fixed income securities. See note 1. B. for more information on the adoption of the ASU. Available-for-sale securities in the fixed income portfolio are subjected to several criteria to determine if those securities should be included in the allowance for expected credit loss evaluation, including:
| ● | Changes in technology that may impair the earnings potential of the investment, |
| ● | The discontinuance of a segment of business that may affect future earnings potential, |
| ● | Reduction of or non-payment of interest and/or principal, |
| ● | Specific concerns related to the issuer’s industry or geographic area of operation, |
| ● | Significant or recurring operating losses, poor cash flows and/or deteriorating liquidity ratios and |
| ● | Downgrades in credit quality by a major rating agency. |
If changes in interest rates and credit spreads do not reasonably explain the unrealized loss for an available-for-sale security or if any of the criteria above indicate a potential credit loss, the security is subjected to a discounted cash flow analysis. Inputs into the discounted cash flow analysis include prepayment assumptions for structured securities, default rates and recoverability rates based on credit rating. The allowance for any security is limited to the amount that the securities fair value is below amortized cost. If we intend to sell a security or if we determine it is more likely than not that we will be required to sell a security before recovery of its amortized cost basis, any allowance for credit loss or unrealized loss would be written off and the amortized cost basis of the security would be written down to the security’s fair value.
There have been no other significant changes to critical accounting policies during the year.
IMPACT OF COVID-19
The coronavirus (COVID-19) pandemic continues to impact individuals, businesses and the economy. As an employee-owned company, the health and well-being of our customers, partners and associates is our highest priority. While a large percentage of our associates are still working from home, our processes and controls continue to operate effectively and we have been able to maintain the highest service and support levels possible for our customers.
It is difficult to predict how and to what extent the economic slowdown will have on our revenues in the coming months. To date, our most impacted product line has been public transportation. A large number of our passenger transportation customers have been unable to effectively operate under social-distancing protocols and stay-at-home orders. For the six-month period ended June 30, 2020, transportation gross written premium was down $33.3 million when compared to 2019. We would expect transportation premium to continue to be down from prior periods until the use of public transportation increases, which may not be until after there is a vaccine, effective treatment or significant reduction in cases. Additionally, slowdowns in the construction industry contributed to premium declines for our general liability and surety products in the second quarter. A number of our products support the construction industry and revenues may continue to be impacted to the extent this sector experiences disruption. However, we have many product lines that may see little to no impact on the amount of premium we write, including our personal lines products, management liability products and property businesses.
We have been fair and flexible with our customers in regards to modifying exposures and payment terms and we are in compliance with any applicable state regulatory directives on such changes. Insureds continue to make payments in accordance with the agreed upon schedules and we have not experienced a material increase in the amount of expense associated with uncollectible receivables.
The loss exposure arising out of the spread of COVID-19 and resulting shutdown will take time to resolve. We do not offer event cancellation, travel, trade credit or pandemic-related coverages which would be more directly impacted by the COVID-19 pandemic. The Company has received a number of claims, the majority of which relate to business interruption. We are reviewing the individual circumstances of each claim submitted and will fulfill our obligation to pay if coverage applies. The derivative implications that COVID-19 has on the economy may have negative implications on products that are correlated with the credit cycle, including, but not limited to, some of our executive products and surety offerings. In the second quarter of 2020, $5.8 million of net reserves were established to address the increased risk of loss and expense that emanated from the economic downturn brought on by the pandemic. Combined with the reserves established in the first quarter
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that addressed the expected increase in costs to investigate and defend business interruption claims, $10.8 million of COVID-19 related net losses have been recognized in the first six months of 2020.
Actuarial models base future emergence on historic experience, with adjustments for current trends, and the appropriateness of these assumptions involved greater uncertainty as of June 30, 2020. We expect there will be impacts to the timing of loss emergence and ultimate loss ratios for certain coverages. The industry is experiencing new issues, including the postponement of civil court cases, the extension of various statutes of limitations, changes in settlement trends and a significant reduction in economic activity and insured exposure in some classes. Our booked reserves include consideration of these factors, but the duration and degree to which these issues persist, along with potential legislative, regulatory or judicial actions, could result in loss reserve deficiencies and reduce earnings in future periods.
We continue to evaluate opportunities for expense savings and efficiencies and have taken targeted actions to reduce or defer expenses, including certain hiring freezes, position consolidations and executive merit increase suspensions. Travel was limited and any decision on granting share-based compensation, which normally takes place at our May board meeting, was deferred until a later date, resulting in a reduced level of compensation expense in the second quarter. Bonus and profit sharing expense is correlated with company performance and is responsible for the largest portion of the total expense decline for the six-month period ended June 30, when compared to 2019. The performance-related expenses recognized for the 2020 fiscal year will be dependent on the full year’s results and may increase or decrease in the second half of the year.
Although we have recovered a large portion of the market value declines recorded in the first quarter, equity securities have not fully returned to levels recorded at year end. Net after-tax realized and unrealized losses on equity securities were $33.9 million in the first half of 2020. Conversely, lower interest rates increased the fair value of the fixed income portfolio, which resulted in $40.5 million of after-tax other comprehensive earnings for the six-month period ended June 30, 2020. With the decline in yields, reinvestment rates are now lower than in previous years, which will cap the portfolio’s ability to generate higher levels of investment income, absent a larger invested asset base.
Maui Jim, Inc. (Maui Jim) and Prime Holdings Insurance Services, Inc. (Prime) continued to contribute towards positive net earnings. While earnings for Prime were modestly higher, Maui Jim results were negatively impacted by the shutdown much of the traditional retail sector experienced during the second quarter. The economic downturn may continue to impact the results of these investees, particularly if there is any lasting impact on the retail sector as it relates to Maui Jim.
We produced solid operating results in the first half of the year and believe our financial position has remained strong despite the impact of the COVID-19 pandemic. We generated $83.8 million of net operating cash inflows and believe we have adequate liquidity. Our revolving credit facility provides for a borrowing capacity of $60.0 million, which can be increased to $120.0 million under certain circumstances. Additionally, our membership in the Federal Home Loan Bank system provides a secured lending facility with an aggregate borrowing capacity of approximately $30.0 million. There were no amounts outstanding under any of these facilities as of June 30, 2020. In addition to the $160.7 million of cash and other investments maturing within one year as of June 30, 2020, we believe that cash generated from operations, the liquidity of our fixed income portfolio and our unused lines of credit provide sufficient sources of cash to meet our anticipated needs over the next 12 to 24 months.
