10-Q 1 j4527_10q.htm 10-Q

 

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 June 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

 

37-0889946

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification Number)

 

 

 

9025 North Lindbergh Drive, Peoria, IL

 

61615

(Address of principal executive offices)

 

(Zip Code)

 

 

 

(309) 692-1000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

 

Yes  ý                 No o

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

As of August 9, 2002 the number of shares outstanding of the registrant’s Common Stock was 9,934,612.

 

 



 

PART I

Item 1. Financial Statements

 

RLI Corp. & Subsidiaries

Condensed Consolidated Statement of Earnings and Comprehensive Earnings

For the Three-Month Period Ended June 30,

 

(Unaudited)

 

2002

 

2001

 

 

 

 

 

 

 

Net premiums earned

 

$

81,685,994

 

$

66,638,765

 

Net investment income

 

9,571,744

 

7,709,119

 

Net realized investment gains

 

1,076,701

 

517,467

 

 

 

92,334,439

 

74,865,351

 

Losses and settlement expenses

 

47,356,407

 

38,748,891

 

Policy acquisition costs

 

25,127,461

 

21,693,578

 

Insurance operating expenses

 

6,584,895

 

4,616,059

 

Interest expense on debt

 

481,402

 

811,399

 

General corporate expenses

 

888,449

 

619,228

 

 

 

80,438,614

 

66,489,155

 

Equity in earnings of uncons. Investee

 

1,906,137

 

1,742,769

 

Earnings before income taxes & cumulative effect

 

13,801,962

 

10,118,965

 

Income tax expense

 

3,848,582

 

2,714,999

 

Earnings before cumulative effect

 

9,953,380

 

7,403,966

 

Cumulative effect of initial adoption of SFAS 133

 

0

 

800,415

 

Net earnings

 

$

9,953,380

 

$

8,204,381

 

 

 

 

 

 

 

Other compre. earnings (loss), net of tax

 

(14,644,052

)

3,012,455

 

Comprehensive earnings (loss)

 

$

(4,690,672 

)

$

11,216,836

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

Basic:

 

 

 

 

 

Net earnings per share from operations

 

$

0.93

 

$

0.72

 

Realized gains, net of tax

 

$

0.07

 

$

0.04

 

Basic earnings per share before cumulative effect

 

$

1.00

 

$

0.76

 

Cumulative effect of SFAS 133 adoption

 

$

0.00

 

$

0.08

 

Basic net earnings per share

 

$

1.00

 

$

0.84

 

 

 

 

 

 

 

Basic compre. earnings (loss) per share

 

$

(0.47

)

$

1.14

 

 

 

 

 

 

 

Diluted:

 

 

 

 

 

Net earnings per share from operations

 

$

0.90

 

$

0.71

 

Realized gains, net of tax

 

$

0.07

 

$

0.03

 

Diluted earnings per share before cumulative effect

 

$

0.97

 

$

0.74

 

Cumulative effect of SFAS 133 adoption

 

$

0.00

 

$

0.08

 

Diluted net earnings per share

 

$

0.97

 

$

0.82

 

 

 

 

 

 

 

Diluted compre. earnings (loss) per share

 

$

(0.46

)

$

1.12

 

 

 

 

 

 

 

Weighted average number of common shares outstanding

 

 

 

 

 

Basic

 

9,925,844

 

9,813,920

 

Diluted

 

10,231,662

 

9,991,330

 

Cash dividends declared per common share

 

$

0.17

 

$

0.16

 

 

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 Six-Month Period Ended June 30,

 

(Unaudited)

 

2002

 

2001

 

 

 

 

 

 

 

Net premiums earned

 

$

155,788,373

 

$

129,926,210

 

Net investment income

 

18,656,893

 

15,161,259

 

Net realized investment gains

 

2,863,566

 

1,949,205

 

 

 

177,308,832

 

147,036,674

 

Losses and settlement expenses

 

90,470,857

 

74,612,731

 

Policy acquisition costs

 

47,953,419

 

42,305,550

 

Insurance operating expenses

 

