10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended December 31, 2008
	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   001-09463

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 No.)
9025 North Lindbergh Drive, Peoria, Illinois	61615
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code          (309) 692-1000

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Name of each exchange on which registered
Common Stock $1.00 par value	New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:          NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
	Yes x	No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
	Yes o	No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
	Yes x	No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
		x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x	Accelerated filer o	Non-accelerated filer o	Smaller reporting company o
		(Do not check if a smaller
		reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
	Yes o	No x

The aggregate market value of the registrant’s common stock held by non-affiliates of the Registrant as of June 30, 2008, based upon the closing sale price of the Common Stock on June 30, 2008 as reported on the New York Stock Exchange, was $876,307,820.  Shares of Common Stock held directly or indirectly by each officer and director along with shares held by the Company ESOP have been excluded in that such persons may be deemed to be affiliates.  This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of shares outstanding of the Registrant’s Common Stock, $1.00 par value, on February 13, 2009 was 21,494,311.

DOCUMENTS INCORPORATED BY REFERENCE.

Portions of the 2008 Financial Report to Shareholders for the past year ended December 31, 2008, are incorporated by reference into Parts I and II of this document.

Portions of the Registrant’s definitive Proxy Statement for the 2009 annual meeting of security holders to be held May 7, 2009, are incorporated herein by reference into Part III of this document.

Exhibit index is located on pages 57-58 of this document, which lists documents incorporated by reference herein.

PART I

Item 1.  Business

RLI Corp. underwrites selected property and casualty insurance through major subsidiaries collectively known as RLI Insurance Group.  We conduct operations principally through three insurance companies. RLI Insurance Company, our principal subsidiary, writes multiple lines insurance on an admitted basis in all 50 states, the District of Columbia and Puerto Rico. Mt. Hawley Insurance Company, a subsidiary of RLI Insurance Company, writes surplus lines insurance in all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam. RLI Indemnity Company, a subsidiary of Mt. Hawley Insurance Company, has authority to write multiple lines of insurance on an admitted basis in 49 states and the District of Columbia.  We are an Illinois corporation that was organized in 1965.  We have no material foreign operations.

We maintain an Internet website at http://www.rlicorp.com. We make available free of charge on our website our annual report on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed with or furnished to the Securities and Exchange Commission as soon as reasonably practicable after such materials are filed or furnished.

As a “niche” company, we offer specialty insurance coverages designed to meet specific insurance needs of targeted insured groups and underwrite particular types of coverage for certain markets that are underserved by the insurance industry, such as our difference in conditions coverages or oil and gas surety bonds. We also provide types of coverages not generally offered by other companies, such as our stand-alone personal umbrella policy. The excess and surplus market, which unlike the standard admitted market is less regulated and more flexible in terms of policy forms and premium rates, provides an alternative market for customers with hard-to-place risks. When we underwrite within the surplus lines market, we are selective in the line of business and type of risks we choose to write.  Using our non-admitted status in this market allows us to tailor terms and conditions to manage these exposures more effectively than our admitted counterparts. Often the development of these specialty insurance coverages is generated through proposals brought to us by an agent or broker seeking coverage for a specific group of clients. Once a proposal is submitted, underwriters determine whether it would be a viable product in keeping with our business objectives.

We initially wrote specialty property and casualty insurance through independent underwriting agents. We opened our first branch office in 1984, and began to shift from independent underwriting agents to wholly-owned branch offices that market to wholesale producers. We also market certain coverages to retail producers from several of our casualty, surety and property operations. We produce a limited amount of business under agreements with managing general agents under the direction of our product vice presidents. The majority of business is marketed through our branch offices located throughout the United States.

For the year ended December 31, 2008, the following table provides the geographic distribution of our risks insured as represented by direct premiums earned for all coverages. For the year ended December 31, 2008, no other state accounted for 1.5 percent or more of total direct premiums earned for all coverages.