Ultimately, the extent to which COVID-19 will impact our business will be influenced by how long it takes for the economy to recover. We continue to evaluate all aspects of our operations and are making necessary adjustments to manage our business. Our diversified portfolio of products and financial strength have allowed us to remain on solid footing. We believe we have a strong and sustainable underwriting approach that will allow us to weather the economic downturn and uncertainty we are currently experiencing.
RESULTS OF OPERATIONS
Six Months Ended June 30, 2020 Compared to Six Months Ended June 30, 2019
Consolidated revenue for the first half of 2020 decreased $85.6 million from the first half of 2019 as performance in the equity portfolio varied significantly between the periods. Overall market declines resulted in $55.7 million of unrealized losses on equity securities in 2020, while positive returns generated $42.3 million of unrealized gains in our equity portfolio in the first half of 2019. Net premiums earned for the Group increased 3 percent, driven by growth from our casualty and property segments. Investment income increased 3 percent due to a larger asset base relative to the prior year. Realized gains during the first half were $13.0 million and were comprised of $12.8 million of realized gains on equity securities from rebalancing our portfolio, $2.6 million of realized gains on the fixed income portfolio and $2.4 million of other realized losses. This compares
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to $12.3 million of realized gains on the equity portfolio, $1.3 million of realized gains on the fixed income portfolio and $0.2 million of other realized gains for the same period in 2019.
For the Six-Month Periods | ||||||
Ended June 30, | ||||||
| 2020 |
| 2019 | |||
Consolidated revenues (in thousands) | ||||||
Net premiums earned | $ | 424,316 | $ | 412,230 | ||
Net investment income | 34,695 | 33,563 | ||||
Net realized gains (losses) | 13,043 | 13,832 | ||||
Net unrealized gains (losses) on equity securities | (55,690) | 42,308 | ||||
Total consolidated revenue | $ | 416,364 | $ | 501,933 | ||
Net earnings for the first six months of 2020 totaled $30.9 million, compared to $105.9 million for the same period last year. The decrease in earnings for 2020 was primarily attributed to $44.0 million of net after-tax unrealized losses on equity securities, compared to $33.4 million of after-tax unrealized gains in 2019. Underwriting results for both periods reflect profitable current accident year results and favorable development from prior years’ loss reserves. Favorable development on prior years’ loss reserves provided additional pretax earnings of $40.8 million in the first half of 2020 and 2019. Pretax losses from storms and civil unrest were $6.5 million, compared to $5.0 million of storm losses for the same period in 2019. Pretax bonus and profit sharing-related expenses associated with the net impact of prior years’ reserve development and catastrophe losses totaled $5.1 million in 2020, compared to $5.3 million in 2019. These performance-related expenses affected policy acquisition, insurance operating and general corporate expenses. Bonus and profit-sharing amounts earned by executives, managers and associates are predominately influenced by corporate performance including operating earnings, combined ratio and return on capital.
During the first half of 2020, equity in earnings of unconsolidated investees totaled $9.6 million. This amount includes $5.2 million from Maui Jim and $4.4 million from Prime. Comparatively, the first half of 2019 reflected $13.8 million of earnings, including $10.1 million from Maui Jim and $3.7 million from Prime. The decline in earnings from Maui Jim is reflective of the shutdown much of the traditional retail sector experienced as a result of the pandemic during the second quarter.
Comprehensive earnings totaled $71.4 million for the first six months of 2020, compared to $163.1 million for the first half of 2019. Other comprehensive earnings primarily included net after-tax unrealized gains from the fixed income portfolio and totaled $40.5 million in the first half of 2020, compared to $57.2 million in 2019. The unrealized gains were attributable to declining interest rates in both periods, which increased the fair value of securities held in the fixed income portfolio. However, wider credit spreads partially offset the impact of the lower treasury rates in 2020.
Premiums
Gross premiums written for the Group increased $18.8 million, or 4 percent, for the first half of 2020 when compared to the same period of 2019. Products in our property and casualty segments drove the growth. Net premiums earned increased $12.1 million, or 3 percent, also driven by products in our property and casualty segments.
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Gross Premiums Written | Net Premiums Earned | |||||||||||||||||||
For the Six-Month Periods Ended June 30, | For the Six-Month Periods Ended June 30, | |||||||||||||||||||
(in thousands) | 2020 |
| 2019 | % Change |
| 2020 |
| 2019 | % Change | |||||||||||
Casualty | ||||||||||||||||||||
Commercial excess and personal umbrella | $ | 115,533 | $ | 90,422 | 28 | % | $ | 82,409 | $ | 66,621 | 24 | % | ||||||||
General liability | 51,357 | 54,773 | (6) | % | 46,649 | 49,235 | (5) | % | ||||||||||||
Professional services | 45,967 | 44,984 | 2 | % | 42,079 | 39,574 | 6 | % | ||||||||||||
Commercial transportation | 15,097 | 48,391 | (69) | % | 32,324 | 40,912 | (21) | % | ||||||||||||
Small commercial | 33,257 | 30,208 | 10 | % | 31,424 | 26,503 | 19 | % | ||||||||||||
Executive products | 47,959 | 37,649 | 27 | % | 14,306 | 12,450 | 15 | % | ||||||||||||
Other casualty | 40,113 | 34,803 | 15 | % | 29,444 | 39,949 | (26) | % | ||||||||||||
Total | $ | 349,283 | $ | 341,230 | 2 | % | $ | 278,635 | $ | 275,244 | 1 | % | ||||||||
Property | ||||||||||||||||||||
Marine | $ | 46,925 | $ | 44,150 | 6 | % | $ | 40,289 | $ | 35,600 | 13 | % | ||||||||
Commercial property | 67,090 | 57,450 | 17 | % | 38,203 | 33,150 | 15 | % | ||||||||||||
Specialty personal | 10,177 | 10,957 | (7) | % | 9,936 | 9,376 | 6 | % | ||||||||||||
Other property | 1,815 | 824 | 120 | % | 1,307 | 592 | 121 | % | ||||||||||||
Total | $ | 126,007 | $ | 113,381 | 11 | % | $ | 89,735 | $ | 78,718 | 14 | % | ||||||||
Surety | ||||||||||||||||||||
Commercial | $ | 20,902 | $ | 22,223 | (6) | % | $ | 21,744 | $ | 21,787 | (0) | % | ||||||||
Miscellaneous | 22,260 | 22,400 | (1) | % | 21,015 | 22,882 | (8) | % | ||||||||||||
Contract | 14,533 | 14,949 | (3) | % | 13,187 | 13,599 | (3) | % | ||||||||||||
Total | $ | 57,695 | $ | 59,572 | (3) | % | $ | 55,946 | $ | 58,268 | (4) | % | ||||||||
Grand Total | $ | 532,985 | $ | 514,183 | 4 | % | $ | 424,316 | $ | 412,230 | 3 | % | ||||||||
Casualty
Gross premiums written for the casualty segment were up $8.1 million in the first six months of 2020. Premiums from commercial excess and personal umbrella increased $25.1 million, due to an expanded distribution base in personal umbrella and rate increases. Small commercial continued to benefit from new production sources and geographic expansion. Substantial rate increases led to a 27 percent increase for our executive products group. Other casualty increased $5.3 million, as our general binding authority (GBA) business continued to grow.
