10-Q

QuickLinks -- Click here to rapidly navigate through this document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
ý	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2002
or
o	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                              to

Commission File Number: 0-6612

RLI Corp.
(Exact name of registrant as specified in its charter)

ILLINOIS (State or other jurisdiction of incorporation or organization)	37-0889946 (I.R.S. Employer Identification Number)
9025 North Lindbergh Drive, Peoria, IL (Address of principal executive offices)	61615 (Zip Code)
(309) 692-1000 (Registrant's telephone number, including area code)

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý    No o

APPLICABLE ONLY TO CORPORATE ISSUERS:

        As of October 25, 2002 the number of shares outstanding of the registrant's Common Stock was 19,875,631.

PART I—FINANCIAL INFORMATION

Item 1.    Financial Statements

RLI Corp. & Subsidiaries
Condensed Consolidated Statement of Earnings and Comprehensive Earnings

		For the Three-Month Period Ended September 30,
(Unaudited)
		2002			2001
Net premiums earned		$	91,639,002		$	69,827,121
Net investment income			9,401,086			8,643,706
Net realized investment gains (loss)			(6,636,108	)		1,528,364
			94,403,980			79,999,191
Losses and settlement expenses			53,992,262			39,925,768
Policy acquisition costs			27,804,288			23,622,742
Insurance operating expenses			5,426,266			4,840,003
Interest expense on debt			456,651			676,497
General corporate expenses			693,998			647,932
			88,373,465			69,712,942
Equity in earnings of uncons. Investee			1,127,566			469,434
Earnings before income taxes & cumulative effect			7,158,081			10,755,683
Income tax expense			1,517,907			2,856,498
Earnings before cumulative effect			5,640,174			7,899,185
Cumulative effect of initial adoption of SFAS 133			0			0
Net earnings		$	5,640,174		$	7,899,185
Other compre. earnings (loss), net of tax			(19,089,011	)		(14,698,728	)
Comprehensive earnings (loss)		$	(13,448,837	)	$	(6,799,543	)
Earnings per share:
	Basic:
	Basic earnings per share before cumulative effect	$	0.28		$	0.40
	Cumulative effect of SFAS 133 adoption	$	0.00		$	0.00
	Basic net earnings per share	$	0.28		$	0.40
	Basic compre. earnings (loss) per share	$	(0.68	)	$	(0.35	)
	Diluted:
	Diluted earnings per share before cumulative effect	$	0.28		$	0.39
	Cumulative effect of SFAS 133 adoption	$	0.00		$	0.00
	Diluted net earnings per share	$	0.28		$	0.39
	Diluted compre. earnings (loss) per share		*			*
Weighted average number of common shares outstanding
	Basic		19,868,315			19,633,518
	Diluted		20,466,885			20,033,640
Cash dividends declared per common share		$	0.09		$	0.08

*

The impact of common stock equivalents was antidilutive.

The accompanying notes are an integral part of the financial statements.

2

RLI Corp. & Subsidiaries
Condensed Consolidated Statement of Earnings and Comprehensive Earnings

		For the Nine-Month Period Ended September 30,
(Unaudited)
		2002			2001
Net premiums earned		$	247,427,375		$	199,753,331
Net investment income			28,057,979			23,804,965
Net realized investment gains (loss)			(3,772,542	)		3,477,569
			271,712,812			227,035,865
Losses and settlement expenses			144,463,119			114,538,499
Policy acquisition costs			75,757,707			65,928,292
Insurance operating expenses			17,624,660			14,143,281
Interest expense on debt			1,361,660			2,689,933
General corporate expenses			2,612,882			2,069,261
			241,820,028			199,369,266
Equity in earnings of uncons. investee			3,566,907			2,745,210
Earnings before income taxes & cumulative effect			33,459,691			30,411,809
Income tax expense			8,760,993			7,975,286
Earnings before cumulative effect			24,698,698			22,436,523
Cumulative effect of initial adoption of SFAS 133			0			800,415
Net earnings		$	24,698,698		$	23,236,938
Other compre. earnings (loss), net of tax			(32,032,857	)		(25,962,587	)
Comprehensive earnings		$	(7,334,159	)	$	(2,725,649	)
Earnings per share:
	Basic:
	Basic earnings per share before cumulative effect	$	1.24		$	1.14
	Cumulative effect of SFAS 133 adoption	$	0.00		$	0.04
	Basic net earnings per share	$	1.24		$	1.18
	Basic compre. earnings (loss) per share	$	(0.37	)	$	(0.14	)
	Diluted:
	Diluted earnings per share before cumulative effect	$	1.21		$	1.12
	Cumulative effect of SFAS 133 adoption	$	0.00		$	0.04
	Diluted net earnings per share	$	1.21		$	1.16
	Diluted compre. earnings (loss) per share		*		$	(0.14	)
Weighted average number of common shares outstanding
	Basic		19,852,123			19,627,994
	Diluted		20,425,765			20,009,952
Cash dividends declared per common share		$	0.26		$	0.24

*

The impact of common stock equivalents was antidilutive.

The accompanying notes are an integral part of the financial statements.

3

RLI Corp. and Subsidiaries
Condensed Consolidated Balance Sheet

				September 30, 2002			December 31, 2001
				(Unaudited)
ASSETS
Investments
	Fixed maturities
		Held-to-maturity, at amortized cost		$	240,131,061		$	263,029,279
		Trading, at fair value			8,468,262			7,568,299
		Available-for-sale, at fair value			309,851,790			191,675,513
	Equity securities, at fair value				213,408,571			277,621,467
	Short-term investments, at cost				95,716,728			53,648,406
	Total investments				867,576,412			793,542,964
Accrued investment income					7,939,034			7,869,914
Premiums and reinsurance balances receivable					125,698,915			105,167,722
Ceded unearned premium					103,779,049			66,626,272
Reinsurance balances recoverable on unpaid losses					332,677,947			277,255,399
Deferred policy acquisition costs					58,441,560			52,871,630
Property and equipment					18,175,572			18,438,338
Investment in unconsolidated investee					24,305,618			20,892,696
Goodwill					28,928,955			28,458,957
Other assets					17,462,606			19,845,891
			TOTAL ASSETS	$	1,584,985,668		$	1,390,969,783
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
	Unpaid losses and settlement expenses			$	704,334,242		$	604,505,055
	Unearned premiums				349,636,132			256,449,724
	Reinsurance balances payable				80,168,307			58,438,042
	Short-term debt, LOC and notes payable				87,416,250			77,239,125
	Income Taxes—current				802,196			1,115,618
	Income taxes—deferred				21,631,593			43,151,188
	Other liabilities				17,778,258			14,639,233
			TOTAL LIABILITIES		1,261,766,978			1,055,537,985
Shareholders' Equity:
	Common stock ($1 par value)
	(12,834,675 pre-split, 25,669,350 post-split shares issued at 9/30/02)
	(12,820,727 shares issued at 12/31/01)				12,834,675			12,820,727
Paid-In Capital					73,306,981			73,181,415
Accumulated other comprehensive earnings					61,442,757			93,475,614
Retained Earnings					256,640,960			237,006,454
Deferred compensation					5,440,714			6,039,586
Less: Treasury shares at cost
	(2,898,758 pre-split, 5,797,516 post-split shares at 9/30/02)
	(2,908,131 shares at 12/31/01)				(86,447,397	)		(87,091,998	)
			TOTAL SHAREHOLDERS' EQUITY		323,218,690			335,431,798
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY				$	1,584,985,668		$	1,390,969,783

The accompanying notes are an integral part of the financial statements.

4

RLI Corp. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)

		For the Nine-Month Period Ended September 30,
		2002			2001
Net cash provided by operating activities		$	120,843,001		$	54,908,195
Cash Flows from Investing Activities
	Investments purchased		(179,999,399	)		(148,322,748	)
	Issuance of note receivable		500,000			0
	Investments sold		57,642,603			57,113,582
	Investments called or matured		39,588,627			55,350,918
	Net increase in short-term investments		(42,354,048	)		(826,112	)
	Net property and equipment purchased		(2,433,909	)		(1,543,381	)
Net cash used in investing activities			(127,056,126	)		(38,227,741	)
Cash Flows from Financing Activities
	Cash dividends paid		(4,861,747	)		(4,513,041	)
	Proceeds from issuance of notes payable		10,940,000			0
	Payments on debt		(762,875	)		(12,379,195	)
	Change in contributed capital		416,969			334,678
	Treasury shares reissued		480,778			0
	Treasury shares purchased		0			(122,896	)
Net cash used in financing activities			6,213,125			(16,680,454	)
Net increase in cash			0			0
Cash at the beginning of the year			0			0
Cash at September 30		$	0		$	0

The accompanying notes are an integral part of the financial statements.

5

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

        1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES    The financial information is prepared in conformity with accounting principles generally accepted in the United States of America, and such principles are applied on a basis consistent with those reflected in the 2001 annual report filed with the Securities and Exchange Commission. Management has prepared the financial information included herein without audit by independent certified public accountants. The condensed consolidated balance sheet as of December 31, 2001 has been derived from, and does not include all the disclosures contained in, the audited consolidated financial statements for the year ended December 31, 2001.

        The information furnished includes all adjustments and normal recurring accrual adjustments, which are, in the opinion of management, necessary for a fair statement of results for the interim periods. Results of operations for the nine-month periods ended September 30, 2002 and 2001 are not necessarily indicative of the results of a full year.

        The accompanying financial data should be read in conjunction with the notes to the financial statements contained in the 2001 Annual Report on Form 10-K.

        Earnings Per Share:    Basic earnings per share (EPS) excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the dilution that could occur if securities or other contracts to issue common stock (common stock equivalents) were exercised or converted into common stock. When inclusion of common stock equivalents increases the earnings per share or reduces the loss per share, the effect on earnings is antidilutive. Under these circumstances, the diluted net earnings or net loss per share is computed excluding the common stock equivalents.

        Additionally, on October 15, 2002, the Company's stock split on a 2-for-1 basis. All earnings per share data has been retroactively stated to reflect this split. Reference to common stock activity, before the distribution of the related stock split, has not been restated.

        Pursuant to disclosure requirements contained in Statement 128, "Earnings Per Share," the following represents a reconciliation of the numerator and denominator of the basic and diluted EPS computations contained in the financial statements.

6

	For the Nine-Month Period Ended September 30, 2002
	Income (Numerator)		Shares (Denominator)	Per Share Amount
Basic EPS
Income available to common stockholders	$	24,698,698	19,852,123	$	1.24
Effect of Dilutive Securities
Incentive Stock Options		—	573,642
Diluted EPS
Income available to common stockholders	$	24,698,698	20,425,765	$	1.21

	For the Nine-Month Period Ended September 30, 2001
	Income (Numerator)		Shares (Denominator)	Per Share Amount
Basic EPS
Income available to common stockholders	$	23,236,938	19,627,994	$	1.18
Effect of Dilutive Securities
Incentive Stock Options		—	381,958
Diluted EPS
Income available to common stockholders	$	23,236,938	20,009,952	$	1.16

        Other Accounting Standards:    In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133 addresses the accounting for and disclosure of derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. SFAS 133 standardizes the accounting for derivative instruments by requiring that an entity recognize those items as assets or liabilities in the statement of financial position and measure them at fair value. SFAS 133, as amended by SFAS 137 and 138, was effective for all fiscal quarters of fiscal years beginning after June 15, 2000.