12,198,394

 

9,303,278

 

Interest expense on debt

 

905,009

 

2,013,436

 

General corporate expenses

 

1,918,884

 

1,421,329

 

 

 

153,446,563

 

129,656,324

 

Equity in earnings of uncons. investee

 

2,439,341

 

2,275,776

 

Earnings before income taxes & cumulative effect

 

26,301,610

 

19,656,126

 

Income tax expense

 

7,243,086

 

5,118,788

 

Earnings before cumulative effect

 

19,058,524

 

14,537,338

 

Cumulative effect of initial adoption of SFAS 133

 

0

 

800,415

 

Net earnings

 

$

19,058,524

 

$

15,337,753

 

 

 

 

 

 

 

Other compre. earnings (loss), net of tax

 

(12,943,846

)

(11,263,859

)

Comprehensive earnings

 

$

6,114,678

 

$

4,073,894

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

Basic:

 

 

 

 

 

Net earnings per share from operations

 

$

1.73

 

$

1.35

 

Realized gains, net of tax

 

$

0.19

 

$

0.13

 

Basic earnings per share before cumulative effect

 

$

1.92

 

$

1.48

 

Cumulative effect of SFAS 133 adoption

 

$

0.00

 

$

0.08

 

Basic net earnings per share

 

$

1.92

 

$

1.56

 

 

 

 

 

 

 

Basic compre. earnings per share

 

$

0.62

 

$

0.42

 

Diluted:

 

 

 

 

 

Net earnings per share from operations

 

$

1.69

 

$

1.32

 

Realized gains, net of tax

 

$

0.18

 

$

0.13

 

Diluted earnings per share before cumulative effect

 

$

1.87

 

$

1.45

 

Cumulative effect of SFAS 133 adoption

 

$

0.00

 

$

0.08

 

Diluted net earnings per share

 

$

1.87

 

$

1.53

 

 

 

 

 

 

 

Diluted compre. earnings per share

 

$

0.60

 

$

0.41

 

 

 

 

 

 

 

Weighted average number of common shares outstanding

 

 

 

 

 

Basic

 

9,921,946

 

9,812,593

 

Diluted

 

10,202,535

 

9,999,032

 

Cash dividends declared per common share

 

$

0.33

 

$

0.31

 

 

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

 

3



 

RLI Corp. and Subsidiaries Condensed Consolidated Balance Sheet

 

 

 

June 30, 2002

 

December 31, 2001

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Investments

 

 

 

 

 

Fixed maturities

 

 

 

 

 

Held-to-maturity, at amortized cost

 

$

247,560,136

 

$

263,029,279

 

Trading, at fair value

 

7,737,805

 

7,568,299

 

Available-for-sale, at fair value

 

270,067,758

 

191,675,513

 

Equity securities, at fair value

 

259,880,999

 

277,621,467

 

Short-term investments, at cost

 

45,792,852

 

53,648,406

 

Total investments

 

831,039,550

 

793,542,964

 

Accrued investment income

 

8,749,113

 

7,869,914

 

Premiums and reinsurance balances receivable

 

138,762,068

 

105,167,722

 

Ceded unearned premium

 

93,050,967

 

66,626,272

 

Reinsurance balances recoverable on unpaid losses

 

324,416,458

 

277,255,399

 

Deferred policy acquisition costs

 

55,640,093

 

52,871,630

 

Property and equipment

 

18,819,640

 

18,438,338

 

Investment in unconsolidated investee

 

23,375,628

 

20,892,696

 

Goodwill

 

28,928,955

 

28,458,957

 

Other assets

 

19,534,815

 

19,845,891

 

TOTAL ASSETS

 

$

1,542,317,287

 

$

1,390,969,783

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Liabilities:

 

 

 

 

 

Unpaid losses and settlement expenses

 

$

683,650,964

 

$

604,505,055

 

Unearned premiums

 

315,758,987

 

256,449,724

 

Reinsurance balances payable

 

73,728,357

 

58,438,042

 

Short-term debt, LOC and notes payable

 