Commercial transportation has been significantly affected by the stay at home orders associated with COVID-19, particularly our public lines. Public transportation focuses on charter, school and transit busses, which stopped running to a large degree in March. The reduced utilization led to a $33.3 million decline in gross premiums written in the first six months of 2020.
Property
Gross premiums written for the property segment were up $12.6 million in the first half of 2020. Our commercial property business was up $9.6 million, as an improving market allowed our underwriters to find more opportunities with acceptable rate levels. Additionally, rates on wind-prone and earthquake exposures continued to increase over the first half of the year. Rate increases and market disruption, which created new business opportunities, led to $2.8 million of growth for our marine product. Other property premium increased as a result of property exposed GBA business that continues to gain scale.
Surety
The surety segment recorded gross premiums written of $57.7 million for the first six months of 2020, a decrease of $1.9 million from the same period last year. The economic slowdown and decreased commodity pricing has reduced demand for surety bonds. Additionally, we continually monitor our portfolio for higher risk accounts and have selectively eliminated exposures that no longer met our underwriting standards.
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Underwriting Income
Underwriting income for the Group totaled $41.4 million for the first six months of 2020, compared to $37.4 million in the same period of 2019. Both periods reflect positive underwriting results for the current accident year and similar amounts of favorable reserve development on prior accident years. The combined ratio for the Group totaled 90.2 in the first half of 2020, compared to 90.9 in the same period of 2019. The loss ratio increased to 50.0 from 48.1, primarily due to the addition of $10.8 million in current accident year reserves related to COVID-19 loss and claim defense costs. The Group’s expense ratio decreased to 40.2 from 42.8, as 2019 experienced stronger growth in book value, which led to larger levels of bonus and profit-sharing expenses.
For the Six-Month Periods | ||||||
Ended June 30, | ||||||
| 2020 |
| 2019 | |||
Underwriting income (in thousands) | ||||||
Casualty | $ | 8,410 | $ | 12,282 | ||
Property | 16,075 | 7,810 | ||||
Surety | 16,917 | 17,273 | ||||
Total | $ | 41,402 | $ | 37,365 | ||
Combined ratio | ||||||
Casualty | 97.0 | 95.5 | ||||
Property | 82.1 | 90.1 | ||||
Surety | 69.8 | 70.4 | ||||
Total | 90.2 | 90.9 | ||||
Casualty
The casualty segment recorded underwriting earnings of $8.4 million in the first half of 2020, compared to $12.3 million of underwriting income for the same period last year. Reserve releases reduced loss and settlement expenses for the casualty segment by $27.5 million, primarily on accident years 2016 through 2019. Transportation, general liability, executive products and small commercial were drivers of the favorable development. In comparison, $30.7 million of reserves were released in the first half of 2019. General liability, professional services, transportation, commercial excess, personal umbrella and small commercial developed favorably, while executive products developed adversely.
The combined ratio for the casualty segment was 97.0 in 2020, compared to 95.5 in 2019. The segment’s loss ratio was 61.7 in 2020, up from 58.3 in 2019. The loss ratio increased in 2020 as a result of less favorable development on prior years’ reserves and the addition of $7.7 million in current year reserves related to COVID-19 loss and defense costs. The expense ratio for the casualty segment was 35.3, down from 37.2 for the same period last year, as reduced levels of bonus and profit-sharing expenses were incurred.
Property
The property segment recorded underwriting income of $16.1 million for the first six months of 2020, compared to $7.8 million for the same period last year. Underwriting results for 2020 included $5.5 million of favorable development on prior years’ loss and catastrophe reserves, primarily from the marine business, $5.3 million of storm and civil unrest losses and $2.0 million of reserves related to COVID-19 investigative and defense costs. Comparatively, the 2019 underwriting results included $2.1 million of favorable development on prior years’ loss and catastrophe reserves and $4.7 million of storm losses.
Underwriting results for the first half of 2020 translated into a combined ratio of 82.1, compared to 90.1 for the same period last year. The segment’s loss ratio was 41.8 in 2020, down from 45.1 in 2019 due to lower current accident year losses and more favorable development on prior years’ reserves. The segment’s expense ratio decreased to 40.3 in 2020 from 45.0 in the prior year, as increased levels of earned premium allowed the segment to better leverage expenses.
Surety
The surety segment recorded underwriting income of $16.9 million for the first half of 2020, compared to $17.3 million for the same period last year. Both periods reflected positive current accident year underwriting performance and benefited from favorable development on prior years’ loss reserves. Results for 2020 included favorable development on prior accident
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years’ reserves, which decreased loss and settlement expenses for the segment by $7.8 million, and offset $1.1 million in current year reserves established for COVID-19 related losses. Comparatively, 2019 results included favorable development on prior accident years’ loss reserves, which decreased the segment’s loss and settlement expenses by $8.0 million.