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State	Direct Premiums Earned		Percent of Total
	(in thousands)
California	$	130,780	18.8	%
New York	106,108		15.2	%
Florida	88,000		12.6	%
Texas	55,888		8.0	%
New Jersey	25,787		3.7	%
Illinois	19,272		2.8	%
Washington	18,413		2.6	%
Pennsylvania	16,970		2.4	%
Hawaii	16,544		2.4	%
Louisiana	14,851		2.1	%
Massachusetts	11,257		1.6	%
Michigan	10,867		1.6	%
Ohio	10,465		1.5	%
Arizona	10,402		1.5	%
All Other	160,219		23.2	%
Total direct premiums	$	695,823	100.0	%

                In the ordinary course of business, we rely on other insurance companies to share risks through reinsurance. A large portion of the reinsurance is put into effect under contracts known as treaties and, in some instances, by negotiation on each individual risk (known as facultative reinsurance). We have quota share, excess of loss and catastrophe reinsurance contracts that protect against losses over stipulated amounts arising from any one occurrence or event. The arrangements allow us to pursue greater diversification of business and serve to limit the maximum net loss on catastrophes and large risks. Reinsurance is subject to certain risks, specifically market risk, which affects the cost of and the ability to secure these contracts, and credit risk, which is the risk that our reinsurers may not pay on losses in a timely fashion or at all. The following table illustrates, through premium volume, the degree to which we have utilized reinsurance during the past three years. For an expanded discussion of the impact of reinsurance on our operations, see Note 5 to our audited consolidated financial statements included in our 2008 Financial Report to Shareholders, attached as Exhibit 13 and incorporated by reference herein.

Premiums Written	Year Ended December 31,
(in thousands)	2008			2007			2006
Direct & Assumed	$	681,169		$	739,334		$	799,013
Reinsurance ceded	(167,713		)	(200,571		)	(247,477		)
Net	$	513,456		$	538,763		$	551,536

Specialty Insurance Market Overview

                The specialty insurance market differs significantly from the standard market. In the standard market, insurance rates and forms are highly regulated, products and coverage are largely uniform with relatively predictable exposures, and companies tend to compete for customers on the basis of price. In contrast, the specialty market provides coverage for risks that do not fit the underwriting criteria of the standard carriers. Competition tends to focus less on price and more on availability, service and other value-based considerations. While specialty market exposures may have higher insurance risks than their standard market counterparts, we manage these risks to achieve higher financial returns. To reach our financial and operational goals, we must have extensive knowledge and expertise in our markets. Most of our risks are considered on an individual basis and restricted limits, deductibles, exclusions and surcharges are employed in order to respond to distinctive risk characteristics.

                We operate in the excess and surplus insurance market and the specialty admitted insurance market.

Excess and Surplus Insurance Market

                The excess and surplus market focuses on hard-to-place risks. Excess and surplus eligibility allows us to underwrite nonstandard market risks with more flexible policy forms and unregulated premium rates. This typically results in coverages that are more restrictive and more expensive than in the standard admitted market. The excess and surplus lines regulatory environment and production model also effectively filters submission flow and matches market opportunities to

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our expertise and appetite.  In 2008, the excess and surplus market represented approximately $27 billion, or 5 percent, of the entire $504 billion domestic property and casualty industry, as measured by direct premiums written. Our excess and surplus operation wrote gross premiums of $321.6 million, or 47 percent, of our total gross premiums written.

Specialty Admitted Insurance Market

                We also write business in the specialty admitted market. Most of these risks are unique and hard to place in the standard market, but for marketing and regulatory reasons, they must remain with an admitted insurance company. The specialty admitted market is subject to greater state regulation than the excess and surplus market, particularly with regard to rate and form filing requirements, restrictions on the ability to exit lines of business, premium tax payments and membership in various state associations, such as state guaranty funds and assigned risk plans. For 2008, our specialty admitted operations wrote gross premiums of $359.6 million representing approximately 53 percent of our total gross premiums written for the year.

Business Segment Overview

                Our segment data is derived using the guidance set forth in Statement of Financial Accounting Standards (SFAS) 131, “Disclosures about Segments of an Enterprise and Related Information.”  As prescribed by the pronouncement, reporting is based on the internal structure and reporting of information as it is used by management.  The segments of our insurance operations are casualty, property and surety.  For additional information, see Note 11 to our audited consolidated financial statements included in our 2008 Financial Report to Shareholders, attached as Exhibit 13 and incorporated by reference herein.