76,508,750

 

77,239,125

 

Income Taxes- current

 

666,177

 

1,115,618

 

Income taxes-deferred

 

34,673,145

 

43,151,188

 

Other liabilities

 

18,810,189

 

14,639,233

 

TOTAL LIABILITIES

 

1,203,796,569

 

1,055,537,985

 

 

 

 

 

 

 

Shareholders’ Equity:

 

 

 

 

 

Common stock  ($1 par value, authorized) (12,833,835 shares issued at 6/30/02) (12,820,727 shares issued at 12/31/01)

 

12,833,835

 

12,820,727

 

Paid-In Capital

 

73,387,915

 

73,181,415

 

Accumulated other comprehensive earnings

 

80,531,768

 

93,475,614

 

Retained Earnings

 

252,789,250

 

237,006,454

 

Deferred compensation

 

5,331,412

 

6,039,586

 

Less: Treasury shares at cost
(2,901,908 shares at 6/30/02)
(2,908,131 shares at 12/31/01)

 

(86,353,462

)

(87,091,998

)

TOTAL SHAREHOLDERS’ EQUITY

 

338,520,718

 

335,431,798

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

 

$

1,542,317,287

 

$

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 Six-Month Period
Ended June 30,

 

 

 

2002

 

2001

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

58,510,715

 

$

15,483,479

 

Cash Flows from Investing Activities

 

 

 

 

 

Investments purchased

 

(117,729,272

)

(84,639,713

)

Issuance of note receivable

 

0

 

(6,000,000

)

Investments sold

 

33,542,553

 

32,240,656

 

Investments called or matured

 

22,855,534

 

34,318,271

 

Net decrease in short-term investments

 

8,181,367

 

25,321,786

 

Net property and equipment purchased

 

(2,182,175

)

(1,195,294

)

Net cash used in investing activities

 

(55,331,993

)

45,706

 

 

 

 

 

 

 

Cash Flows from Financing Activities

 

 

 

 

 

Cash dividends paid

 

(3,173,319

)

(2,942,325

)

Proceeds from issuance of notes payable

 

32,500

 

0

 

Payments on debt

 

(762,875

)

(12,864,695

)

Change in contributed capital

 

415,373

 

334,678

 

Treasury shares reissued

 

309,599

 

0

 

Treasury shares purchased

 

0

 

(56,843

)

Net cash used in financing activities

 

(3,178,722

)

(15,529,185

)

Net increase in cash

 

0

 

0

 

Cash at the beginning of the year

 

0

 

0

 

Cash at June 30

 

$

0

 

$

0

 

 

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

 

5



 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1.                            SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - The financial information is prepared in conformity with 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 six-month periods ended June 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.

 

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.

 

 

 

For the Six-Month Period Ended June 30, 2002

 

 

 

Income
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

Basic EPS

 

 

 

 

 

 

 

Income available to common stockholders

 

$

19,058,524

 

9,921,946

 

$

1.92

 

 

 

 

 

 

 

 

 

Effect of Dilutive Securities

 

 

 

 

 

 

 

Incentive Stock Options

 

 

280,589

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Income available to common stockholders

 

$

19,058,524

 

10,202,535

 

$

1.87

 

 

6



 

 

 

For the Six-Month Period Ended June 30, 2001

 

 

 

Income
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

Basic EPS

 

 

 

 

 

 

 

Income available to common stockholders

 

$

15,337,753

 

9,812,593

 

$

1.56

 

 

 

 

 

 

 

 

 

Effect of Dilutive Securities

 

 

 

 

 

 

 

Incentive Stock Options

 

 

186,439

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Income available to common stockholders

 

$

15,337,753

 

9,999,032

 

$

1.53

 

 

Other Accounting Standards: In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 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 tax.  The change in fair value of this instrument from April 1 to June 30, 2001 totaled $374,000 and was recorded through the statement of earnings as net investment income.

 

During the first six months of 2002, the Company recorded $1.1 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.