The combined ratio for the surety segment totaled 69.8 for the first six months of 2020, compared to 70.4 for the same period in 2019. The segment’s loss ratio was 5.0 in 2020, up from 3.6 in 2019. The expense ratio was 64.8, down from 66.8 in the prior year.
Investment Income and Realized Capital Gains
Our investment portfolio generated net investment income of $34.7 million during the first half of 2020, an increase of 3.4 percent from that reported for the same period in 2019. The increase in investment income was largely due to a larger asset base relative to the prior year.
Yields on our fixed income investments for the first half of 2020 and 2019 were as follows:
| 2020 |
| 2019 | ||
Pretax Yield | |||||
Taxable | 3.22 | % | 3.44 | % | |
Tax-Exempt | 2.75 | % | 2.83 | % | |
After-Tax Yield | |||||
Taxable | 2.54 | % | 2.72 | % | |
Tax-Exempt | 2.61 | % | 2.68 | % |
We recognized $13.0 million of realized gains in the first half of 2020, which were comprised of $12.8 million of realized gains on equity securities from rebalancing our portfolio, $2.6 million of realized gains on the fixed income portfolio and $2.4 million of other realized losses. This compares to realized gains of $13.8 million in the first half of 2019, which were comprised of $12.3 million of realized gains on the equity portfolio, $1.3 million of realized gains on the fixed income portfolio and $0.2 million of other realized gains.
The following table depicts the composition of our investment portfolio at June 30, 2020 as compared to December 31, 2019:
June 30, 2020 | December 31, 2019 | |||||||||||
Financial | Financial | |||||||||||
(in thousands) |
| Stmt Value |
| % |
|
| Stmt Value |
| % | |||
Fixed income | $ | 2,075,093 | 78.4 | % | $ | 1,983,086 | 77.5 | % | ||||
Equity securities | 422,198 | 16.0 | % | 460,630 | 18.0 | % | ||||||
Other invested assets | 63,440 | 2.4 | % | 70,441 | 2.7 | % | ||||||
Cash and short-term investments | 84,797 | 3.2 | % | 46,203 | 1.8 | % | ||||||
Total | $ | 2,645,528 | 100.0 | % | $ | 2,560,360 | 100.0 | % | ||||
We believe our overall asset allocation best meets our strategy to preserve capital for policyholders, provide sufficient income to support insurance operations, and to effectively grow book value over a long-term investment horizon.
The fixed income portfolio increased by $92.0 million in the first six months of 2020. The increase was due to declines in interest rates during the first six months of the year, lifting the fair value of securities in the fixed income portfolio. Average fixed income duration was 4.6 years at June 30, 2020, reflecting our current liability structure and sound capital position. The equity portfolio decreased by $38.4 million during the first six months of 2020 as the equity market sold off sharply in the first quarter.
Income Taxes
Our effective tax rate for the first six months of 2020 was 13.0 percent, compared to 18.9 percent for the same period in 2019. Effective rates are dependent upon components of pretax earnings or losses and the related tax effects. The effective rate was lower for the first half of 2020 as lower levels of pre-tax earnings caused tax-favored adjustments to be larger on a percentage basis when compared to the prior year.
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Three Months Ended June 30, 2020 Compared to Three Months Ended June 30, 2019
Consolidated revenue for the second quarter of 2020 increased $60.1 million from the second quarter of 2019. A partial recovery from the market declines experienced in the first quarter resulted in $74.7 million of unrealized gains on equity securities in the second quarter of 2020, compared to $8.8 million of unrealized gains in the second quarter of 2019. Net premiums earned for the Group increased 1 percent, driven by growth from our property segment, which offset declines in our surety segment. Investment income decreased 1 percent due to lower average yields relative to the prior year. Realized losses during the quarter were $2.1 million and were comprised of $2.3 million of realized losses on equity securities from rebalancing our portfolio, $0.3 million of realized gains on the fixed income portfolio and $0.1 million of other realized losses. This compares to realized gains of $4.8 million in the second quarter of 2019, which were comprised of $3.9 million of realized gains on the equity portfolio, $0.7 million of realized gains on the fixed income portfolio and $0.2 million of miscellaneous realized gains.
For the Three-Month Periods | ||||||
Ended June 30, | ||||||
| 2020 |
| 2019 | |||
Consolidated revenues (in thousands) | ||||||
Net premiums earned | $ | 208,734 | $ | 207,541 | ||
Net investment income | 16,917 | 16,998 | ||||
Net realized gains (losses) | (2,109) | 4,764 | ||||
Net unrealized gains (losses) on equity securities | 74,705 | 8,810 | ||||
Total consolidated revenue | $ | 298,247 | $ | 238,113 | ||
Net earnings for the second quarter of 2020 totaled $92.2 million, compared to $40.5 million for the same period in 2019. The increase in earnings for 2020 was primarily attributed to $59.0 million of net after-tax unrealized gains on equity securities, compared to $7.0 million in 2019. Underwriting results for both periods reflect profitable current accident year results and favorable development from prior years’ loss reserves. Favorable development on prior years’ loss reserves provided additional pretax earnings of $25.6 million in the second quarter of 2020, compared to $21.2 million in 2019. Catastrophe activity consisted of $6.0 million of pretax storm and civil unrest losses in the second quarter of 2020, compared to $4.0 million of storm losses in 2019. Pretax bonus and profit sharing-related expenses associated with the net impact of prior years’ reserve development and catastrophe losses totaled $2.9 million in 2020, compared to $2.5 million in 2019. These performance-related expenses affected policy acquisition, insurance operating and general corporate expenses. Bonus and profit-sharing amounts earned by executives, managers and associates are predominately influenced by corporate performance including operating earnings, combined ratio and return on capital.
During the second quarter of 2020, equity in earnings of unconsolidated investees totaled $5.1 million. This amount includes $2.6 million from Maui Jim and $2.5 million from Prime. Comparatively, the second quarter of 2019 reflected $8.5 million of earnings, including $6.5 million from Maui Jim and $2.0 million from Prime. The decline in earnings from Maui Jim is reflective of the shutdown much of the traditional retail sector experienced as a result of the pandemic.