Casualty Segment

General Liability

                Our general liability business consists primarily of coverage for third party liability of commercial insureds including manufacturers, contractors, apartments and mercantile. Net premiums earned from this business totaled $140.9 million, $167.9 million and $180.0 million, or 25 percent, 26 percent, and 28 percent of consolidated revenues for 2008, 2007, and 2006, respectively.

Commercial and Personal Umbrella Liability

                Our commercial umbrella coverage is principally written in excess of primary liability insurance provided by other carriers and, to a modest degree, in excess of primary liability written by us. The personal umbrella coverage is written in excess of the homeowners and automobile liability coverage provided by other carriers, except in Hawaii, where some underlying homeowners’ coverage is written by us. Net premiums earned from this business totaled $65.1 million, $66.3 million and $64.7 million, or 12 percent, 10 percent, and 10 percent of consolidated revenues for 2008, 2007, and 2006, respectively.

Commercial Transportation

                Our transportation insurance facility in Atlanta provides automobile liability and physical damage insurance to local, intermediate and long haul truckers, public transportation risks and equipment dealers. In early 2005, we expanded our focus to include other types of commercial automobile risks. We also offer incidental, related insurance coverages, including general liability, commercial umbrella and excess liability, and motor truck cargo. The facility is staffed by highly experienced transportation underwriters who produce business through independent agents and brokers nationwide. Net premiums earned from this business totaled $46.7 million, $49.1 million, and $48.3 million, or 8 percent of consolidated revenues for 2008, 2007, and 2006.

Executive Products

                We provide a variety of professional liability coverages, such as directors’ and officers’ (D&O) liability insurance, employment practices liability and other miscellaneous professional liability coverages, for a variety of low to moderate classes of risks. We tend to focus on smaller accounts, avoiding the large account sector which is generally more sensitive to price competition.  Our target accounts include publicly traded companies with market capitalization below $5 billion (where we are writing part of the traditional D&O program), Clause 1 (also known as “Side A” coverage, which is direct liability coverage for the individual directors and officers), private companies, nonprofit organizations, and sole-sponsored and multi-employer fiduciary liability accounts.  We successfully transitioned from primarily writing high layers of excess D&O for publicly traded companies to writing more Clause 1 coverage.  Additionally, we are having success rounding out our portfolio by writing more fiduciary liability coverage, primary and excess D&O coverage for private companies and non-profit organizations.  Net

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premiums earned from this business totaled $13.8 million, $12.0 million, and $13.0 million, or 2 percent of consolidated revenues for 2008, 2007, and 2006.

Specialty Program Business

                We offer program business in a variety of areas, which are typically multiple coverages combined into a package or portfolio policy.  Our program coverages include: commercial property, general liability, inland marine, and crime. We rely primarily on program administrators as sources for this business.    Net premiums earned from this business totaled $31.4 million, $29.4 million, and $25.5 million for 2008, 2007, and 2006, respectively. These amounts represent 6 percent, 5 percent, and 4 percent of consolidated revenues for 2008, 2007, and 2006, respectively.

Other

                We offer a variety of other smaller programs in our casualty segment, including deductible buy-back, at-home business, and employer’s excess indemnity. Net premiums earned from these lines totaled $15.5 million, $18.7 million, and $16.6 million, or 3 percent of consolidated revenues for 2008, 2007, and 2006.

Property Segment

Commercial

                Our commercial property coverage consists primarily of excess and surplus lines and specialty insurance such as fire, earthquake and “difference in conditions,” which can include earthquake, wind, flood and collapse coverages, and inland marine.  We provide insurance for a wide range of commercial and industrial risks, such as office buildings, apartments, condominiums, and certain industrial and mercantile structures. We also write boiler and machinery coverage under the same management as commercial property.  Net premiums earned from commercial property business totaled $85.3 million, $92.6 million, and $91.5 million, or 15 percent, 14 percent, and 14 percent of consolidated revenues for 2008, 2007, and 2006, respectively.