 

7



 

Amortization of intangible assets was $253,000 in the first six months of 2002 compared to $1.1 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 June 30, 2002, net intangible assets totaled $2.1 million, net of $2.1 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 June 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 six months and three months ended June 30, 2001.

 

 

 

For the Six-Month Period
Ended June 30,

 

 

 

2002

 

2001

 

 

 

 

 

 

 

Net income, as originally reported

 

$

19,058,324

 

$

15,337,753

 

Add back: goodwill amortization expense, net of tax

 

 

844,470

 

Adjusted net income

 

19,058,324

 

16,182,223

 

 

 

 

 

 

 

Basic earnings per share:

 

 

 

 

 

As originally reported

 

$

1.92

 

$

1.56

 

Add back: goodwill amortization

 

 

0.09

 

As adjusted

 

1.92

 

1.65

 

 

 

 

 

 

 

Diluted earnings per share:

 

 

 

 

 

As originally reported

 

$

1.87

 

$

1.53

 

Add back: goodwill amortization

 

 

0.08

 

As adjusted

 

1.87

 

1.61

 

 

8



 

 

 

For the Three-Month Period
Ended June 30,

 

 

 

2002

 

2001

 

 

 

 

 

 

 

Net income, as originally reported

 

$

9,953,380

 

$

8,204,381

 

Add back: goodwill amortization expense, net of tax

 

 

432,975

 

Adjusted net income

 

9,953,380

 

8,637,356

 

 

 

 

 

 

 

Basic earnings per share:

 

 

 

 

 

As originally reported

 

$

1.00

 

$

0.84

 

Add back: goodwill amortization

 

 

0.04

 

As adjusted

 

1.00

 

0.88

 

 

 

 

 

 

 

Diluted earnings per share:

 

 

 

 

 

As originally reported

 

$

0.97

 

$

0.82

 

Add back: goodwill amortization

 

 

0.04

 

As adjusted

 

0.97

 

0.86

 

 

In August 2001, the FASB issued SFAS No. 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 No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” which supersedes SFAS No. 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 No. 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 No. 145, “Recission of FASB Statements No. 4, 44, 64, Amendment of FASB Statement No. 13, Technical Corrections.”  This Statement will rescind FASB Statements No. 4, 44, and 64, amend FASB Statement No. 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.

 

In April 2002, the FASB issued SFAS No. 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 No. 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.

 

The provisions of SFAS 143, 144, 145, and 146 do not have a material impact on the Company’s consolidated financial statements.

 

9



 

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

 

SEGMENT DATA— (in thousands)

 

EARNINGS

 

REVENUES

 

 

 

2002

 

2001

 

2002

 

2001

 

Property

 

7,072

 

2,693

 

41,176

 

34,881

 

Casualty

 

(628

)

(708 

)

90,118

 

74,190

 

Surety

 

(1,278

)

1,719

 

24,494

 

20,855

 

Net investment income

 

18,657

 

15,161

 

18,657

 

15,161

 

Realized gains

 

2,864

 

1,949

 

2,864

 

1,949

 

General corporate expense and interest on debt

 

(2,824

)

(3,433

)

 

 

 

 

Equity in earnings of unconsolidated investee

 

2,439

 

2,276

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total segment earnings before income taxes and cumulative effect

 

26,302

 

19,657

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income taxes

 

7,243

 

5,119

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings before cumulative effect

 

19,059

 

14,538

 

 

 

 

 

Cumulative effect of initial adoption of SFAS 133

 

0

 

800

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

19,059

 

15,338 

 

177,309

 

147,036

 

 

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, through its subsidiaries, underwrites selected property and casualty insurance products.

 

The most significant operation is RLI Insurance Group (the Group), which provides specialty property and casualty coverages for primarily commercial risks. The Group accounted for 88% of the Company’s total revenue for the first six months of 2002 and 2001.

 

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

 

10



 

results could differ significantly from those estimates.

 

The most critical accounting policies involve significant estimates and include those used in determining the liability for unpaid losses and settlement expenses, investment valuation, recoverability of reinsurance balances 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.