Comprehensive earnings totaled $145.7 million for the second quarter of 2020, compared to $68.3 million of comprehensive earnings for the second quarter of 2019. Other comprehensive earnings primarily included after-tax unrealized gains and losses from the fixed income portfolio. The second quarter’s $53.6 million of other comprehensive earnings was due to declines in interest rates, which increased the market value of the portfolio. This compares to $27.9 million of other comprehensive earnings for the same period in 2019.
Premiums
Gross premiums written for the Group increased $3.9 million for the second quarter of 2020 when compared to the same period of 2019. Rate increases across the property and casualty portfolios were the largest influence on growth. Net premiums earned increased $1.2 million, also driven by products in the property segment.
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Gross Premiums Written | Net Premiums Earned | |||||||||||||||||||
For the Three-Month Periods Ended June 30, | For the Three-Month Periods Ended June 30, | |||||||||||||||||||
(in thousands) | 2020 |
| 2019 | % Change |
| 2020 |
| 2019 | % Change | |||||||||||
Casualty | ||||||||||||||||||||
Commercial excess and personal umbrella | $ | 59,943 | $ | 49,427 | 21 | % | $ | 42,321 | $ | 34,340 | 23 | % | ||||||||
General liability | 26,666 | 32,030 | (17) | % | 22,651 | 25,347 | (11) | % | ||||||||||||
Commercial transportation | 18,874 | 30,712 | (39) | % | 11,139 | 20,508 | (46) | % | ||||||||||||
Professional services | 24,469 | 23,958 | 2 | % | 21,384 | 19,275 | 11 | % | ||||||||||||
Small commercial | 17,140 | 16,244 | 6 | % | 15,791 | 13,315 | 19 | % | ||||||||||||
Executive products | 27,012 | 22,100 | 22 | % | 6,975 | 6,381 | 9 | % | ||||||||||||
Other casualty | 15,943 | 14,652 | 9 | % | 14,954 | 19,178 | (22) | % | ||||||||||||
Total | $ | 190,047 | $ | 189,123 | 0 | % | $ | 135,215 | $ | 138,344 | (2) | % | ||||||||
Property | ||||||||||||||||||||
Marine | $ | 25,814 | $ | 24,070 | 7 | % | $ | 20,712 | $ | 18,579 | 11 | % | ||||||||
Commercial property | 37,311 | 33,900 | 10 | % | 19,048 | 16,275 | 17 | % | ||||||||||||
Specialty personal | 5,305 | 5,878 | (10) | % | 4,936 | 4,792 | 3 | % | ||||||||||||
Other property | 856 | 512 | 67 | % | 691 | 326 | 112 | % | ||||||||||||
Total | $ | 69,286 | $ | 64,360 | 8 | % | $ | 45,387 | $ | 39,972 | 14 | % | ||||||||
Surety | ||||||||||||||||||||
Commercial | $ | 9,622 | $ | 10,569 | (9) | % | $ | 10,806 | $ | 10,975 | (2) | % | ||||||||
Miscellaneous | 10,312 | 10,572 | (2) | % | 10,499 | 11,280 | (7) | % | ||||||||||||
Contract | 7,886 | 8,647 | (9) | % | 6,827 | 6,970 | (2) | % | ||||||||||||
Total | $ | 27,820 | $ | 29,788 | (7) | % | $ | 28,132 | $ | 29,225 | (4) | % | ||||||||
Grand Total | $ | 287,153 | $ | 283,271 | 1 | % | $ | 208,734 | $ | 207,541 | 1 | % | ||||||||
Casualty
Gross premiums written for the casualty segment were up $0.9 million in the second quarter of 2020. Premiums from commercial excess and personal umbrella increased $10.5 million, due to an expanded distribution base in personal umbrella, which supplemented rate increases. Substantial rate increases led to a 22 percent increase for our executive products group.
Transportation continues to be significantly affected by the stay at home orders associated with COVID-19. This is particularly impactful on our public transportation book that has a focus on charter or city buses, which stopped running to a large degree in March. A slowdown or suspension of construction activity in certain parts of the country also led to the decline in general liability.
Property
Gross premiums written for the property segment totaled $69.3 million for the second quarter of 2020, up $4.9 million from the same period last year. Our commercial property business was up $3.4 million, as rates on wind-prone and earthquake exposures continued to increase. Market disruption created new business opportunities and led to $1.7 million of growth for our marine product. Other property premium increased as a result of property exposed GBA business that continues to gain scale.
Surety
The surety segment recorded gross premiums written of $27.8 million for the second quarter of 2020, a decrease of $2.0 million from the same period last year. The surety market remains very competitive. Additionally, the economic downturn, decreased commodity pricing and less regulation has reduced demand for bonds.
Underwriting Income
Underwriting income for the Group totaled $24.2 million for the second quarter of 2020, compared to $14.9 million in the same period last year. Both periods reflect positive underwriting results for the current accident year and favorable reserve
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development on prior accident years, with 2020 experiencing a larger benefit. The combined ratio for the Group totaled 88.4 in the second quarter of 2020, compared to 92.8 in the same period of 2019. The loss ratio decreased to 48.5 from 50.1, due to the increased level of favorable development in 2020. The Group’s expense ratio decreased to 39.9 from 42.7, as 2019 experienced stronger earnings and growth in book value in the six-month period ended June 30, which led to larger levels of bonus and profit-sharing expenses.
For the Three-Month Periods | ||||||
Ended June 30, | ||||||
| 2020 |
| 2019 | |||
Underwriting income (loss) (in thousands) | ||||||
Casualty | $ | 9,733 | $ | 6,939 | ||
Property | 6,167 | (436) | ||||
Surety | 8,263 | 8,429 | ||||
Total | $ | 24,163 | $ | 14,932 | ||
Combined ratio | ||||||
Casualty | 92.8 | 95.0 | ||||
Property | 86.4 | 101.1 | ||||
Surety | 70.6 | 71.2 | ||||
Total | 88.4 | 92.8 | ||||
Casualty
The casualty segment recorded underwriting income of $9.7 million in the second quarter of 2020, compared to $6.9 million for the same period last year. Reserve releases reduced loss and settlement expenses for the casualty segment by $21.1 million, primarily on accident years 2016 through 2018. Transportation, executive products, general liability and professional services were drivers of the favorable development. Partially offsetting these benefits, $4.7 million of current year reserves were established in the second quarter of 2020 for COVID-19 related loss and defense costs. In comparison, $17.5 million of reserves were released in the second quarter of 2019, with nearly every product contributing to the favorable development.