        In March 2001, the FASB adopted the guidance set forth in Derivatives Implementation Group (DIG) Issue A17, "Contracts That Provide for Net Share Settlement." Based on this guidance, the Company determined that stock warrants received in conjunction with the purchase of a note receivable qualify as derivatives under SFAS 133. Therefore, in accordance with the transition provisions of SFAS 133, the Company accounted for these warrants as derivatives effective April 1, 2001. The warrants were marked to fair value, as of April 1, 2001, with a cumulative- effect adjustment of $800,415, net of

7

tax. The change in fair value of this instrument from April 1 to September 30, 2001 totaled $1.0 million and was recorded through the statement of earnings as net investment income.

        During the first nine months of 2002, the Company recorded $1.6 million in net investment income to recognize the current period change in the fair value of these stock warrants.

        In July 2001, the FASB issued SFAS 141 "Business Combinations," effective for all business combinations initiated after June 30, 2001, and SFAS 142 "Accounting for Goodwill and Other Intangible Assets, " effective for fiscal years beginning after December 15, 2001. The Company adopted the provisions of these Statements. SFAS 141 requires the purchase method of accounting be used for all business combinations. Goodwill and indefinite lived intangible assets will remain on the balance sheet and not be amortized. Intangible assets with a definite life will continue to be amortized over their estimated useful lives. SFAS 142 establishes a new method of testing goodwill for impairment. On an annual basis, and when there is reason to suspect that their values may have been diminished or impaired, these assets must be tested for impairment. The amount of goodwill determined to be impaired will be expensed to current operations.

        Amortization of intangible assets was $366,000 in the first nine months of 2002 compared to $1.6 million for the same period last year. This decrease is the result of no longer amortizing goodwill, subsequent to the adoption of SFAS 142. Intangible assets that continue to be amortized under SFAS 142 relate to the Company's purchase of customer-related and marketing-related intangibles. These intangibles have useful lives ranging from 5 to 10 years. Amortization expense on the intangible assets is estimated to be $500,000 for each of the next five years. At September 30, 2002, net intangible assets totaled $2.0 million, net of $2.3 million of accumulated amortization, and are included in other assets. At December 31, 2001 net intangible assets totaled $2.4 million, net of $1.9 million of accumulated amortization.

        Goodwill, which is no longer amortized, is broken out separately on the balance sheet and totals $28.9 million at September 30, 2002, compared to $28.5 million at December 31, 2001. During the first quarter of 2002, the Company paid $470,000 for increased ownership in an investment accounted for under the equity method. This payment was recorded as goodwill. Goodwill relates to the Company's surety segment. Impairment testing was performed during the second quarter of 2002, pursuant to the requirements of SFAS 142. Based upon this valuation analysis, goodwill does not appear to be impaired. Impairment testing will continue to be performed on an annual basis, or when there is reason to suspect the value of these assets has diminished or is impaired. Below is a calculation of the pro forma effects of eliminating the amortization of goodwill for the nine months and three months ended September 30, 2001 and 2002, and for each of the years in the three-year period ended December 31, 2001.

8

		For the Nine-Month Period Ended September 30,
		2002		2001
Net income, as originally reported		$	24,698,698	$	23,236,938
Add back: goodwill amortization			—		1,266,705
Adjusted net income			24,698,698		24,503,643
Basic earnings per share:
	As originally reported	$	1.24	$	1.18
	Add back: goodwill amortization		—		0.06
	As adjusted		1.24		1.24
Diluted earnings per share:
	As originally reported	$	1.21	$	1.16
	Add back: goodwill amortization		—		0.06
	As adjusted		1.21		1.22

		For the Three-Month Period Ended September 30,
		2002		2001
Net income, as originally reported		$	5,640,174	$	7,899,185
Add back: goodwill amortization			—		422,235
Adjusted net income			5,640,174		8,321,420
Basic earnings per share:
	As originally reported	$	0.28	$	0.40
	Add back: goodwill amortization		—		0.02
	As adjusted		0.28		0.42
Diluted earnings per share:
	As originally reported	$	0.28	$	0.39
	Add back: goodwill amortization		—		0.02
	As adjusted		0.28		0.41

		For the Twelve-Month Periods Ended December 31,
		2001		2000		1999
Net income, as originally reported		$	31,046,612	$	28,692,419	$	31,451,052
Add back: goodwill amortization			1,691,568		1,663,055		1,524,428
Adjusted net income			32,738,180		30,355,474		32,975,480
Basic earnings per share:
	As originally reported	$	1.58	$	1.46	$	1.55
	Add back: goodwill amortization		0.09		0.08		0.08
	As adjusted		1.67		1.54		1.63
Diluted earnings per share:
	As originally reported	$	1.55	$	1.44	$	1.54
	Add back: goodwill amortization		0.08		0.08		0.07
	As adjusted		1.63		1.52		1.61

9

        In August 2001, the FASB issued SFAS 143, 'Accounting for Asset Retirement Obligations," which becomes effective for fiscal years beginning after June 15, 2002. SFAS 143 addresses the financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs.

        In October 2001, the FASB issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" which supersedes SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and the accounting and reporting provisions of APB 30, "Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" for the disposal of a segment of a business. SFAS 144 retains many of the fundamental provisions of SFAS 121, but resolves certain implementation issues associated with that Statement. SFAS 144 is effective for fiscal years beginning after December 15, 2001.

        In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No. 4, 44, 64, Amendment of FASB Statement 13, Technical Corrections." This Statement will rescind FASB Statements 4, 44, and 64, amend FASB Statement 13, and make certain technical corrections. The rescission of Statements 4 and 64 will affect income statement classification of gains and losses from extinguishment of debt. SFAS 145 is effective for financial statements issued on or after May 15, 2002.

        In April 2002, the FASB issued SFAS 146, "Accounting For Costs Associated With Exit or Disposal Activities." This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." Under SFAS 146, a commitment to an exit or disposal plan no longer will be a sufficient basis for recording a liability for those activities. SFAS 146 is effective for exit or disposal activities that are initiated after December 15, 2002.

        The provisions of SFAS 143, 144, 145, and 146 are not anticipated to have a material impact on the Company's consolidated financial statements.

10

        2. INDUSTRY SEGMENT INFORMATION    Selected information by industry segment for the nine months ended September 30, 2002 and 2001 is presented below.

	EARNINGS						REVENUES
SEGMENT DATA—(in thousands)
	2002			2001			2002			2001
Property	$	13,986		$	4,638		$	64,555		$	52,110
Casualty		(889	)		(2,024	)		145,418			115,111
Surety		(3,515	)		2,529			37,454			32,532
Net investment income		28,058			23,805			28,058			23,805
Realized gains (loss)		(3,773	)		3,478			(3,773	)		3,478
General corporate expense and interest on debt		(3,974	)		(4,759	)
Equity in earnings of unconsolidated investee		3,567			2,745
Total segment earnings before income taxes and cumulative effect	$	33,460		$	30,412
Income taxes		8,761			7,975
Earnings before cumulative effect		24,699			22,437
Cumulative effect of initial adoption of SFAS 133		0			800
Total	$	24,699		$	23,237		$	271,712		$	227,036

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

        "SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995: This discussion and analysis may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 which are not historical facts, and involve risks and uncertainties that could cause actual results to differ materially from those expected and projected. Various risk factors that could affect future results are listed in the Company's filings with the Securities Exchange Commission, including the Form 10-K for the year ended December 31, 2001.

OVERVIEW

        RLI Corp. (the Company) is a holding company that underwrites selected property and casualty insurance through its major subsidiaries, collectively known as RLI Insurance Group (the Group). The Group provides specialty property and casualty coverages for primarily commercial risks and accounted for 91% of the Company's total revenue for the first nine months of 2002 compared to 88% for the same period last year.

Critical Accounting Policies

        In preparing the unaudited consolidated financial statements, management is 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 consolidated financial statements and the reported amounts of revenues and expenses for the reporting period. Actual results could differ significantly from those estimates.

11

        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 and deferred acquisition costs.

Unpaid Losses and Settlement Expenses

        The liability for unpaid losses and settlement expenses represents estimates of amounts needed to pay reported and unreported claims and related expenses. The estimates are based on certain actuarial and other assumptions related to the ultimate cost to settle such claims. Such assumptions are subject to occasional changes due to evolving economic, social and political conditions. All estimates are periodically reviewed and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Such adjustments are reflected in the results of operations in the period in which they are determined.

        Historically, the Company has not experienced significant development, favorable or unfavorable, either with the liability in total or within industry segments. Additional information with respect to reserve development patterns for individual calendar year ended liabilities can be found on pages 10 and 12 of our 2001 Annual Report on Form 10K. Adding to the complexities inherent in the reserving process are issues related to coverage, expansion of coverage, and reinsurance program applicability.

        The Company has insignificant exposure to asbestos and environmental policy liabilities, as a result of entering liability lines after the industry had already recognized it as a problem. What exposure does exist is through the Company's commercial umbrella, general liability, and discontinued assumed reinsurance lines of business. The majority of the exposure that does exist is in the excess layers of the Company's commercial umbrella and assumed reinsurance books of business. Although the Company's environmental exposure is limited, management cannot determine the Company's ultimate liability with any reasonable degree of certainty. This ultimate liability is difficult to assess due to evolving legislation on such issues as joint and several liability, retroactive liability, and standards of cleanup. Additionally, the Company participates primarily in the excess layers, making it even more difficult to assess the ultimate impact.

Investment Valuation

        The Company classifies its investments in debt and equity securities with readily determinable fair values into one of three categories: held-to-maturity securities are carried at amortized cost, available-for-sale securities are carried at fair value and trading securities are carried at fair value.

        Management regularly reviews its fixed maturity and equity securities portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. A number of criteria are considered during this process including, but not limited to, the current fair value as compared to amortized cost or cost, as appropriate, of the security, the length of time the security's fair value has been below amortized cost/cost, and by how much, credit ratings, current economic conditions, the horizon over which the recovery of cost is expected, and the Company's decisions to hold or divest of a security.

12

        In addition, we consider certain factors specific to each company that has issued a security, including profitability, leverage, growth, and cash flow. Impairment losses result in a reduction of the cost basis of the underlying investment. Significant changes in the factors from period to period that the Company considers when evaluating investments for impairment losses could result in a significant charge for impairment losses reported in the consolidated financial statements.

Recoverability of Reinsurance Balances

        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 appropriate liabilities, since reinsurance does not relieve the Company of its legal liability to its policyholders. Such balances are subject to the credit risk associated with the individual reinsurer. Additionally, the same uncertainties associated with estimating unpaid losses and settlement expenses impact the estimates for the ceded portion of such liabilities. The Company continually monitors the financial condition of its reinsurers. The Company's policy is to charge to earnings an estimate of unrecoverable amounts from troubled or insolvent reinsurers.

Deferred Policy Acquisition Costs

        We defer commissions, premium taxes and certain other costs that vary with and are primarily related to the acquisition of insurance contracts. These costs are capitalized and charged to expense in proportion to premium revenue recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, anticipated losses and settlement expenses and certain other costs expected to be incurred as the premium is earned. Judgments as to ultimate recoverability of such deferred costs are highly dependent upon estimated future loss costs associated with the premiums written.

NINE MONTHS ENDED SEPTEMBER 30, 2002, COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2001

        Consolidated gross sales, which consist of gross premiums written, net investment income and realized investment gains/losses totaled $559.1 million for the first nine months of 2002 compared to $407.4 million for the same period in 2001. Gross writings of the Group improved 40.7% over 2001 levels fueled by increases in all three business segments. Consolidated net revenue for the first nine months of 2002 increased $44.7 million or 19.7% from the same period in 2001. Net premiums earned increased 23.9%. Net investment income improved 17.9% to $28.1 million. Additionally, the sale of certain securities and the impairment of four equity securities resulted in the recording of $3.8 million in realized losses during the first nine months, compared to realized gains of $3.5 million for the same period last year. In September 2002, the Company recorded $6.5 million of impairment losses on securities whose market value was deemed to be other-than-temporarily impaired. This adjustment was a reclassification from unrealized losses to realized losses and did not impact operating earnings or comprehensive earnings. Further discussion of this adjustment can be found in the section that follows titled Investment Income.