 

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, specific credit issues related to the issuer and current economic conditions.  Impairment losses result in a reduction of the cost basis of the underlying investment.  Significant changes in the factors the Company considers when evaluating investments for impairment losses could result in a significant change in 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.  Additionally, the same uncertainties associated with estimating unpaid losses and settlement expenses impact the estimates for the ceded portion of such liabilities.  The Company continuously 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.

 

Recoverability of Deferred Policy Acquisition Costs

 

Insurance premiums are amortized over the life of the policies in order to properly match policy acquisition costs to the related premium revenue.  The

 

11



 

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, 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.

 

SIX MONTHS ENDED JUNE 30, 2002, COMPARED TO SIX MONTHS ENDED JUNE 30, 2001

 

Consolidated gross sales, which consist of gross premiums written, net investment income and realized investment gains totaled $361.0 million for the first six months of 2002 compared to $271.2 million for the same period in 2001. Gross writings of the Group improved 33.6% over 2001 levels fueled by increases in all three business segments. Consolidated net revenue for the first six months of 2002 increased $30.3 million or 20.6% from the same period in 2001. Net premiums earned increased 19.9%. Net investment income improved 23.1% to $18.7 million.  Additionally, the sale of certain securities during the first half of 2002 resulted in $2.9 million in realized gains, compared to $1.9 million in realized gains for the same period last year.

 

The net after-tax earnings for the first six months of 2002 totaled $19.1 million, $1.87 per diluted share, compared to $15.3 million, $1.53 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 ($0.08 per share) in net after-tax earnings.  Net operating earnings, which consist of the Company’s net earnings reduced by after-tax realized investment gains/losses and cumulative-effect adjustments, totaled $17.2 million, $1.69 per diluted share, compared to $13.3 million, $1.32 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 six 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 $880,000 ($0.08 per diluted share), as a result of decreased amortization expense.  Investment income improved during 2002 due to strong cash flow and $1.1 million($0.07 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 six months of 2001, $374,000 ($0.02 per diluted share) of investment income was recorded for these warrants.  Additionally, first half 2001 results were negatively impacted by losses on the property segment, including Seattle earthquake losses, which totaled just under $1.0 million ($0.06 per diluted share).

 

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 half of 2002 totaled $6.1 million, $.60 per diluted share, compared to $4.1 million, $.41 per diluted share, for the same period in 2001. Unrealized losses, net of tax, for the first six months of 2002 were $12.9 million, $1.27 per diluted share compared to losses of $11.3 million, $1.12 per diluted share, for the same period in 2001.

 

12



 

RLI INSURANCE GROUP

 

Gross written premium for the Group increased to $339.5 million for the first half of 2002 compared to $254.1 million for the same period in 2001.  Improved pricing across all three business segments and various growth initiatives have positively impacted the top-line.  Underwriting income improved to a pre-tax profit of $5.2 million for the first six months of 2002 compared to $3.7 million for the same period in 2001. The GAAP combined ratio declined slightly to 96.7 for the first half of 2002 compared to 97.1 for the same period in 2001.  The property segment was responsible for the majority of the improved results, recording an 82.8 combined ratio, compared to a 92.3 result for the first half of 2001, which was impacted by property losses, including the Seattle earthquake.  Additionally, the casualty segment recorded slightly improved earnings over the same period 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 $23.8 million, or 29%, compared to the first half of 2001.  For the first half of 2002, property premiums totaled $106.1 million.  Fueled by the improved rate environment, difference-in-condition writings improved $9.0 million over 2001, and fire writings grew by $13.9 million.  Additionally, construction writings increased $3.5 million to $21.0 million.  Partially offsetting this increase, however, ocean marine writings declined $2.2 million, as the Company discontinued this line of business.  Underwriting profit for the property segment was $7.1 million for the first half of 2002, compared to $2.7 million in 2001.  The GAAP combined ratio decreased to 82.8 compared to 92.3 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 $200.8 million for the first half of 2002, up $55.7 million, or 38.4%, from 2001.  Growth initiatives and improved pricing contributed to growth in the following products: program business up $37.0 million, general liability up $16.7 million, and executive products up $13.3 million.  Partially offsetting these increases, commercial umbrella declined $14.3 million, due to the re-underwriting of the book.  Underwriting loss on the casualty book was $628,000 compared to a loss of 708,000 for the first half of 2001. These results translate into a combined ratio of 100.7 in 2002 versus 101.0 for the same period in 2001.  The segment’s expense ratio at 31.0 has continued to show improvement, as premium volume has continued to increase, while the loss ratio at 69.7 remains in check.