The combined ratio for the casualty segment was 92.8 in 2020, compared to 95.0 in 2019. The segment’s loss ratio was 57.4 in 2020, down from 57.9 in 2019. The loss ratio decreased in 2020 as a result of a shift in mix of business towards products with lower loss booking ratios and more favorable development on prior years’ reserves. The expense ratio for the casualty segment was 35.4, down from 37.1 for the same period last year, as reduced levels of bonus and profit-sharing expenses were incurred.
Property
The property segment recorded underwriting income of $6.2 million for the second quarter of 2020, compared to $0.4 million of underwriting loss for the same period last year. Underwriting results for 2020 included $0.7 million of favorable development on prior years’ loss and catastrophe reserves and $4.8 million of storm and civil unrest losses. Comparatively, the 2019 underwriting results included $0.1 million of adverse development on prior years’ loss and catastrophe reserves and $3.9 million of storm losses.
Underwriting results for the second quarter of 2020 translated into a combined ratio of 86.4, compared to 101.1 for the same period last year. The segment’s loss ratio was 47.5 in 2020, down from 56.5 in 2019 due to the combination of a larger amount of favorable development and decreased current accident year non-catastrophe losses. The segment’s expense ratio decreased to 38.9 in 2020 from 44.6 in the prior year, as increased levels of earned premium allowed the segment to better leverage expenses and reduced levels of bonus and profit-sharing expenses were incurred.
Surety
The surety segment recorded underwriting income of $8.3 million for the second quarter of 2020, compared to $8.4 million for the same period last year. Both periods reflected positive current accident year underwriting performance and benefited from favorable development on prior years’ loss reserves. Results for 2020 and 2019 included favorable development on prior accident years’ loss reserves across all products, which decreased the segment’s loss and settlement expenses by $3.8 million. Additionally, $1.1 million of reserves were established in 2020 for COVID-19 related losses.
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The combined ratio for the surety segment totaled 70.6 for the second quarter of 2020, compared to 71.2 for the same period in 2019. The segment’s loss ratio was 7.1 in 2020, up from 4.1 in 2019 due to the recognition of COVID-19 related losses. The expense ratio was 63.5, down from 67.1 in the prior year as stronger growth in book value led to increased bonus and profit-sharing expenses in 2019.
Investment Income and Realized Capital Gains
Our investment portfolio generated net investment income of $16.9 million during the second quarter of 2020, a decrease of 0.5 percent from that reported for the same period in 2019. The decrease in investment income was largely due to a decline in yields relative to the prior year.
Yields on our fixed income investments for the second quarter of 2020 and 2019 were as follows:
| 2Q 2020 |
| 2Q 2019 | ||
Pretax Yield | |||||
Taxable | 3.17 | % | 3.43 | % | |
Tax-Exempt | 2.70 | % | 2.83 | % | |
After-Tax Yield | |||||
Taxable | 2.50 | % | 2.71 | % | |
Tax-Exempt | 2.56 | % | 2.68 | % |
We recognized $2.1 million of realized losses in the second quarter of 2020, which were comprised of $2.3 million of realized losses on equity securities from rebalancing our portfolio, $0.3 million of realized gains on the fixed income portfolio and $0.1 million of other realized losses. This compares to realized gains of $4.8 million in the second quarter of 2019, which were comprised of $3.9 million of realized gains on the equity portfolio, $0.7 million of realized gains on the fixed income portfolio and $0.2 million of other realized gains.
Income Taxes
Our effective tax rate for the second quarter of 2020 was 19.8 percent, compared to 17.1 percent for the same period in 2019. Effective rates are dependent upon components of pretax earnings or losses and the related tax effects. The effective rate was higher for the second quarter of 2020 due to higher levels of pre-tax earnings and lower levels of tax-favored adjustments compared to 2019.
LIQUIDITY AND CAPITAL RESOURCES
We have three primary types of cash flows: (1) cash flows from operating activities, which consist mainly of cash generated by our underwriting operations and income earned on our investment portfolio, (2) cash flows from investing activities related to the purchase, sale and maturity of investments, and (3) cash flows from financing activities that impact our capital structure, such as shareholder dividend payments and changes in debt and shares outstanding.
The following table summarizes cash flows provided by (used in) our activities for the six-month periods ended June 30, 2020 and 2019:
(in thousands) |
| 2020 |
| 2019 | ||
Operating cash flows | $ | 83,773 | $ | 105,347 | ||
Investing cash flows | (26,666) | (100,654) | ||||
Financing cash flows | (18,513) | (9,999) | ||||
Total | $ | 38,594 | $ | (5,306) | ||
Our largest source of cash is premiums received from customers and our largest cash outflow is claim payments on insured losses. Cash flows from operating activities can vary among periods due to the timing in which these payments are made or received. Operating cash flows in the first half of 2020 were impacted by increased levels of loss and settlement expense payments relative to the first six months of 2019. Additionally, improved financial performance in 2019 resulted in a higher level of bonus and profit-sharing contributions that were paid in the first quarter of 2020, which also reduced operating cash flows in 2020.
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We have $149.4 million in debt outstanding. On October 2, 2013, we completed a public debt offering, issuing $150.0 million in senior notes maturing September 15, 2023 (a 10-year maturity), and paying interest semi-annually at the rate of 4.875 percent per annum. The notes were issued at a discount resulting in proceeds, net of discount and commission, of $148.6 million. The estimated fair value for the senior note at June 30, 2020 was $162.7 million. The fair value of our debt is estimated based on the limited observable prices that reflect thinly traded securities.
As of June 30, 2020, we had cash and other investments maturing within one year of approximately $160.7 million and an additional $496.0 million maturing between one to five years. Whereas our strategy is to be fully invested at all times, short-term investments in excess of demand deposit balances are considered a component of investment activities, and thus are classified as investments in our consolidated balance sheets.
We also maintain a revolving line of credit with Bank of Montreal, Chicago Branch, which permits us to borrow up to an aggregate principal amount of $60.0 million. This facility was entered into during the first quarter of 2020 and replaced the previous $50.0 million facility with JP Morgan Chase Bank N.A., which was set to expire on May 24, 2020. Under certain conditions, the line may be increased up to an aggregate principal amount of $120.0 million. The facility has a three-year term that expires on March 27, 2023. As of and during the three-month period ended June 30, 2020, no amounts were outstanding on either facility.