        The net after-tax earnings for the first nine months of 2002 totaled $24.7

13

million, $1.21 per diluted share, compared to $23.2 million, $1.16 per diluted share, for the same period in 2001. 2001 results include the cumulative-effect adjustment for the initial adoption of SFAS 133, which totaled $800,415 ($0.04 per diluted share) in net after-tax earnings. Net operating earnings consist of the Company's net earnings reduced by after-tax realized investment gains/losses and cumulative-effect adjustments. Operating earnings depicts more accurately and comparably the results of the Company's ongoing operations, as the excluded realized gains or losses are typically generated through market and tax strategies not related to the Company's near term operating performance objectives. While this measure may not be comparable to the definition of operating earnings used by all companies, it is quite common in the insurance industry. The Company's net operating earnings totaled $27.1 million, $1.33 per diluted share, compared to $20.2 million, $1.01 per diluted share, for the same period in 2001. Improved underwriting income, particularly on the property book, coupled with growth in investment income and decreased debt costs, favorably impacted 2002 earnings. During the first nine months of 2002, the Company implemented SFAS 142, "Goodwill and Other Intangibles." Under this Statement, intangible assets and goodwill with indefinite lives are no longer amortized, but are instead subject to fair value/impairment testing. Implementation of this Statement has favorably improved 2002 earnings by $1.3 million ($0.06 per diluted share), as a result of decreased amortization expense. Investment income improved during 2002 due to strong cash flow and $1.6 million ($0.05 per diluted share) of investment income recorded from the increase in the fair value of warrants, subject to the provisions of SFAS 133. During the first nine months of 2001, $1.0 million ($0.03 per diluted share) of investment income was recorded for these warrants. Additionally, 2001 results were negatively impacted by losses on the property segment, including Seattle earthquake losses, which totaled just under $1.0 million ($0.03 per diluted share). Although the Company had limited exposure to the September 11 terrorist attack, a $500,000 ($0.02 per share) charge for potential costs associated with this event was recorded in September 2001. Through September 2002, a total of ten claims relating to this event had been received. Eight claims were closed with a total incurred loss of $16,000, primarily loss adjustment related. Two claims remain open and relate to commercial business interruption only. The Company has reserved rights as to whether these claims are covered under the policies. Incurred loss adjustment expense to date on these claims is $64,000. The Company believes the remaining loss reserves are adequate to cover any remaining exposure.

        Comprehensive earnings, which include net earnings plus unrealized gains/losses net of tax, were subject to the volatility in the equity and bond markets. Comprehensive earnings for the first nine months of 2002 totaled a loss of $7.3 million, $.37 per diluted share, compared to a loss of $2.7 million, $.14 per diluted share, for the same period in 2001. Unrealized losses, net of tax, for the first nine months of 2002 were $32.0 million, $1.58 per diluted share compared to losses of $26.0 million, $1.30 per diluted share, for the same period in 2001.

14

RLI INSURANCE GROUP

        Gross written premium for the Group increased to $534.8 million for the first nine months of 2002 compared to $380.1 million for the same period in 2001. Improved pricing across all three business segments and various growth initiatives have positively impacted gross written premium. Underwriting income improved to a pre-tax profit of $9.6 million for the first nine months of 2002 compared to $5.1 million for the same period in 2001. The GAAP combined ratio declined to 96.1 for the first nine months of 2002, compared to 97.4 for the same period in 2001. The property segment was responsible for the majority of the improved results, as loss experience continues to be down significantly from last year. Additionally, the casualty segment recorded improved earnings from last year. The surety segment's results, however, were negatively impacted by national economic conditions that affected contract surety experience and certain commercial surety claims.

        The Group's property segment experienced an increase in gross writings of $37.0 million, or 30%, compared to the same period last year. For the first nine months of 2002, property premiums totaled $160.4 million. Fueled by the improved rate environment, difference-in-condition writings improved $15.7 million over 2001, and fire writings grew by $18.7 million. Additionally, construction writings increased $3.4 million to $31.6 million. Underwriting profit for the property segment was $14.0 million for the first nine months of 2002, compared to $4.6 million in 2001. The GAAP combined ratio decreased to 78.3 compared to 91.1 for the same period last year. Seattle earthquake losses and loss experience on discontinued property classes negatively impacted 2001 results.

        Gross written premiums for the casualty segment were $324.7 million for the first nine months of 2002, up $108.6 million, or 50.3%, from 2001. Growth initiatives and improved pricing contributed to growth in the following products: program business up $60.6 million, general liability up $33.3 million, executive products up $22.7 million, personal umbrella up $5.5 million, and transportation up $5.4 million. Partially offsetting these increases, commercial umbrella declined $19.3 million, due to the re-underwriting of the book. Underwriting loss on the casualty book was $889,000 compared to a loss of $2.0 million for the first nine months 2001. These results translate into a combined ratio of 100.6 in 2002 versus 101.8 for the same period in 2001. The segment's expense ratio at 30.2 has continued to show improvement, as premium volume has continued to increase, while the loss ratio at 70.4 remains stable.

        Gross written premiums for the surety segment increased to $49.7 million for the first nine months of 2002, up $9.1 million, or 22.3%, from the same period in 2001. Growth is evident across all surety lines, including contract, oil and gas, commercial and miscellaneous. Commercial surety is up $3.4 million over the first nine months of 2001. This product was launched during the first part of 2001. Contract premium is up $2.3 million over the first nine months of 2001, primarily driven by increased rates. Additionally, oil and gas premium is up $2.0 million over 2001 levels, due to increased commodity prices and achieved rate increases. The surety book reported an underwriting loss of $3.5 million for the first nine months of 2002, compared to an underwriting gain of $2.5 million for the same period last year. The combined ratio for the surety segment totaled 109.3 in 2002 compared to 92.2 in 2001.

15

        The expense ratio increased to 64.7 compared to 63.8 last year, primarily due to increased reinsurance costs. The loss ratio component increased to 44.6 compared to 28.4 last year, as a result of national economic conditions that negatively impacted contract surety loss experience and commercial surety claims. The Company is in litigation regarding certain commercial surety bond claims arising out of a specific bond program. The Company is currently investigating and evaluating its obligations due to a variety of complex coverage issues.

INVESTMENT INCOME

        The Company's investment portfolio generated net dividends and interest income of $28.1 million during the first nine months of 2002, an increase of 17.9% over that reported for the same period in 2001. Diversification of the fixed income portfolio and continued growth in operating cash flow has resulted in the rise in investment income. Additionally, pursuant to SFAS 133 requirements, the Company recorded $1.6 million in net investment income during 2002 to recognize the current period change in the fair value of stock warrants received in conjunction with the purchase of a note receivable. This compares to $1.0 million recognized in the same period in 2001. Further discussion of SFAS 133 and its impact on the Company can be found in note 1, Other Accounting Standards.

        The Company experienced a net realized loss from investments of $3.8 million in the first nine months of 2002, compared to a net realized gain of $3.5 million for the same period in 2001. Realized losses associated with the impairment of four specific equity securities in the technology and utility sectors, resulted in this shift. The Company regularly evaluates the quality of its investment portfolio. When the Company believes that a specific security has suffered an other-than-temporary decline in value, the investment's value is adjusted by charging off the loss against income. In the third quarter of 2002, the Company's analysis identified $6.5 million in other-than-temporary declines in value, related to four specific equity positions in the technology and utility sectors. Stocks within the technology sector have been negatively impacted by a slow-down in economic activity in general, and in capital spending in particular. Stocks within the utility sector have been negatively impacted by liquidity, regulatory, and legal concerns in the wake of energy trading scandals. As a result, in September 2002, the Company recorded $6.5 million of impairment losses on these securities. The loss was calculated as the difference between the cost basis and market value as of September 30, 2002. The effect of this adjustment was a reclassification from unrealized losses to realized losses. After the impairment of these securities, cumulative unrealized gains of $94.4 million remained in the investment portfolio. For the same period in 2001, no impairment charges were recorded. Partially offsetting the impairment loss, $2.7 million in net realized gains were recorded from the sale of certain equity and fixed income investments, during the first nine months of 2002.

        At September 30, 2002, the Company had exposure to the technology sector within the equity portfolio of $8.8 million at market, representing 4.1% of total equity securities held. Our technology equity position had gross unrealized gains of $0.6 million and gross unrealized losses of $0.3 million for a net unrealized gain of $0.3 million. At September 30, 2002 the Company

16

had exposure to the utility sector of $42.7 million, representing 20.0% of total equity securities held. Our utility equity position had gross unrealized gains of $8.7 million and gross unrealized losses of $3.4 million for a net unrealized gain of $5.3 million. All other industry sectors in our equity portfolio had a net unrealized gain position as of September 30, 2002. Based on our evaluation of specific securities held within these specific industry sectors and all other sectors, we do not believe any other securities have suffered an other-than-temporary decline in value. As of September 30, 2002, the Company held $23.7 million worth of equity and fixed income securities that individually had an unrealized loss greater than 10%. The cumulative unrealized loss on these securities was $7.8 million, which represented 0.9% of total invested assets as of September 30, 2002. Management does not believe that any of these securities are other than temporarily impaired, but additional impairments within the portfolio during the remainder of 2002 are possible if current economic and financial conditions worsen, and such impairments may be material. For the nine months ended September 30, 2002, the Company experienced a $49.1 million pre-tax unrealized loss on its investment portfolio.

        As of September 30, 2002, 98% of the Company's fixed income portfolio consisted of securities rated A or better, with 87% rated AA or better. 100% of fixed income securities held as of September 30, 2002 were investment grade. The year-to-date yields on the Company's fixed income investments for the nine-month periods ended September 30, 2002 and 2001 are as follows:

	2002		2001
Taxable	6.22	%	6.55	%
Non-taxable	4.87	%	4.95	%

        For the first nine months of 2002, yields on both taxable and non-taxable bonds decreased slightly. The slight decline is attributed to a decrease in treasury yields on the short and intermediate part of the yield curve and to the reinvestment of called and matured bonds at lower yields. Despite the lower treasury yields, the overall impact on the fixed income portfolio has been limited due to sector diversification and continued growth in operational cash flow.

        The Company's available-for-sale portfolio of debt and equity securities had a net unrealized loss before tax of $49.1 million for the first nine months of 2002, compared with a $40.0 million loss for the same period in 2001. The 2002 year-to-date loss reflects largely stock market fluctuations experienced during the first nine months of the year. The Company's net cumulative unrealized gain before tax was $94.4 million, down from $143.5 million at December 31, 2001. Unrealized appreciation on securities, net of tax, is reflected in accumulated other comprehensive earnings, a component of shareholders' equity.