 

Gross written premiums for the surety segment increased to $32.6 million for the first half of 2002, up $5.9 million, or 21.9%, from the same period in 2001.  Growth is evident across all surety lines, including contract, oil and gas, commercial and miscellaneous.  Contract premium is up $1.3 million over the first six months of 2001, primarily driven by increased rates.  Commercial surety is up $2.6 million over the first six months of 2001.  This product was launched during the first half of 2001.  Additionally, oil and gas premium is up $1.2 million over 2001 levels, due to increased commodity prices and achieved rate increases.  The surety book reported an underwriting loss of $1.3 million, compared to an underwriting gain of $1.7 million for the first half of 2001.  The combined ratio for the surety segment totaled 105.3 in 2002 compared to 91.8 in 2001.  The loss ratio component increased to 40.4 compared to 29.1 last year, as a result of national economic conditions that negatively

 

13



 

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.  The expense ratio increased to 64.9 compared to 62.7 last year, primarily due to increased reinsurance costs.

 

INVESTMENT INCOME

 

The Company’s investment portfolio generated net dividends and interest income of $18.7 million during the first six months of 2002, an increase of 23.1% 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 $1.1 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 $374,000 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 gain from investments of $2.9 million in the first six months of 2002, compared to a net realized gain of $1.9 million for the same period in 2001. The majority of gains realized in the first six months of 2002 were the result of the sale of certain fixed income and equity securities.  For the six months ended June 30, 2002, the Company experienced a $20.0 million pre-tax unrealized loss on its investment portfolio.

 

Virtually all the Company’s fixed income portfolio consists of securities rated A or better, with 84% rated AA or better.  The year-to-date yields on the Company’s fixed income investments for the six-month periods ended June 30, 2002 and 2001 are as follows:

 

 

 

2002

 

2001

 

 

 

 

 

 

 

Taxable

 

6.25

%

6.59

%

Non-taxable

 

4.90

%

5.00

%

 

For the first six 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 $20.0 million for the first six months of 2002, compared with a $17.3 million loss for the same period in 2001.  The 2002 year-to-date loss reflects largely stock market fluctuations experienced during the first six months of the year.   The Company’s net cumulative unrealized gain before tax was $123.5 million, down from $143.5 million at December 31, 2001.  Unrealized appreciation on securities, net of tax, is

 

14



 

reflected in accumulated other comprehensive earnings, a component of shareholders’ equity.

 

Interest expense on debt obligations decreased to $905,000 for the first six months of 2002, a $1.1 million decrease from the same period in 2001.  This change is related to decreased debt costs resulting from falling interest rates, offset by a $6.7 million increase in average outstanding debt.  Interest expense has been incurred at a rate of 2.36% for the first six months of 2002 compared to a rate of 5.74% for the same period last year.  At June 30, 2002, outstanding short-term balances totaled $76.5 million, compared to $65.9 million at June 30, 2001.

 

INCOME TAXES

 

The Company’s effective tax rate for the first six months of 2002 was 28% compared to 26% for the same period in 2001.  The change in the effective rate is reflective of an increase in underwriting profits, which are taxed at the 35% 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 first six 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%

 

$

9,205,564

 

35

%

$

6,879,644

 

35

%

Increase (reduction) in taxes resulting from:

 

 

 

 

 

 

 

 

 

Tax exempt interest income

 

(1,421,506

)

(5

)%

(1,411,422

(7

)% 

Dividends received deduction

 

(778,551

)

(3

)%

(725,753

(4

)% 

Dividends paid deduction

 

(151,809

)

(1

)%

(136,166

(1

)% 

Goodwill amortization

 

0

 

0

%

277,622

 

2

%

State tax and other items, net

 

389,388

 

2

%

234,863

 

1

%

 

 

 

 

 

 

 

 

 

 

Total tax expense

 

$

7,243,086

 

28

%

$

5,118,788

 

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 did not repurchase any of its outstanding shares during the first six months of 2002.  During the first six months of 2001, the Company retired 1,272 outstanding shares at a cost of $57,000.