Additionally, two of our insurance companies, RLI Ins. and Mt. Hawley, are members of the Federal Home Loan Bank of Chicago (FHLBC). Membership in the Federal Home Loan Bank System provides both companies access to an additional source of liquidity via a secured lending facility. Our membership allows each insurance subsidiary to determine tenor and structure at the time of borrowing. As of and during the six-month period ended June 30, 2020, there were no outstanding borrowing amounts with the FHLBC.
We believe that cash generated by operations and investments will provide sufficient sources of liquidity to meet our anticipated needs over the next 12 to 24 months. In the event they are not sufficient, we believe cash available from financing activities and other sources will provide sufficient additional liquidity.
We have not had any liquidity issues affecting our operations as we have sufficient cash flow to support operations. In addition to our bank credit facility and FHLBC membership, our highly liquid investment portfolio provides an additional source of liquidity.
We maintain a diversified investment portfolio representing policyholder funds that have not yet been paid out as claims, as well as the capital we hold for our shareholders. Invested assets at June 30, 2020 have increased $85.2 million from December 31, 2019. As of June 30, 2020, our investment portfolio had the following asset allocation breakdown:
Portfolio Allocation | |||||||||||||
(in thousands) | |||||||||||||
Cost or | Fair | Unrealized | % of Total | ||||||||||
Asset class |
| Amortized Cost |
| Value |
| Gain/(Loss) |
| Fair Value |
| Quality* | |||
U.S. government | $ | 171,174 | $ | 186,838 | $ | 15,664 | 7.1 | % | AAA | ||||
U.S. agency | 27,913 | 32,091 | 4,178 | 1.2 | % | AAA | |||||||
Non-U.S. govt. & agency | 7,316 | 7,692 | 376 | 0.3 | % | BBB | |||||||
Agency MBS | 388,036 | 409,167 | 21,131 | 15.5 | % | AAA | |||||||
ABS/CMBS** | 214,548 | 218,507 | 3,959 | 8.2 | % | AA+ | |||||||
Corporate | 717,748 | 765,125 | 47,377 | 28.9 | % | BBB+ | |||||||
Municipal | 429,402 | 455,673 | 26,271 | 17.2 | % | AA | |||||||
Total Fixed Income | $ | 1,956,137 | $ | 2,075,093 | $ | 118,956 | 78.4 | % | AA- | ||||
Equity | 270,987 | 422,198 | 151,211 | 16.0 | % | ||||||||
Other Invested Assets | 72,291 | 63,440 | (8,851) | 2.4 | % | ||||||||
Cash | 84,797 | 84,797 | — | 3.2 | % | ||||||||
Total Portfolio | $ | 2,384,212 | $ | 2,645,528 | $ | 261,316 | 100.0 | % | |||||
*Quality ratings provided by Moody’s, S&P and Fitch
**Asset-backed and commercial mortgage-backed securities
Quality is an average of each bond’s credit rating, adjusted for its relative weighting in the portfolio. As of June 30, 2020, our fixed income portfolio had the following rating distribution:
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AAA |
| 45.9 | % |
AA | 17.9 | % | |
A | 20.4 | % | |
BBB | 9.3 | % | |
BB | 3.2 | % | |
B | 2.4 | % | |
CCC | 0.3 | % | |
NR | 0.6 | % | |
Total | 100.0 | % |
As of June 30, 2020, the duration of the fixed income portfolio was 4.6 years. Our fixed income portfolio remained well diversified, with 1,288 individual issues.
Our investment portfolio has limited exposure to structured asset-backed securities. As of June 30, 2020, we had $137.9 million in ABS which are pools of assets collateralized by cash flows from several types of loans, including home equity, credit cards, autos and structured bank loans in the form of collateralized loan obligations (CLOs).
As of June 30, 2020, we had $80.6 million in commercial mortgage backed securities and $409.2 million in mortgage backed securities backed by government sponsored enterprises (GSEs - Freddie Mac, Fannie Mae and Ginnie Mae). Excluding the GSE backed MBS, our exposure to ABS and CMBS was 8.2 percent of our investment portfolio at quarter end.
We had $765.1 million in corporate fixed income securities as of June 30, 2020, which includes $98.2 million invested in a high yield credit strategy. This high-yield portfolio consists of floating rate bank loans and bonds that are below investment grade in credit quality and offer incremental yield over our core fixed income portfolio.
We also maintain an allocation to municipal fixed income securities. As of June 30, 2020, we had $455.7 million in municipal securities. The municipal portfolio includes approximately 73 percent tax-exempt securities and 27 percent taxable securities. Approximately 86 percent of our municipal bond portfolio maintains an ‘AA’ or better rating, while 99 percent of the municipal bond portfolio is rated ‘A’ or better.
Our equity portfolio had a fair value of $422.2 million as of June 30, 2020 and is also a source of liquidity. The securities within the equity portfolio remain primarily invested in large-cap issues with a focus on dividend income. In the equity portfolio, the strategy remains one of value investing, with security selection taking precedence over market timing.
As of June 30, 2020, our equity portfolio had a dividend yield of 2.1 percent, compared to 1.9 percent for the S&P 500 index. Because of the corporate dividend-received-deduction applicable to our dividend income, we pay an effective tax rate of 13.1 percent on dividends, compared to 21.0 percent on taxable interest and 5.3 percent on municipal bond interest income. The equity portfolio is managed in a diversified and granular manner, with 221 individual securities and three ETF positions. No single stock exposure is greater than 2 percent of the equity portfolio.
We had $63.4 million of other invested assets at June 30, 2020, including investments in low income housing tax credit partnerships, membership in the FHLBC, investments in private funds and investments in restricted stock. As of June 30, 2020, $14.6 million of investments were pledged as collateral with the FHLBC to ensure timely access to the secured lending facility that ownership of FHLBC stock provides. As of and during the six-month period ending June 30, 2020, there were no outstanding borrowings with the FHLBC.
Our investment portfolio does not have any exposure to derivatives.