        Interest expense on debt obligations decreased to $1.4 million for the first nine months of 2002, a $1.3 million decrease from the same period in 2001. This change is related to decreased debt costs resulting from falling interest rates, offset by an $8.2 million increase in average outstanding debt. At September 30, 2002, outstanding short-term balances totaled $87.4 million, compared to $66.4 million at September 30, 2001. At September 30, 2002, short-term debt consisted of $40.0 million under a line of credit and $47.4

17

under reverse repurchase agreements whereby we borrow on a short-term basis against the value of certain fixed income investments. At September 30, 2001, short-term debt consisted of $19.7 million under a line of credit and $46.7 million under reverse repurchase agreements. The Company has utilized debt to repurchase shares, facilitate acquisitions, and increase capital in our insurance operating companies. The Company has incurred interest expense on debt at the following average interest rates for the nine month periods ended September 30, 2002 and 2001:

	2002		2001
Line of credit	2.87	%	5.65	%
Reverse repurchase agreements	2.03	%	5.04	%
Total debt	2.36	%	5.22	%

INCOME TAXES

        The Company's effective tax rate for the first nine months of 2002 and 2001 was 26%. Income tax expense attributable to income from operations differed from the amounts computed by applying the U.S. federal tax rate of 35% to pretax income for the first nine months of 2002 and 2001 as a result of the following:

		2002					2001
		Amount			%		Amount			%
Provision for income taxes at the statutory rate of 35%		$	11,710,892		35	%	$	10,644,133		35	%
Increase (reduction) in taxes resulting from:
	Tax exempt interest income		(2,170,366	)	(6	%)		(2,105,364	)	(7	%)
	Dividends received deduction		(1,145,243	)	(4	%)		(1,072,998	)	(4	%)
	Dividends paid deduction		(229,324	)	(1	%)		(209,385	)	(1	%)
	Goodwill amortization		0		0	%		416,433		2	%
	State tax and other items, net		595,034		2	%		302,467		1	%
Total tax expense		$	8,760,993		26	%	$	7,975,286		26	%

LIQUIDITY AND CAPITAL RESOURCES

        Historically, the primary sources of the Company's liquidity have been funds generated from insurance premiums and investment income (operating activities) and maturing investments (investing activities). In addition, the Company has occasionally received proceeds from financing activities such as the sale of common stock to the employee stock ownership plan, the sale of convertible debentures, and short-term borrowings. The Company continually monitors capital adequacy and surplus leverage, including the Group's statutory premiums to surplus ratio. Given the premium growth over the past twelve to twenty-four months, the Company may seek to raise capital to support further premium growth.

        The Company did not repurchase any of its outstanding shares during the first nine months of 2002. During the first nine months of 2001, the Company repurchased 5,544 outstanding shares at a cost of $123,000.

        Invested assets at September 30, 2002 increased by $74.0 million, or 9.3%, from December 31, 2001. Contributing to this increase was the investment of cash flows from operations, offset by unrealized losses on the investment portfolio totaling $49.1 million.

18

        At September 30, 2002 the Company had short-term investments, cash and other investments maturing within one year, of approximately $127.8 million and additional investments of $133.3 million maturing within five years. The Company maintains one primary source of credit, a $40.0 million line of credit. This facility was recently expanded from a $30.0 million line and was renewed for a three-year period ending May 31, 2005. It is non-cancelable during its term. As of September 30, 2002, the Company had $40.0 million in outstanding short-term borrowings on this facility. Additionally, the Company was party to four reverse repurchase transactions totaling $47.4 million.

        Management believes that cash generated by operations, cash generated by investments and cash available from financing activities will provide sufficient sources of liquidity to meet its anticipated needs over the next twelve to twenty-four months.

        Dividend payments to the Company from its principal insurance subsidiary are restricted by state insurance laws as to the amount that may be paid without prior approval of the regulatory authority of Illinois. The maximum dividend distribution is limited by Illinois law to the greater of: 10% of RLI Insurance Company's policyholder surplus as of December 31 of the preceding year or its net income for the 12-month period ending December 31 of the preceding year. Therefore, the maximum dividend distribution that can be paid by RLI Insurance Company during 2002 without prior approval is $29.0 million-10% of RLI Insurance Company's 2001 policyholder surplus. The actual amount paid to the Company thus far in 2002 is $5.3 million.

THREE MONTHS ENDED SEPTEMBER 30, 2002, COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2001

        Consolidated gross sales, which consist of gross premiums written, net investment income and realized investment gains/losses totaled $198.1 million for the third quarter of 2002 compared to $136.2 million for the same period in 2001. Gross writings of the Group improved 55% over 2001 levels fueled by increases in all three business segments. Consolidated net revenue for the third quarter of 2002 increased $14.4 million or 18% from the same period in 2001. Net premiums earned increased 31.2%. Net investment income improved 8.8% to $9.4 million. Partially offsetting these increases, $6.6 million of realized investment losses negatively impacted revenue for the quarter. These losses were primarily the result of the impairment of four equity securities. In September 2002, the Company recorded $6.5 million of impairment losses on securities whose market value was deemed to be other-than-temporarily impaired. As mentioned previously, this adjustment was a reclassification from unrealized losses to realized losses and did not impact operating earnings or comprehensive earnings.

        The net after-tax earnings for the third quarter of 2002 totaled $5.6 million, $0.28 per diluted share, compared to $7.9 million, $0.39 per diluted share, for the same period in 2001. The decline in net earnings is the result of $6.6 million ($0.21 per diluted share) in realized investment losses recorded during the quarter, compared to $1.5 million ($0.05 per diluted share) of net investment gains reported in the third quarter of 2001. Net operating earnings consist of the Company's net earnings reduced by after-tax realized investment gains/losses and cumulative-effect adjustments. Operating earnings depicts more accurately and comparably the results of the Company's ongoing

19

operations, as the excluded realized gains or losses are typically generated through market and tax strategies not related to the Company's near term operating performance objectives. While this measure may not be comparable to the definition of operating earnings used by all companies, it is quite common in the insurance industry. The Company's net operating earnings totaled $10.0 million, $0.49 per diluted share, compared to $6.9 million, $0.34 per diluted share, for the same period in 2001. Improved underwriting income, particularly on the property book, coupled with growth in investment income and decreased debt costs, favorably impacted third quarter 2002 earnings. Additionally, third quarter 2002 results were favorably impacted by the adoption of SFAS 142. Under this Statement, intangible assets and goodwill with indefinite lives are no longer amortized, but are instead subject to fair value/impairment testing. Implementation of this Statement favorably improved third quarter 2002 earnings by $440,000 ($0.02 per diluted share), as a result of decreased amortization expense. Investment income continued to improve during the third quarter of 2002, due to strong cash flow.

        Comprehensive earnings, which include net earnings plus unrealized gains/losses net of tax, were subject to the volatility in the equity and bond markets. Comprehensive earnings for the third quarter of 2002 totaled a loss of $13.5 million, $0.68 per diluted share, compared to a comprehensive loss of $6.8 million, $0.35 per diluted share, for the same period in 2001. Unrealized losses, net of tax, for the third quarter of 2002 were $19.1 million, $0.96 per diluted share compared to unrealized losses of $14.7 million, $0.74 per diluted share, for the same period in 2001.

RLI INSURANCE GROUP

        Gross written premium for the Group increased to $195.3 million for the third quarter of 2002 compared to $126.0 million for the same period in 2001. Improved pricing across all three business segments and various growth initiatives have positively impacted the gross written premium. Underwriting income improved to a pre-tax profit of $4.4 million for the third quarter of 2002 compared to $1.4 million for the same period in 2001. The GAAP combined ratio declined to 95.2 for the third quarter of 2002 compared to 98.0 for the third quarter of 2001. The property segment was responsible for the majority of the improved results posting a 70.4 combined ratio. The casualty segment reported a 100.5 combined ratio, bettering the 103.2 result of one year ago. The surety segment, however, posted an underwriting loss for the quarter, as results continued to be negatively impacted by national economic conditions that affected contract surety loss experience.

        The Group's property segment experienced an increase in gross writings of $13.2 million, or 32.1%, compared to third quarter 2001. For the third quarter of 2002, property premiums totaled $54.3 million. Fueled by the improved rate environment, difference-in-condition writings improved by $6.7 million over 2001, and fire writings grew by $4.8 million. Due to exceptional seasonal results, underwriting profit for the property segment was $6.9 million for the third quarter of 2002, compared to $1.9 million for the same period in 2001. Furthermore, early indications are that little impact has occurred from either Tropical Storm Isidore or Hurricane Lili. For the quarter, the GAAP combined ratio decreased to 70.4 compared to 88.8 for the same period last year. Loss experience on discontinued property classes negatively impacted 2001 results.

20

        Gross written premiums for the casualty segment were $123.9 million for the third quarter of 2002, up $52.9 million, or 74.6%, from 2001. Growth initiatives and improved pricing contributed to growth in the following products: program business up $23.5 million, general liability up $16.5 million, executive products up $9.4 million, and transportation up $4.9 million. Partially offsetting these increases, commercial umbrella declined $5.0 million, due to the re-underwriting of the book. Underwriting loss on the casualty book was $261,000 compared to a loss of $1.3 million for the third quarter of 2001. These results translate into a combined ratio of 100.5 in 2002 versus 103.2 for the same period in 2001. Included in the third quarter 2001 results was $500,000 in losses recorded to reflect potential costs associated with the September 11 terrorist attack. As mentioned previously, the Company had limited exposure to areas affected by this event. The segment's expense ratio at 28.8 has continued to show improvement, as premium volume has continued to increase, while the loss ratio at 71.7 remains stable.

        Gross written premiums for the surety segment were $17.2 million for the third quarter of 2002, up 23%, from the same period in 2001. Growth has primarily been achieved through increased rates. The combined ratio for the surety segment totaled 117.3 in 2002 compared to 93.1 in 2001. The loss ratio component increased to 52.8 compared to 27.2 last year, as a result of national economic conditions that negatively impacted contract surety loss experience. For the quarter, the expense ratio decreased 1.4 points, to 64.5. Cost associated with the expansion of the commercial surety product caused third quarter 2001 expenses to trend higher.

INVESTMENT INCOME

        The Company's investment portfolio generated net dividends and interest income of $9.4 million during the third quarter of 2002, an increase of 8.7% over that reported for the same period in 2001. Diversification of the fixed income portfolio and positive operating cash flow has resulted in the rise in investment income. Additionally, pursuant to SFAS 133 requirements, the Company recorded $472,000 in net investment income during the third quarter of 2002 to recognize the current period change in the fair value of stock warrants received in conjunction with the purchase of a note receivable. This compares to $630,000 in the same period of 2001. Further discussion of SFAS 133 and its impact on the Company can be found in note 1, Other Accounting Standards.

        The Company experienced a net realized loss from investments of $6.6 million in the third quarter of 2002, compared to a net realized gain of $1.5 million for the same period of 2001. Included within the realized loss for the third quarter of 2002 was an impairment charge of $6.5 million related to certain equity holdings in the technology sector. There were no impairment charges for the same period in 2001. Partially offsetting these losses for the third quarter of 2002 were gains realized from ongoing investment portfolio management activity.