 

Invested assets at June 30, 2002 increased by $37.5 million, or 4.7%, 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 $20.0 million.

 

15



 

At June 30, 2002 the Company had short-term investments, cash and other investments maturing within one year, of approximately $92.9 million and additional investments of $146.1 million maturing within five years.  The Company maintains one primary source of credit, a $40.0 million line of credit that cannot be canceled during its annual term.  As of June 30, 2002, the Company had $30.0 million in outstanding short-term borrowings on this facility.  Additionally, the Company was party to four reverse repurchase transactions totaling $46.5 million.

 

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

 

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

 

Consolidated gross sales, which consist of gross premiums written, net investment income and realized investment gains totaled $193.8 million for the second quarter of 2002 compared to $142.2 million for the same period in 2001. Gross writings of the Group improved 36.7% over 2001 levels fueled by increases in all three business segments. Consolidated net revenue for the second quarter of 2002 increased $17.5 million or 23.3% from the same period in 2001. Net premiums earned increased 22.6%. Net investment income improved 24.2% to $9.6 million.  Additionally, the sale of certain securities during the second quarter of 2002 resulted in $1.1 million in realized gains, compared to $517,000 in realized gains for the same period last year.

 

The net after-tax earnings for the second quarter of 2002 totaled $10.0 million, $.97 per diluted share, compared to $8.2 million, $.82 per diluted share, for the same period in 2001.  As mentioned previously, the cumulative-effect adjustment for the initial adoption of SFAS 133 totaled $800,415($0.08 per share) and is included in the second quarter 2001 net after-tax earnings number.  Net operating earnings, which consist of the Company’s net earnings reduced by after-tax realized investment gains/losses and cumulative-effect adjustment, totaled $9.3 million, $.90 per diluted share, compared to $7.1 million, $.71 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 second quarter 2002 earnings.  Additionally, second 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 second quarter 2002 earnings by $440,000 ($0.04 per diluted share), as a result of decreased amortization expense.  Investment income continued to improve during the second quarter of 2002, due to strong cash flow and $481,000($0.03 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 second quarter 2001, $374,000 of investment income was recorded for the change in fair value of these warrants from the initial adoption, April 1, through June 30.

 

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 second quarter of 2002 totaled a loss

 

16



 

of $4.7 million, $.46 per diluted share, compared to comprehensive earnings of $11.2 million, $1.12 per diluted share, for the same period in 2001. Unrealized losses, net of tax, for the second quarter of 2002 were $14.6 million, $1.43 per diluted share compared to unrealized gains of $3.0 million, $.30 per diluted share, for the same period in 2001.

 

RLI  INSURANCE GROUP

 

Gross written premium for the Group increased to $183.2 million for the second quarter of 2002 compared to $134.0 million for the same period in 2001.  Improved pricing across all three business segments and various growth initiatives have positively impacted the top-line.  Underwriting income improved to a pre-tax profit of $2.6 million for the second quarter of 2002 compared to $1.6 million for the same period in 2001. The GAAP combined ratio declined slightly to 96.8 for the second quarter of 2002 compared to 97.6 for the second quarter of 2001.  The property segment was responsible for the majority of the improved results posting a 79.9 combined ratio.  The casualty segment reported a 100.5 combined ratio, in line with second quarter 2001.  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 $11.7 million, or 25.8%, compared to second quarter 2001.  For the second quarter of 2002, property premiums totaled $56.9 million.  Fueled by the improved rate environment, difference-in-condition writings improved by $4.4 million over 2001, and fire writings grew by $6.9 million.  Due to exceptional seasonal results, underwriting profit for the property segment was $4.2 million for the second quarter of 2002, compared to $1.1 million in 2001. The GAAP combined ratio decreased to 79.9 compared to 93.7 for the same period last year.  Loss experience on discontinued property classes negatively impacted 2001 results.