Our capital structure is comprised of equity and debt outstanding. As of June 30, 2020, our capital structure consisted of $149.4 million in 10-year maturity senior notes maturing in 2023 (debt) and $1.1 billion of shareholders’ equity. Debt outstanding comprised 12.4 percent of total capital as of June 30, 2020. Interest and fees on debt obligations totaled $3.8 million during the first six months of 2020, compared to $3.7 million during the same period in 2019. We have incurred interest expense on debt at an average annual interest rate of 4.91 percent for the three-month periods ended June 30, 2020 and 2019.
We paid a regular quarterly cash dividend of $0.24 per share on June 19, 2020, a $0.01 increase over the prior quarter. We have increased dividends in each of the last 45 years.
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Our three insurance subsidiaries are subsidiaries of RLI Corp, with RLI Ins. as the first-level, or principal, insurance subsidiary. At the holding company (RLI Corp.) level, we rely largely on dividends from our insurance company subsidiaries to meet our obligations for paying principal and interest on outstanding debt, corporate expenses and dividends to RLI Corp. shareholders. As discussed further below, dividend payments to RLI Corp. from our principal insurance subsidiary are restricted by state insurance laws as to the amount that may be paid without prior approval of the insurance regulatory authorities of Illinois. As a result, we may not be able to receive dividends from such subsidiary at times and in amounts necessary to pay desired dividends to RLI Corp. shareholders. On a GAAP basis, as of June 30, 2020, our holding company had $1.1 billion in equity. This includes amounts related to the equity of our insurance subsidiaries, which is subject to regulatory restrictions under state insurance laws. The unrestricted portion of holding company net assets is comprised primarily of investments and cash, including $43.4 million in liquid assets, which would cover the majority of our annual holding company expenditures. Unrestricted funds at the holding company are available to fund debt interest, general corporate obligations and dividend payments to our shareholders. If necessary, the holding company also has other potential sources of liquidity that could provide for additional funding to meet corporate obligations or pay shareholder dividends, which include a revolving line of credit, as well as access to capital markets.
Ordinary dividends, which may be paid by our principal insurance subsidiary without prior regulatory approval, are subject to certain limitations based upon statutory income, surplus and earned surplus. The maximum ordinary dividend distribution from our principal insurance subsidiary in a rolling 12-month period is limited by Illinois law to the greater of 10 percent of RLI Ins. policyholder surplus, as of December 31 of the preceding year, or the net income of RLI Ins. for the 12-month period ending December 31 of the preceding year. Ordinary dividends are further restricted by the requirement that they be paid from earned surplus. Any dividend distribution in excess of the ordinary dividend limits is deemed extraordinary and requires prior approval from the Illinois Department of Insurance (IDOI). In the first six months of 2020, RLI Ins. paid $22.0 million in ordinary dividends to RLI Corp. In 2019, our principal insurance subsidiary paid ordinary dividends totaling $59.0 million. As of June 30, 2020, $43.3 million of the net assets of our principal insurance subsidiary were not restricted and could be distributed to RLI Corp. as ordinary dividends without prior approval from the IDOI. Because the limitations are based upon a rolling 12-month period, the amount and impact of these restrictions vary over time. In addition to restrictions from our principal subsidiary’s insurance regulator, we also consider internal models and how capital adequacy is defined by our rating agencies in determining amounts available for distribution.
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 currency exchange rates and commodity prices. Historically, our primary market risks have been equity price risk associated with investments in equity securities and interest rate risk associated with investments in fixed maturities. We have limited exposure to both foreign currency risk and commodity risk.
Credit risk is the potential loss resulting from adverse changes in an issuer’s ability to repay its debt obligations. We monitor our portfolio to ensure that credit risk does not exceed prudent levels. We have consistently invested in high credit quality, investment grade securities. Our fixed maturity portfolio has an average rating of AA-, with 84 percent rated A or better by at least two nationally recognized rating organizations.
On an overall basis, our exposure to market risk has not significantly changed from that reported in our 2019 Annual Report on Form 10-K. The COVID-19 pandemic does present new and emerging uncertainty to the financial markets. See further discussion in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Part II, Item 1A., Risk Factors, of this Quarterly Report on Form 10-Q.
ITEM 4. Controls and Procedures
We maintain a system of controls and procedures designed to provide reasonable assurance as to the reliability of the financial statements and other disclosures included in this report, as well as to safeguard assets from unauthorized use or disposition. An evaluation of the effectiveness of the design and operation of our disclosure controls and procedures was performed, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective, as of the end of the period covered by this report.
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In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objective, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. We believe that our disclosure controls and procedures provide such reasonable assurance.
No changes were made to our internal control over financial reporting during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. | Legal Proceedings – There were no material changes to report. |
Item 1A. | Risk Factors |
There have been no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, as updated in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2020.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds - |
Items 2(a) and (b) are not applicable.
In 2010, our Board of Directors implemented a $100 million share repurchase program. We did not repurchase any shares during 2020. We have $87.5 million of remaining capacity from the repurchase program. The repurchase program may be suspended or discontinued at any time without prior notice.
Item 3. | Defaults Upon Senior Securities - Not Applicable. | |
Item 4. | Mine Safety Disclosures - Not Applicable. | |
Item 5. | Other Information - Not Applicable. | |
Item 6. | Exhibits | ||||||||
Exhibit No. | Description of Document | Reference | |||||||
3.1 | Incorporated by reference to the Company’s Current Report on Form 8-K filed May 8, 2020. | ||||||||
10.1 | Attached as Exhibit 10.1. | ||||||||
10.2 | Attached as Exhibit 10.2. | ||||||||
31.1 | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | Attached as Exhibit 31.1. | |||||||
31.2 | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | Attached as Exhibit 31.2. | |||||||
32.1 | Attached as Exhibit 32.1. | ||||||||
32.2 | Attached as Exhibit 32.2. | ||||||||
101 | iXBRL-Related Documents | Attached as Exhibit 101. | |||||||
104 | Cover Page Interactive Data File | Embedded in Inline XBRL and contained in Exhibit 101. | |||||||
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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/ Todd W. Bryant | |
Todd W. Bryant | |
Vice President, Chief Financial Officer | |
(Principal Financial and Chief Accounting Officer) | |
Date: July 24, 2020 |
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