21

INCOME TAXES

        The Company's effective tax rate for the third quarter of 2002 was 21% compared to 27% reported for the same period in 2001. Despite significant improvement in underwriting income, realized losses recorded during the third quarter of 2002 resulted in a decline in pretax income and, corresponding, the effective tax rate. Income tax expense attributable to income from operations differed from the amounts computed by applying the U.S. federal tax rate of 35% to pretax income for the third quarter of 2002 and 2001 as a result of the following:

		2002					2001
		Amount			%		Amount			%
Provision for income taxes at the statutory rate of 35%		$	2,505,328		35	%	$	3,764,489		35	%
Increase (reduction) in taxes resulting from:
	Tax exempt interest income		(748,860	)	(10	)%		(693,942	)	(6	)%
	Dividends received deduction		(366,692	)	(5	)%		(347,246	)	(3	)%
	Dividends paid deduction		(77,514	)	(1	)%		(73,219	)	(1	)%
	Goodwill amortization		0		0	%		138,811		1	%
	State tax and other items, net		205,645		2	%		67,605		1	%
Total tax expense		$	1,517,907		21	%	$	2,856,498		27	%

OTHER MATTERS

        The Company maintains a noncontributory defined pension plan covering substantially all employees meeting age and service requirements. The Company accounts for this plan pursuant to the requirements of SFAS 87, "Employers' Accounting for Pensions," and SFAS 106, "Employers Accounting for Postretirement Benefits Other Than Pensions." According to these Statements, the measurement of net periodic pension cost for both interim and annual financial statements should be based on the assumptions used for the previous year-end measurements, unless a significant event occurs that would require an interim re-measurement. Company management believed that a 50-basis point drop in Aa corporate bond yields during the first nine months of 2002, coupled with a reduction in the fair value of plan assets constituted an event for which an interim review of plan assumptions was warranted. As disclosed in Company's 2001 Annual Report on Form 10-K, the following pension assumptions were used: 7.25% discount rate, 6% compensation increase, and 10% return on plan assets. As a result of the interim review, the Company began applying the following assumptions, prospectively, on July 1, 2002: 6.75% discount rate, 5% compensation increase, and 9% return on plan assets. The change to the discount rate was made to reflect the 50-basis point drop in Aa corporate yields, since year-end. The rate of compensation increase is impacted by a number of factors, including the overall labor market, workforce demographics, and inflation. The Company believes that 5% provides a reasonable estimate, given the current environment. The Company's pension assets continue to be invested predominately in equity securities. Including the market's downward experience over the past two years, the inception-to-date annual return for the plan is 9.89%, through September 30, 2002. The Company believes 9% was a reasonable assumption to use going forward. The net impact on pension expense from the July 1, 2002 change in assumptions totaled $72,000 for the third quarter. Additionally in September 2002, the Company contributed $2.6 million in cash to the pension plan to maintain a current liability funded ratio of 100%.

22

ITEM 3.    Quantitative and Qualitative Disclosures About Market Risk

        Market risk is the risk of economic losses due to adverse changes in the estimated fair value of a financial instrument as the result of changes in equity prices, interest rates, foreign exchange rates and commodity prices. The Company's consolidated balance sheets include assets and liabilities whose estimated fair values are subject to market risk. The primary market risks to the Company are equity price risk associated with investments in equity securities and interest rate risk associated with investments in fixed maturities. From time to time, equity prices and interest rates fluctuate causing an effect on the Company's investment portfolio. The Company has no exposure to foreign exchange risk and no direct commodity risk.

        The Company's market risk exposures at September 30, 2002, have not materially changed from those identified at December 31, 2001.

ITEM 4.    Controls and Procedures

        The Company maintains 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. The Company evaluated the effectiveness of the design and operation of our disclosure controls and procedures under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, within 90 days prior to the filing date of this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. No significant changes were made to internal controls or other factors that could significantly affect these controls subsequent to the date of the evaluation.

PART II—OTHER INFORMATION

Item 1.    Legal Proceedings—

The following is a description of a complex set of litigation wherein the Company is both a plaintiff and a defendant. While it is impossible to ascertain the ultimate outcome of this matter at this time, the Company believes, based upon facts known to date and the opinion of trial counsel, that its position is meritorious. Management's opinion is that the final resolution of these matters will not have a material adverse effect on the Company's financial statements taken as a whole.

The Company is the plaintiff in an action captioned RLI Insurance Co. v. Commercial Money Center, which was filed in U.S. District Court, Southern District of California (San Diego) on February 1, 2002. Other defendants in that action are Commercial Servicing Corporation ("CSC"), Sterling Wayne Pirtle, Anita Pirtle, Americana Bank & Trust, Atlantic Coast Federal Bank, Lakeland Bank and Sky Bank. The Company filed a similar complaint against the Bank of Waukegan in San Diego, California Superior Court. Americana Bank & Trust, Atlantic Coast Federal Bank, Lakeland Bank, Sky Bank and Bank of Waukegan are referred to as the "Investor Banks".

23

The litigation arises out of the equipment and vehicle leasing program of Commercial Money Center ("CMC"). CMC would originate leases, procure bonds pertaining to the performance of obligations of each lessee under each lease, then form "pools" of such leases that it marketed to banks and other institutional investors. The Company sued for rescission and/or exoneration of the bonds it issued to CMC and sale and servicing agreements it entered into with CMC and the Investor Banks, which had invested in CMC's equipment leasing program. The Company contends it was fraudulently induced to issue the bonds and enter into the agreements by CMC, who misrepresented and concealed the true nature of its program and the underlying leases originated by CMC (for which bonds were procured). The Company also sued for declaratory relief to determine its rights and obligations, if any, under the instruments. Each Investor Bank disputes the Company's claims for relief. CMC is currently in Chapter 7 bankruptcy proceedings.

Each Investor Bank subsequently filed a complaint against the Company in various state courts, which the Company removed to U.S. District Courts. Each Investor Bank sued the Company on certain bonds the Company issued to CMC as well as a sale and servicing agreement between the Investor Bank, CMC and the Company. Each Investor Bank sued for breach of contract, bad faith and other extra-contractual theories. The Company has answered and denies each Investor Bank's entitlement to relief. The Investor Banks claim entitlement to aggregate payment of approximately $53 million under either the surety bonds or the sale and servicing agreements, plus unknown extra-contractual damages, attorneys' fees and interest. The litigation to date has focused on issues of jurisdiction, venue and consolidation of the proceedings. The Company disputes both liability and damages. Based on the facts and circumstances now known to the Company, the Company believes that it has meritorious defenses to these claims. The Company is vigorously disputing liability and is vigorously asserting its positions in the pending litigation.

The Company is party to numerous claims and lawsuits that arise in the normal course of its business. Many of such claims or lawsuits involve claims under policies that the Company underwrites as an insurer. The Company believes that the resolution of these claims and lawsuits will not have a material adverse effect on its financial condition, results of operations or cash flows.

Item 2.    Change in Securities and Use of Proceeds—

        Not Applicable

Item 3.    Defaults Upon Senior Securities—

        Not Applicable

24

Item 4.    Submission of Matters to a Vote of Security Holders—

At the May 2, 2002 annual shareholders meeting, the vote of the holders of outstanding shares of common stock entitled to vote was as follows:

Election of Directors

	Votes Cast
	For	Withheld
William R. Keane	8,486,906	178,271
Gerald I. Lenrow	8,521,453	143,723
Edwin S. Overman	8,547,095	118,081

Continuing directors of the Company were: Bernard J. Daenzer, Edward F. Sutkowski, and Jonathan E. Michael, whose terms expire in 2003, and Richard H. Blum, F. Lynn McPheeters, Gerald D. Stephens, and Robert O. Viets, whose terms expire in 2004.

Reapprove Market Value Potential Plan

For	Against	Abstain
7,853,375	374,346	437,448

As brokers are allowed to vote all available shares where applicable for routine proposals, and both of the above-noted proposals were considered routine, there were no broker non-votes.

Item 5.    Other Information—

        Not Applicable

Item 6.    Exhibits and Reports on Form 8-K

(a)

Exhibit 3.2    By-Laws



(b)

Exhibit 99.1    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley 2002

Exhibit 99.2    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley 2002

(c)

The Company did not file any reports on Form 8-K during the three months ended September 30, 2002.

SIGNATURES

        Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	RLI Corp.
/s/  JOSEPH E. DONDANVILLE Joseph E. Dondanville Sr. Vice President, Chief Financial Officer (Duly authorized and Principal Financial and Accounting Officer)
Date: November 4, 2002

25

CERTIFICATIONS

Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Jonathan E. Michael, certify that:

        1.    I have reviewed this quarterly report on Form 10-Q of RLI Corp.

        2.    Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

        3.    Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

        4.    The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a)

designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;



b)

evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and



c)

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

        5.    The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a)

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and



b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

        6.    The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 4, 2002 /s/  JONATHAN E. MICHAEL Jonathan E. Michael
President & CEO

26

Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Joseph E. Dondanville, certify that:

        1.    I have reviewed this quarterly report on Form 10-Q of RLI Corp.

        2.    Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

        3.    Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

        4.    The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a)

designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;



b)

evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and



c)

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

        5.    The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a)

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and



b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

        6.    The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 4, 2002 /s/  JOSEPH E. DONDANVILLE Joseph E. Dondanville
Senior VP, Chief Financial Officer

27

QuickLinks

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Statement of Earnings and Comprehensive Earnings
Condensed Consolidated Balance Sheet
Condensed Consolidated Statements of Cash Flows

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
ITEM 4. Controls and Procedures

PART II—OTHER INFORMATION

Item 1. Legal Proceedings—
Item 2. Change in Securities and Use of Proceeds—
Item 3. Defaults Upon Senior Securities—
Item 4. Submission of Matters to a Vote of Security Holders—
Item 5. Other Information—
Item 6. Exhibits and Reports on Form 8-K

SIGNATURES

EX-3.2

QuickLinks -- Click here to rapidly navigate through this document

Exhibit 3.2

Amended By-Laws of RLI Corp.

Table of Contents

	ARTICLE I: Offices	1
1.1	Registered Office	1
1.2	Other Offices	1
	ARTICLE II: Meetings of Shareholders	1
2.1	Annual Meeting	1
2.2	Special Meetings	1
2.3	Place of Meetings	1
2.4	Notice of Meetings	1
2.5	Shareholder List	2
2.6	Quorum	2
2.7	Proxies	2
2.8	Voting	3
2.9	Voting of Certain Shares	4
2.10	Action Without Meeting	4
	ARTICLE III: Directors	5
3.1	Number and Election	5
3.2	Resignations	5
3.3	Removal	5
3.4	Vacancies	6
3.5	Retirement	6
3.6	Management of Affairs of Corporation	6
3.7	Dividends and Reserves	7
3.8	Regular Meetings	7
3.9	Special Meetings	7
3.10	Notice of Special Meetings	7
3.11	Quorum	7
3.12	Presumption of Assent	8
3.13	Action Without Meeting	8
3.14	Chairman of the Board	8
3.15	Executive Committee	8
3.16	Other Committees	9
3.17	Quorum and Manner of Acting—Committees	9
3.18	Committee Chairman, Books and Records	9
3.19	Fees and Compensation of Directors	10
3.20	Reliance Upon Records	10
	ARTICLE IV: Notices	10
4.1	Manner of Notice	10
4.2	Waiver of Notice	10
	ARTICLE V: Officers	11
5.1	Office and Official Positions	11

i

5.2	Election and Term of Office	11
5.3	Removal and Resignation	12
5.4	Vacancies	12
5.5	President	12
5.6	Vice Presidents	13
5.7	Secretary	13
5.8	Treasurer	14
5.9	Assistant Treasurers and Assistant Secretaries	15
5.10	Salaries	15
	ARTICLE VI: Divisions	15
6.1	Divisions of the Corporation	15
6.2	Official Positions Within a Division	15
	ARTICLE VII: Contracts, Loans, Checks and Deposits	16
7.1	Contracts and Other Instruments	16
7.2	Loans	16
7.3	Checks, Drafts	16
7.4	Deposits	16
	ARTICLE VIII: Certificates of Shares and Their Transfer	16
8.1	Certificates of Shares	16
8.2	Lost, Stolen or Destroyed Certificate	17
8.3	Transfers of Shares	17
8.4	Restrictions on Transfer	17
8.5	No Fractional Share Certificates	17
8.6	Fixing Record Date	17
8.7	Shareholders of Record	18
	ARTICLE IX: General Provisions	18
9.1	Fiscal Year	18
9.2	Seal	18
	ARTICLE X: Indemnification	18
10.1	Third Party Action	18
10.2	Corporation Action	19
10.3	Fees	19
10.4	Conditions Precedent	20
10.5	Expenses	20
10.6	Non-Exclusivity	20
10.7	Insurance	21
10.8	Reporting	21
10.9	Definitions	21
	ARTICLE XI: Amendments	22

ii

ARTICLE I: Offices

        1.1    Registered Office.    The registered office of RLI Corp. ("Corporation") in the State of Illinois shall be located at 9025 North Lindbergh Drive, Peoria, Illinois 61615. The name of its registered agent is Camille J. Hensey. The registered office and agent may be periodically changed by the Board of Directors.