 

Gross written premiums for the casualty segment were $109.8 million for the second quarter of 2002, up $36.6 million, or 49.9%, from 2001.  Growth initiatives and improved pricing contributed to growth in the following products: program business up $25.2 million, general liability up $10.0 million, executive products up $4.1 million, and transportation up $1.6 million.  Partially offsetting these increases, commercial umbrella declined $7.3 million, due to the re-underwriting of the book.  Underwriting loss on the casualty book was $286,000 compared to a loss of $94,000 for the second quarter of 2001. These results translate into a combined ratio of 100.5 in 2002 versus 100.2 for the same period in 2001.  The segment’s expense ratio at 31.7 has continued to show improvement, as premium volume has continued to increase, while the loss ratio at 68.8 remains in check.

 

Gross written premiums for the surety segment were $16.4 million for the second quarter of 2002, up 6.3%, from the same period in 2001. Growth has primarily been achieved through increased rates.  The combined ratio for the surety segment totaled 111.4 in 2002 compared to 94.9 in 2001.  The loss ratio component increased to 46.6 compared to 32.1 last year, as a result of national economic conditions that negatively impacted contract surety loss experience.  The expense ratio increased to 64.8 compared to 62.8 last year, primarily due to increased reinsurance costs.

 

17



 

INVESTMENT INCOME

 

The Company’s investment portfolio generated net dividends and interest income of $9.6 million during the second quarter of 2002, an increase of 24.2% 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 $481,000 in net investment income during the second 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 $374,000 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 gain from investments of $1.1 million in the second quarter of 2002, compared to a net realized gain of $517,000 for the same period in 2001.  The majority of gains realized in the second quarter of 2002 were the result of the sale of certain fixed income and equity securities.

 

INCOME TAXES

 

The Company’s effective tax rate for the second quarter of 2002 was 28% compared to 27% reported for the same period in 2001. Income tax expense attributable to income from operations differed from the amounts computed by applying the U.S. federal tax rate of 35% to pretax income for the second quarter of 2002 and 2001 as a result of the following:

 

 

 

2002

 

2001

 

 

 

Amount

 

%

 

Amount

 

%

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes at the statutory rate of 35%

 

$

4,830,687

 

35

%

$

3,541,638

 

35

%

Increase (reduction) in taxes resulting from:

 

 

 

 

 

 

 

 

 

Tax exempt interest income

 

(723,686 

)

(5

)%

(703,804

(7

)% 

Dividends received deduction

 

(388,386 

)

(3

)%

(349,859

(3

)% 

Dividends paid deduction

 

(73,488 

)

(1

)%

(69,723

(1

)% 

Goodwill amortization

 

0

 

0

%

138,811

 

1

%

State tax and other items, net

 

203,455

 

2

%

157,936

 

2

%

 

 

 

 

 

 

 

 

 

 

Total tax expense

 

$

3,848,582

 

28

%

$

2,714,999

 

27

%

 

18



 

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 June 30, 2002, have not materially changed from those identified at December 31, 2001.

 

19



 

PART II - OTHER INFORMATION

 

Item 1.       Legal Proceedings - Not Applicable

 

Item 2.       Change in Securities - Not Applicable

 

Item 3.       Defaults Upon Senior Securities - Not Applicable

 

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

On May 2, 2002, at the Company’s Annual Meeting of Shareholders, the following members were elected to the Board of Directors:

William R. Keane                         Gerald I. Lenrow

Edwin S. Overman

 

Item 5.       Other Information - Not Applicable

 

Item 6.       Exhibits and Reports on Form 8-K

 

(a)                                  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

 

(b)                                 The Company did not file any reports on Form 8-K during the three months ended June 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: August 12, 2002

 

 

 

20