        1.2    Other Offices.    The Corporation may also have offices at such other places both within or without the State of Illinois as the Board of Directors may periodically determine or the business of the Corporation may require.

ARTICLE II: Meetings of Shareholders

        2.1    Annual Meeting.    The annual meeting of the shareholders shall be held at 2:00 P.M. on the first Thursday in May of each year, if not a legal holiday, or, if a legal holiday, then on the next succeeding business day, for the purpose of electing directors and for the transaction of such other business as may come before the meeting. If the election of directors shall not be held on the day designated for the annual meeting, or at any adjournment thereof, the Board of Directors shall cause such election to be held at a special meeting of shareholders.

        2.2    Special Meetings.    Any special meeting of the shareholders may be called by the President, by the Board of Directors, or by the holders of not less than one-fifth of the outstanding shares entitled to vote on the matter for which the meeting is called.

        2.3    Place of Meetings.    Any meeting of the shareholders for the election of directors shall be held at the office of the Corporation in Peoria, Illinois, unless the Board of Directors shall, by resolution, designate any other location, within or without the State of Illinois, as the place of such meeting.

        Any meeting of shareholders for any other purpose may be held at such place, within or without the State of Illinois, and at such time as shall be determined pursuant to Section 2.2 Special Meetings.

        2.4    Notice of Meetings.    Written notice stating the place, day and hour of the meeting and, in the case of a special meeting, the purpose for which the meeting is called, shall be delivered not less than ten (10) nor more than sixty (60) days before the date of the meeting, or in the case of a merger, consolidation, share exchange, dissolution or sale, lease or exchange of assets not

1

less than twenty (20) nor more than sixty (60) days before the date of the meeting, either personally or by mail, by or at the direction of the President, the Secretary or the officer or persons calling the meeting, to each shareholder of record entitled to vote at such meeting. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail addressed to the shareholder at such shareholder's address as it appears on the records of the Corporation, with postage thereon prepaid.

        When a meeting is adjourned to another time or place, no notice of the adjourned meeting, other than an announcement at the meeting, need be given unless the adjournment is for more than thirty (30) days or a new record date is fixed for the adjourned meeting after such adjournment.

        2.5    Shareholder List.    At least ten (10) days before every meeting of shareholders, a complete list of the shareholders entitled to vote at such meeting, arranged in alphabetical order, and showing the address of each such shareholder and the number of shares registered in the name of each such shareholder, shall be prepared by the Secretary.

        The list shall be open to examination of any shareholder of the Corporation, and to copying at the shareholder's expense, during ordinary business hours, for any purpose germane to the meeting during the ten (10) day period ending on the date of the meeting, at the office of the Corporation in Peoria, Illinois. The list shall be produced and kept at the time and place of meeting during the meeting and be subject to inspection by any shareholder for any purpose germane to the meeting.

        2.6    Quorum.    Except as otherwise provided by statute, the articles of incorporation or By-Laws, the holders of shares of the Corporation having a majority of the voting power thereof, present in person or represented by proxy, shall be requisite for, and shall constitute, a quorum at all meetings of the shareholders of the Corporation for the transaction of business. If such quorum shall not be present or represented at any meeting of the shareholders, the shareholders entitled to vote, present in person or represented by proxy, shall have power to adjourn the meeting from time to time until a quorum shall be present or represented. At such adjourned meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally notified.

        2.7    Proxies.    A shareholder may vote such shareholder's shares in person or may appoint a proxy to vote or otherwise act for such

2

shareholder by signing an appointment form and delivering it to the person so appointed.

        No proxy shall be valid after the expiration of eleven (11) months from the date thereof unless otherwise provided in the proxy. Every proxy continues in full force and effect until revoked by the person executing it prior to the vote pursuant thereto, except as otherwise provided in this section. Such revocation may be effected by a writing delivered to the Corporation stating that the proxy is revoked or by a subsequent proxy executed by, or by attendance at the meeting and voting in person by, the person executing the proxy. The dates contained on the forms of proxy presumptively determine the order of execution, regardless of the postmark dates on the envelopes in which they are mailed.

        An appointment of a proxy is revocable by the shareholder unless the appointment form conspicuously states that it is revocable and the appointment is coupled with an interest, as such term is defined by applicable law. A transferee for value of shares subject to an irrevocable appointment may revoke the appointment if the transferee was ignorant of its existence when the shares were acquired and both the existence of the appointment and its irrevocability were not noted conspicuously on the certificate, or information statement for shares without certificates, representing the shares.

        The death or incapacity of the shareholder appointing a proxy does not revoke the proxy's authority unless notice of the death or incapacity is received by the officer or agent who maintains the Corporation's share transfer book before the proxy exercises such shareholder's authority under the appointment.

        Unless the appointment of a proxy contains an express limitation on the proxy's authority, the Corporation may accept the proxy's vote or other action as that of the shareholder making the appointment. If the proxy appointed fails to vote or otherwise act in accordance with the appointment, the shareholder is entitled to such legal or equitable relief as is appropriate in the circumstances.

        2.8    Voting.    Except as otherwise provided by the articles of incorporation, each shareholder shall be entitled to one (1) vote for each share of the Corporation entitled to vote thereat and registered in the name of such shareholder on the books of the Corporation on the referent record date. No holder of any class or series of shares of this Corporation shall have cumulative voting rights with respect to any matter voted upon by the holders of such shares.

3

        When a quorum is present at any meeting of the shareholders, the vote of the holders of a majority of the shares having voting power which is present in person or represented by proxy shall, except as otherwise required by applicable law, the articles of incorporation, or these By-Laws, decide any question brought before such meeting.

        2.9    Voting of Certain Shares.    Shares standing in the name of another corporation, and entitled to vote may be voted by such officer, agent, or proxy as the by-laws of such corporation may prescribe or, in the absence of such provision, as the board of directors of such corporation may determine. Shares standing in the name of a deceased person, a minor or an incompetent and entitled to vote may be voted by such person's administrator, executor, guardian or conservator, as the case may be, either in person or by proxy. Shares standing in the name of a trustee, receiver or pledgee and entitled to vote may be voted by such trustee, receiver or pledgee either in person or by proxy as provided by applicable law.

        2.10    Action Without Meeting.    Unless otherwise provided in the articles of incorporation, any action required to be taken at any annual or special meeting of the shareholders, or any action which may be taken at a meeting of the shareholders, may be taken without a meeting and without a vote if a consent in writing, expressing the action so taken, shall be signed: if five (5) days prior notice of the proposed action is given in writing to all of the shareholders entitled to vote with respect to the subject matter thereof, by the holders of outstanding shares having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voting; or, by all of the shareholders entitled to vote with respect to the subject matter thereof.

        Prompt notice of the taking of Corporation action without a meeting by less than unanimous written consent shall be given in writing to those shareholders who have not consented in writing. If the action which is consented to is such as would have required the filing of a certificate under applicable law if such action had been voted on by the shareholders at a meeting thereof, the certificate filed shall state, in lieu of any statement required

4

by applicable law, concerning any vote of shareholders, that written consent has been given in accordance with the provisions of this section and that written notice has been given as provided in this section.

ARTICLE III: Directors

        3.1    Number and Election.    The number of directors of this Corporation shall be ten. The members of the Board of Directors shall be divided into three classes, each class to be as nearly equal in number as is possible.

        The term of office of directors of the first class shall expire at the first annual meeting of shareholders after their election, that of the second class shall expire at the second annual meeting of shareholders after their election, and that of the third class shall expire at the third annual meeting of the shareholders after their election. At each annual meeting, the number of directors equal to the number of the class whose terms expire at the time of such meeting shall be elected to hold office until the third succeeding annual meeting of the shareholders.

        Except for vacancies filled pursuant to Section 3.4 Vacancies, the directors shall be elected by the shareholders of the Corporation, and at each election the persons receiving the greatest number of votes, up to the number of directors then to be elected, shall be the persons then elected. The election of directors is subject to any provisions contained in the articles of incorporation relating thereto.

        3.2    Resignations.    Any director may resign at any time by giving written notice to the Board of Directors or to the President, provided that the party to whom such notice is given is other than the individual director giving the notice. Any such resignation shall take effect at the date of the receipt of such notice or at any later time specified therein. Unless otherwise specified in such resignation, the acceptance of such resignation shall not be necessary to make it effective.

        3.3    Removal.    Except as otherwise provided in the following sentence, a director of the Corporation may be removed only for cause by the affirmative vote of a majority of the outstanding shares then entitled to vote at an election of directors. No

5

director shall be removed at a meeting of shareholders unless the notice of such meeting shall state that a purpose of such meeting is to vote upon the removal of the director named in the notice, and only the named director may be removed at such meeting.

        3.4    Vacancies.    Except as otherwise provided in the articles of incorporation, any vacancy in the Board, whether because of death, resignation, disqualification, an increase in the number of directors or any other cause, may be filled by the vote of the majority of the remaining directors, although less than a quorum. Each director so chosen to fill a vacancy shall hold office until such director's successor shall have been elected and shall qualify or until such director shall resign or shall have been removed. No decrease in the number of directors constituting the Board of Directors shall shorten the term of any incumbent director.

        3.5    Retirement.    The term of a director, except a current director as of August 24, 2000, shall expire at the beginning of the first annual meeting of shareholders of this Corporation on or after such director shall have attained age 72.

        3.6    Management of Affairs of Corporation.    The property and business of the Corporation shall be managed by its Board of Directors, which may exercise any such power of the Corporation and do any such lawful act as are not by applicable law, the articles of incorporation or these By-Laws directed or required to be exercised or done by shareholders.

        If the Corporation shall transact any business or enter into any contract with a director, or with any firm of which one or more of its directors are members, or with any trust, firm, corporation or association in which any director is a shareholder, director or officer or otherwise interested, the officers of the Corporation and directors in question shall be severally under the duty of disclosing all material facts as to their interest to the remaining directors promptly if and when such interested officers or such interested directors in question shall become advised of the circumstances. In the case of continuing relationships in the normal course of business such disclosure shall be deemed effective, when once given, as to all transactions and contracts subsequently entered into.

6

        3.7    Dividends and Reserves.    Dividends upon shares may be declared by the Board of Directors at any regular or special meeting. Dividends may be paid in cash, in property, in shares or otherwise in the form, and to the extent, permitted by applicable law. The Board of Directors may set apart, out of any funds of the Corporation available for dividends, a reserve or reserves for working capital or for any other lawful purpose, and also may abolish any such reserve in the manner in which it was created.

        3.8    Regular Meetings.    An annual meeting of the Board of Directors shall be held, without notice other than as provided in these By-Laws, immediately after, and at the same place as, the annual meeting of the shareholders. The Board of Directors may provide, by resolution, the time and place, either within or without the State of Illinois, for the holding of additional regular meetings without notice other than such resolution.

        3.9    Special Meetings.    Special meetings of the Board of Directors may be called by the President and shall be called by the Secretary at the request of any two directors, to be held at such time and place, either within or without the State of Illinois, as shall be designated by the call.

        3.10    Notice of Special Meetings.    Except as otherwise prescribed by statute, written or actual oral notice of the time and place of each special meeting of the Board of Directors shall be given at least two (2) day prior to the time of holding the meeting. Any director may waive notice of any meeting.

        3.11    Quorum.    The presence of not less than a majority of the Board of Directors shall be necessary and sufficient to constitute a quorum for the transaction of business. Except as otherwise provided by applicable law, the articles of incorporation or these By-Laws, the act of a majority of the directors present at any meeting at which there is a quorum shall be the act of the Board of Directors. If a quorum shall not be present at any meeting of directors, the directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present.

        Unless otherwise provided by the articles of incorporation, any member of the Board of Directors or of any committee designated by the Board may participate in a meeting of the directors or

7

committee by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting by means of such equipment shall constitute presence in person at such meeting.

        3.12    Presumption of Assent.    Unless otherwise provided by applicable law, a director of the Corporation who is present at a meeting of the Board of Directors at which action is taken on any corporate matter shall be presumed to have assented to the action taken unless such director's dissent shall be entered in the minutes of the meeting or unless such director shall file such director's written dissent to such action with the person acting as secretary of the meeting before the adjournment thereof or shall forward such dissent by registered mail to the Secretary of the Corporation immediately after the adjournment of the meeting. Such right to dissent shall not apply to a director who voted in favor of such action.

        3.13    Action Without Meeting.    Except as otherwise provided by applicable law, the articles of incorporation or these By-Laws, any action required or permitted to be taken at any meeting of the Board of Directors, or of any committee thereof, may be taken without a meeting, if a written consent thereto, setting forth the action so taken, is signed by all members of the board or of such committee entitled to vote, as the case may be, and such written consent is filed with the minutes of proceedings of the board or committee.

        3.14    Chairman of the Board.    The Board of Directors may, by resolution passed by a majority of the directors present at the meeting, annually elect a director to serve as Chairman of the Board. Such Director shall serve as Chairman until the first to occur of the election of such Chairman's successor, or such Chairman's death, resignation or removal. If a Chairman of the Board is elected, he or she shall preside at all meetings of the shareholders and directors at which he or she may be present.

        3.15    Executive Committee.    The Board of Directors may, by resolution passed by a majority of the number of directors fixed by these By-Laws, designate two or more directors of the Corporation to constitute an executive committee. The executive committee shall, to the extent provided in the resolution and by

8

applicable law, have and may exercise any power and authority of the Board of Directors in the management of the business and affairs of the Corporation.

        3.16    Other Committees.    The Board of Directors may, by resolution passed by a majority of the number of directors, designate such other committees as it may periodically determine. Any committee shall consist of such number of directors, shall serve for such term and shall have and may exercise, during intervals between meetings of the Board of Directors, such duties, functions and powers as the Board of Directors may periodically prescribe, except that a committee may not authorize distributions; approve or recommend to shareholders any act required by applicable law to be approved by shareholders; fill vacancies on the board or on any of its committees; elect or remove officers or fix the compensation of any member of the committee; adopt, amend or repeal these By-Laws; approve a plan of merger not requiring shareholder approval; authorize or approve reacquisition of shares, except according to a general formula or method prescribed by the Board of Directors; authorize or approve the issuance or sale, or contract for sale, of shares or determine the designation and relative rights, preferences and limitations of a series of shares, except that the board may direct a committee to fix the specific terms of the issuance or sale or contract for sale or the number of shares to be allocated to particular employees under an employee benefit plan; or amend, alter, repeal or take action inconsistent with any resolution or action of the Board of Directors when the resolution or action of the Board of Directors provides by its terms that it shall not be amended, altered or repealed by action of a committee.

        3.17    Quorum and Manner of Acting—Committees.    The presence of a majority of members of any committee shall constitute a quorum for the transaction of business at any meeting of such committee, and the act of a majority of those present shall be necessary for the taking of any action.

        3.18    Committee Chairman, Books and Records.    The Chairman of any committee shall be selected from among the members of the committee by the Board of Directors. Any committee shall keep a record of its acts and proceedings, and any action of each committee shall be reported to the Board of Directors at its next meeting. Any committee shall fix its own rules of procedure not

9

inconsistent with applicable law, these By-Laws or the resolution of the Board of Directors designating such committee and shall meet at such times and places and upon such call or notice as shall be provided by such designation.

        3.19    Fees and Compensation of Directors.    The Board of Directors shall, by the affirmative vote of a majority of directors then in office, and irrespective of any personal interest of any of its members, have the authority to establish reasonable compensation of all directors for services to the Corporation as directors, including expenses incurred.

        3.20    Reliance Upon Records.    Each director of the Corporation, or member of any committee designated by the Board of Directors shall be fully protected in relying in good faith upon the books of account or reports made to the Corporation by any of its officials, by an independent certified public accountant, by an appraiser selected with reasonable care by the Board of Directors or by such committee, or in relying in good faith upon other records of the Corporation, including the records expressing or relating to the value and amount of assets, liabilities and profits of the Corporation or any other facts pertinent to the existence and amount of surplus or other funds from which dividends may properly be declared or paid or with which shares of the Corporation might lawfully be purchased or redeemed.

ARTICLE IV: Notices

        4.1    Manner of Notice.    Whenever notice is required to be given to any shareholder, director or member of any committee designated by the Board of Directors, such notice may be given by any commercially acceptable means in writing or otherwise, including by depositing such notice in a sealed envelope, in the United States mail, postage prepaid, addressed to such addressee at the address of such addressee as it appears on the books of the Corporation or, in the case of a director, at such director's last known address. Notice shall be deemed to be given at the time when deposited in the United States mails or otherwise delivered to the commercially acceptable means of communication.

        Except in the case of written shareholder notice, any notice requirement shall be deemed satisfied if actual notice is received by the person entitled thereto as far in advance of the event with

10

respect to which notice is given as the minimum notice period required by applicable law or these By-Laws.

        4.2    Waiver of Notice.    Any notice requirement may be waived in writing signed by the person entitled to such notice, whether before, at or after the time stated therein. Except where a person attends a meeting for the purpose of objecting to such meeting, or for the purpose of objecting to the transaction of any business because such notice is not lawfully called or convened, attendance at a meeting by a person who is the subject of a notice requirement shall constitute a waiver of notice of such meeting.

        Except as otherwise required by applicable law, the articles of incorporation or these By-Laws, neither the business to be transacted at, nor the purpose of, any regular or special meeting of the shareholders, directors or committee of directors need be specified in any written waiver of notice.

ARTICLE V: Officers

        5.1    Office and Official Positions.    The officers of the Corporation shall be a President, one or more Vice Presidents, a Secretary, a Treasurer, and such Assistant Secretaries, Assistant Treasurer, and other officers as the Board of Directors shall periodically determine to be appropriate.

        Any two or more offices may be held by the same person. None of the officers need be a director, a shareholder of the Corporation or a resident of the State of Illinois. The Board of Directors may periodically establish, and abolish, official positions within the divisions into which the business and operations of the Corporation are divided and assign titles and duties to such positions. A person appointed to any official position within any division need not be an officer of the Corporation.

        The Board of Directors may periodically appoint officers to official positions within a division and remove any person so appointed with or without cause. The authority incident to an official position within a division shall be limited to acts and transactions within the scope of the business and operations of such division.

        5.2    Election and Term of Office.    The officers of the

11

Corporation shall be elected annually by the Board of Directors. Any officer shall hold office until the first to occur of the election of such officer's successor, or such officer's death, resignation or removal.

        5.3    Removal and Resignation.    Any officer may be removed, with or without cause, by a majority of the directors then in office at any regular or special meeting of the board.

        Any officer may resign upon written notice to the Board of Directors, to the President or to the Secretary. Except as otherwise specified in such resignation, any resignation shall be effective on the date received and need not be accepted by the Corporation.

        5.4    Vacancies.    A vacancy in any office because of death, resignation, removal, or any other cause may be filled for the unexpired portion of the term by the Board of Directors.

        5.5    President.    The President shall be the chief executive officer of the Corporation and shall preside at all meetings of the shareholders, the Board of Directors or any committee of the Board if such President is a member.

        The President shall have the overall supervision of the business of the Corporation and shall direct the affairs and policies of the Corporation, subject to such policies and directions as may periodically be promulgated by the Board of Directors. The President shall have authority to designate the duties and powers of other officers and delegate special powers and duties to specified officers, so long as such designation shall not be inconsistent with applicable law, the articles of incorporation, these By-Laws or action of the Board of Directors. The President may execute any deed, mortgage, bond, contract or other instrument of the Corporation except where required or permitted by law to be otherwise signed and executed and except where the signing and execution thereof shall be expressly delegated by the Board of Directors or by the President to some other officer or agent of the Corporation.

        The President may sign with the Secretary or any Assistant Secretary or the Treasurer or any Assistant Treasurer, any certificate for shares, the issuance of which shall have been duly

12

authorized by the Board of Directors, and shall vote, or give a proxy to any other person to vote, all shares of any other corporation standing in the name of the Corporation.

        Subject to the limitations and satisfaction of the conditions expressed in the preceding paragraphs, the President shall have all powers and shall perform all duties which are incident to the chief executive office of a Corporation or as may periodically be prescribed by the Board of Directors.

        5.6    Vice Presidents.    Absent the President, the Vice Presidents in order of their rank as fixed by the Board of Directors or, if not ranked, the Vice President designated by the Board of Directors or the President, shall perform all duties and shall have all powers of the President.

        The Vice Presidents shall have such other powers and perform such other duties, not inconsistent with applicable law, the articles of incorporation, these By-Laws, or action of the Board of Directors, as may periodically be prescribed for them, respectively, by the Board of Directors or the President. Any Vice President may sign, with the Secretary or an Assistant Secretary, or the Treasurer or an Assistant Treasurer, certificates for shares of the Corporation, the issuance of which shall have been duly authorized by the Board of Directors.

        5.7    Secretary.    The Secretary shall:

(a)

keep the minutes of the meetings of the shareholders, the Board of Directors and committees of directors, in one or more books provided for such purpose;



(b)

see that all notices are fully given in accordance with the provisions of these By-Laws or as required by applicable law;



(c)

have charge of the corporate records and of the seal of the Corporation;



(d)

affix the seal of the Corporation or a facsimile thereof, or cause it to be affixed, to all certificates for shares prior to the issue thereof and to all documents the execution of which on behalf of the Corporation under its seal is duly

13

authorized by the Board of Directors or otherwise in accordance with the provisions of these By-Laws;

(e)

keep a register of the post office address of each shareholder, director and committee member which shall periodically be furnished to the Secretary by such shareholder, director or member;



(f)

sign with the President, or a Vice President, certificates for shares of the Corporation, the issuance of which shall have been duly authorized by resolution of the Board of Directors;



(g)

have general charge of the stock transfer books of the Corporation; and



(h)

perform all duties incident to the office of Secretary and such other duties as may periodically be assigned to the Secretary by the President or by the Board of Directors. The Secretary may delegate such details of the performance of duties of the Secretary's office as may be appropriate in the exercise of reasonable care to one or more persons, but shall not be relieved of responsibility for the performance of such duties.

        5.8    Treasurer.    The Treasurer shall:

(a)

be responsible to the Board of Directors for the receipt, custody and disbursements of all funds and securities of the Corporation;



(b)

receive and give receipts for moneys due and payable to the Corporation from any source whatsoever and deposit all such moneys in the name of the Corporation in such banks, trust companies or other depositories as shall from time to time be selected in accordance with the provisions of these By-Laws;



(c)

disburse the funds of the Corporation as ordered by the Board of Directors or the President or as otherwise required in the conduct of the business of the Corporation;



(d)

render to the President or Board of Directors, upon

14

request, an account of all transactions as Treasurer and on the financial condition of the Corporation;

(e)

perform all the duties incident to the office of Treasurer and such other duties as may periodically be assigned to the Treasurer by the President, by the Board of Directors or these By-Laws. The Treasurer may sign, with the President, or a Vice President, certificates for shares of the Corporation, the issuance of which shall have been duly authorized by resolution of the Board of Directors. The Treasurer may delegate such details of the performance of duties of the Treasurer's office as may be appropriate in the exercise of reasonable care to one or more persons, but shall not be relieved of responsibility for the performance of such duties.

        5.9    Assistant Treasurers and Assistant Secretaries.    The Assistant Treasurers and Assistant Secretaries shall perform all functions and duties which the Secretary or Treasurer, as the case may be, may assign or delegate.

        5.10    Salaries.    The salaries of the officers shall be periodically determined by the Board of Directors or as it shall otherwise direct. No officer shall be prevented from receiving a salary or other compensation by reason of the fact that such officer is also a director of the Corporation.

ARTICLE VI: Divisions

        6.1    Divisions of the Corporation.    The Board of Directors may periodically establish such operating divisions of the Corporation as the Board of Directors periodically determines to be appropriate.

        6.2    Official Positions Within a Division.    Except as otherwise periodically provided by the Board of Directors, the President may appoint and remove, with or without cause, any individual as an officer within a division.

15

ARTICLE VII: Contracts, Loans, Checks and Deposits

        7.1    Contracts and Other Instruments.    The Board of Directors may periodically authorize any person to enter into any contract or execute and deliver any instrument in the name of and on behalf of the Corporation, or of any division thereof and such authorization may be general or confined to specific instances.

        7.2    Loans.    No loan shall be contracted on behalf of the Corporation, or any division thereof, and no evidence of indebtedness shall be issued in the name of the Corporation, or any division thereof, unless authorized by a resolution of the Board of Directors and such authorization may be general or confined to specific instances.

        7.3    Checks, Drafts.    Any check, demand, draft or other order for the payment of money, note or other evidence of indebtedness issued in the name of the Corporation, or any division thereof, shall be signed by such person as the Board of Directors shall periodically designate.

        7.4    Deposits.    Any funds of the Corporation, or any division thereof, not otherwise employed shall be periodically deposited to the credit of the Corporation in such bank, trust company or other depository as the Board of Directors may periodically designate.

ARTICLE VIII: Certificates of Shares and Their Transfer

        8.1    Certificates of Shares.    The certificates of shares shall be in such form as may be periodically determined by the Board of Directors, shall be numbered and entered in the books of the Corporation as they are issued, and shall exhibit the holder's name and number of shares, that the Corporation is organized under the Illinois Business Corporation Act, and shall be signed by the President or a Vice President and by the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary.

        If any share certificate is signed by a transfer agent and a registrar, the signature of any officer of the Corporation may be facsimile. If any officer whose facsimile signature has been used on any certificate, and such officer shall cease to act in such capacity before such certificate is delivered by the Corporation, such certificate may nevertheless be delivered by the Corporation

16

without regard to the cessation of such officer.

        Any certificate surrendered to the Corporation for transfer shall be cancelled and no new certificate shall be issued to evidence transferred shares until the former certificate shall have been surrendered.

        8.2    Lost, Stolen or Destroyed Certificate.    The Board of Directors may periodically promulgate procedures to be followed in connection with the issuance of new certificates in replacement of any certificate previously issued by the Corporation.

        8.3    Transfers of Shares.    Subject to the satisfaction of the conditions periodically expressed by the Board of Directors, upon the surrender of a certificate representing shares of the Corporation, the Corporation shall issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books. Transfers of shares shall be made only on the books of the Corporation by the registered holder thereof or by its attorney or successor duly authorized as evidenced by documents filed with the Secretary or transfer agent of the Corporation. The person in whose name shares stand on the books of the Corporation shall be deemed the owner thereof for all purposes.

        8.4    Restrictions on Transfer.    Subject to such conditions and limitations as the Board of Directors may periodically promulgate, and except as otherwise provided by any applicable law, the articles of incorporation or these By-Laws, any shareholder or the Corporation may enter into any agreement restricting the transferability of any shares of the Corporation, granting put, call, or other rights or responsibilities with respect to such shares on such terms and conditions as are equally applicable to any other shareholder of the Corporation. Any restriction on the transferability of any shares may be expressed on the certificate representing such shares.

        8.5    No Fractional Share Certificates.    Certificates shall not be issued representing any fractional share.

        8.6    Fixing Record Date.    The Board of Directors may fix in advance a date, not exceeding sixty (60) days, nor less than ten (10) days, preceding the date of any meeting of shareholders, or

17

the date for the payment of any dividend, or the date for the allotment of rights, or the date when any change or conversion or exchange of shares shall be effective, or a date in connection with obtaining any consent, as a record date for the termination of the shareholders entitled to notice of, and to vote at, any such meeting, or adjournment thereof, or entitled to receive payment of any such dividend, or to any such allotment of rights, or to exercise the rights in respect of any such change, conversion or exchange of shares, or to give such consent, and in such case such shareholders and only such shareholders as shall be shareholders of record on the date so fixed shall be entitled to notice of, and to vote at, such meeting and any adjournment thereof, or to receive payment of such dividend, or to receive such allotment of rights, or to exercise such rights, or to give such consent, as the case may be, notwithstanding any transfer of any shares on the books of the Corporation after any such record date.

        8.7    Shareholders of Record.    Except as otherwise required by applicable law, the Corporation may treat the holder of record of any share as the holder in fact thereof.

ARTICLE IX: General Provisions

        9.1    Fiscal Year.    The fiscal year of the Corporation shall begin on January 1 and shall end on December 31.

        9.2    Seal.    The Board of Directors may provide a corporate seal which shall have inscribed thereon the name of the Corporation, and the words "CORPORATE SEAL" and "Illinois;" and it shall otherwise be in the form approved by the Board of Directors. The seal may be used by causing it, or a facsimile thereof, to be impressed or affixed or otherwise reproduced.

ARTICLE X: Indemnification

        10.1    Third Party Action.    The Corporation shall indemnify any person who was or is a party, or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Corporation) by reason of the fact that such person is or was a director, officer, employee or agent of the Corporation, or who is

18

or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding, if such person acted in good faith and in a manner he or she reasonably believed to be in, or not opposed to the best interests of the Corporation, and with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which such person reasonably believed to be in or not opposed to the best interests of the Corporation or with respect to any criminal action or proceeding, that the person had reasonable cause to believe that his or her conduct was unlawful.

        10.2    Corporation Action.    The Corporation shall indemnify any person who was or is a party, or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that such person is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees) actually and reasonably incurred by such person in connection with the defense or settlement of such action or suit, if such person acted in good faith and in a manner he or she reasonably believed to be in, or not opposed to the best interests of the Corporation, provided that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for negligence or misconduct in the performance of his or her duty to the Corporation, unless and only to the extent that the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability, but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses as the court shall deem proper.

        10.3    Fees.    To the extent that a director, officer, employee or

19

agent of the Corporation has been successful, on the merits or otherwise, in the defense of any action, suit or proceeding referred to in Sections 10.1 Third Party Action or 10.2 Corporation Action, or in defense of any claim, issue or matter therein, such person shall be indemnified against expenses, including attorneys' fees, actually and reasonably incurred by such person in connection therewith.

        10.4    Conditions Precedent.    Any indemnification under Sections 10.1 Third Party Action or 10.2 Corporation Action, unless ordered by a court, shall be made by the Corporation only as authorized in the specific case, upon a determination that indemnification of the director, officer, employee or agent is proper in the circumstances because he or she has met the applicable standard of conduct expressed in Sections 10.1 Third Party Action or 10.2 Corporation Action. Such determination shall be made by the board of directors by a majority vote of a quorum consisting of directors who were not parties to such action, suit or proceeding, or if such quorum is not obtainable or, even if obtainable, if a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or by the shareholders.

        10.5    Expenses.    Expenses incurred in defending a civil or criminal action, suit or proceeding may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding, as authorized by the board of directors in the specific case, upon receipt of an undertaking by or on behalf of the director, officer, employee or agent to repay such amount, unless it shall ultimately be determined that he or she is entitled to be indemnified by the Corporation as authorized in this Article.

        10.6    Non-Exclusivity.    The indemnification provided by this Article shall not be deemed exclusive of any other rights to which those seeking indemnification may be entitled under any by-law, the articles of incorporation, agreement, vote of shareholders or disinterested directors or otherwise, both as to action in such person's official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a director, officer, employee or agent, and shall inure to the benefit of the heirs, executors and administrators of such a person.

20

        10.7    Insurance.    The Corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the Corporation or who is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against any liability asserted against such person and incurred by such person in any such capacity, or arising out of such person's status as such, whether or not the Corporation would have the power to indemnify such person against such liability under the provisions of this section.

        10.8    Reporting.    If the Corporation has paid indemnity or has advanced expenses to a director, officer, employee or agent, the Corporation shall report the indemnification or advance in writing to the shareholders with or before the notice of the next shareholders meeting.

        10.9    Definitions.    For purposes of this Article, references to "the Corporation" or "this Corporation" shall include, in addition to any surviving corporation, any merging corporation (including any corporation having merged with a merging corporation) absorbed in a merger which, if its separate existence had continued, would have had the power and authority to indemnify its directors, officers and employees or agents, so that any person who was a director, officer, employee or agent of such merging corporation, or was serving at the request of such merging corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprises, shall stand in the same position under the provisions of this Article with respect to the surviving corporation as such person would have with respect to such merging corporation if its separate existence had continued.

        For purposes of this Article, references to "other enterprises" shall include employee benefit plans; references to "fines" shall include any excise taxes assessed on a person with respect to an employee benefit plan; and references to "serving at the request of the Corporation" shall include any service as a director, officer, employee or agent of the Corporation which imposes duties on, or involves services by such director, officer, employee or agent with respect to an employee benefit plan, its participants or beneficiaries. A person who acted in good faith and in a manner

21

he or she reasonably believed to be in the best interests of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interest of the Corporation" as referred to in this Article.

ARTICLE XI: Amendments

        These By-Laws may be made, altered, amended or repealed by the shareholders or the Board of Directors. Any By-Law made, altered, amended or repealed by the shareholders may be altered, amended or repealed by the Board of Directors, or by the shareholders.

22

QuickLinks

Exhibit 3.2

EX-99.1

QuickLinks -- Click here to rapidly navigate through this document

Exhibit 99.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of RLI Corp. (the "Company") on Form 10-Q for the period ending September 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Jonathan E. Michael, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

        (1)  The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, and

        (2)  The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

/s/  JONATHAN E. MICHAEL

Jonathan E. Michael
President & CEO
November 4, 2002

QuickLinks

Exhibit 99.1

EX-99.2

QuickLinks -- Click here to rapidly navigate through this document

Exhibit 99.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of RLI Corp. (the "Company") on Form 10-Q for the period ending September 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Joseph E. Dondanville, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

        (1)  The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, and

        (2)  The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

/s/  JOSEPH E. DONDANVILLE

Joseph E. Dondanville
Senior VP, Chief Financial Officer
November 4, 2002

QuickLinks

Exhibit 99.2