Marine

                In 2005, we launched a new marine insurance division.  Marine coverages include hull, cargo and protection and indemnity (P&I), as well as inland marine coverages including builders’ risks, contractors’ equipment and other “floater” type coverages.  In May 2007, the marine division added specialty cargo coverage that focuses on high-tech and life sciences risks.  In March 2008, the marine division added a yacht program.  In 2008, 2007 and 2006, marine net premiums earned totaled $48.2 million, $32.9 million and $16.8 million, or 9 percent, 5 percent and 3 percent, respectively, of consolidated revenues.

Other

                We offer a variety of other smaller programs in our property segment, including a limited amount of homeowners and dwelling fire insurance in Hawaii.  We have reduced our Hawaii wind exposure through more restrictive underwriting over the last 18 months.

                In July 2007, we launched a new division focusing on facultative reinsurance.  The division is responsible for underwriting property facultative reinsurance for insurance companies utilizing reinsurance intermediaries.

                Net premiums earned from the above coverages totaled $13.4 million, $12.9 million, and $14.3 million, or 2 percent of consolidated revenues for 2008, 2007, and 2006.

Surety Segment

                Our surety segment specializes in writing small-to-large commercial and small contract surety coverages, as well as those for the energy (plugging and abandonment of oil wells), petrochemical, and refining industries. We offer miscellaneous bonds, including license and permit, notary, and court bonds.  In September 2008, we launched a new Fidelity Division focusing on fidelity and crime coverage for commercial insureds and select financial institutions.  These bonds are written through independent agencies as well as regional and national brokers. Net earned premium totaled $68.4 million, $62.7 million, and $59.5 million, or 12 percent, 10 percent and 9 percent of consolidated revenues for 2008, 2007, and 2006, respectively.

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Competition

                Our specialty property and casualty insurance subsidiaries are part of an extremely competitive industry that is cyclical and historically characterized by periods of high premium rates and shortages of underwriting capacity followed by periods of severe competition and excess underwriting capacity. Within the United States alone, approximately 2,400 companies, both stock and mutual, actively market property and casualty coverages. Our primary competitors in our casualty segment are, among others, Ace, Arch, James River, Landmark, Navigators, USLI, Great West, Lancer, National Interstate, Chubb, Philadelphia, Great American, Travelers and CNA. Our primary competitors in our property segment are, among others, Ace, Lexington, Arch, Crum & Forster, Travelers and Markel. Our primary competitors in our surety segment are, among others, Ace, Arch, HCC, CNA, Safeco, North American Specialty, Travelers and Hartford. The combination of coverages, service, pricing and other methods of competition vary from line to line. Our principal methods of meeting this competition are innovative coverages, marketing structure and quality service to the agents and policyholders at a fair price. We compete favorably in part because of our sound financial base and reputation, as well as our broad geographic penetration into all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam. In the property and casualty area, we have acquired experienced underwriting specialists in our branch and home offices. We have continued to maintain our underwriting and marketing standards by not seeking market share at the expense of earnings. We have a track record of withdrawing from markets when conditions become overly adverse. We offer new coverages and new programs where the opportunity exists to provide needed insurance coverage with exceptional service on a profitable basis.

Ratings

A.M. Best ratings for the industry range from ‘‘A++’’ (Superior) to ‘‘F’’ (In Liquidation) with some companies not being rated. Standard & Poor’s ratings for the industry range from ‘‘AAA’’ (Extremely strong) to ‘‘R’’ (Regulatory Action). Moody’s ratings for the industry range from “Aaa” (Exceptional) to “C” (Lowest).  The following table illustrates the range of ratings assigned by each of the three major rating companies that has issued a financial strength rating on our insurance companies:

A.M. Best		Standard & Poor’s		Moody’s
SECURE		SECURE		STRONG
A++, A+	Superior	AAA	Extremely strong	Aaa	Exceptional
A,A-	Excellent	AA	Very strong	Aa	Excellent
B++, B+	Very good	A	Strong	A	Good
		BBB	Good	Baa	Adequate
VULNERABLE		VULNERABLE		WEAK
B,B-	Fair	BB	Marginal	Ba	Questionable
C++,C+	Marginal	B	Weak	B	Poor
C,C-	Weak	CCC	Very weak	Caa	Very poor
D	Poor	CC	Extremely weak	Ca	Extremely poor
E	Under regulatory supervision	R	Regulatory action	C	Lowest
F	In liquidation
S	Rating suspended

Within-category modifiers +,- 1,2,3 (1 high, 3 low)

Publications of A.M. Best, Standard & Poor’s and Moody’s indicate that ‘‘A’’ and ‘‘A+’’ ratings are assigned to those companies that, in their opinion, have achieved excellent overall performance when compared to the standards established by these firms and have a strong ability to meet their obligations to policyholders over a long period of time. In evaluating a company’s financial and operating performance, each of the firms reviews the company’s profitability, leverage and liquidity, as well as the company’s spread of risk, the quality and appropriateness of its reinsurance, the quality and diversification of its assets, the adequacy of its policy and loss reserves, the adequacy of its surplus, its capital structure, its risk management practices and the experience and objectives of its management. These ratings are based on factors relevant to policyholders, agents, insurance brokers and intermediaries and are not directed to the protection of investors.

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At December 31, 2008, the following ratings were assigned to our insurance companies:

A.M. Best
RLI Insurance, Mt. Hawley Insurance, and
RLI Indemnity (RLI Group)	A+, Superior
Standard & Poor’s
RLI Insurance and Mt. Hawley Insurance	A+, Strong
Moody’s
RLI Insurance, Mt. Hawley Insurance and
RLI Indemnity	A2, Good

For A.M Best, Standard & Poor’s and Moody’s, the financial strength ratings represented above are affirmations of previously assigned ratings.  A.M. Best, in addition to assigning a financial strength rating, also assigns financial size categories.  During 2008, RLI Insurance Company, Mt. Hawley Insurance Company and RLI Indemnity Company, collectively referred to as RLI Group, were assigned a financial size category of “X” (adjusted policyholders’ surplus of between $500 and $750 million).  As of December 31, 2008, the policyholders’ statutory surplus of RLI Group totaled $678.0 million.

RLI Corp’s existing $100 million of senior notes maturing in 2014 maintains a Standard & Poor’s rating of  “BBB+”, Moody’s “Baa2”, and a Fitch rating of “BBB.”

Reinsurance

                We reinsure a portion of our property and casualty insurance exposure, paying or ceding to the reinsurer a portion of the premiums received on such policies. Earned premiums ceded to non-affiliated reinsurers totaled $172.3 million, $227.1 million, and $264.5 million in 2008, 2007, and 2006, respectively. Insurance is ceded principally to reduce net liability on individual risks and to protect against catastrophic losses. While reinsurance does not relieve us of our legal liability to our policyholders, we use reinsurance as an alternative to using our own capital to fund losses.  Retention levels are adjusted each year to maintain a balance between the growth in surplus and the cost of reinsurance. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does make the assuming reinsurer liable to the insurer to the extent of the insurance ceded.

Reinsurance is subject to certain risks, specifically market risk (which affects the cost of and the ability to secure reinsurance contracts) and credit risk (which relates to the ability to collect from the reinsurer on our claims). We purchase reinsurance from a number of financially strong reinsurers. We evaluate reinsurers’ ability to pay based on their financial results, level of surplus, financial strength ratings, and other risk characteristics.  A reinsurance committee, comprised of senior management, approves our security guidelines and reinsurer usage.  Each of the top 10 largest reinsurers (listed below and ranked based on amounts recoverable) are rated “A-” or better by A.M. Best and Standard and Poor’s rating services. Additionally, more than 91 percent of our reinsurance recoverables are due from companies rated “A” or better by A.M. Best and Standard & Poor’s rating services.

The following table sets forth the ten largest reinsurers in terms of amounts recoverable, net of collateral we are holding from such reinsurers, as of December 31, 2008. Also shown are the amounts of written premium ceded to these reinsurers during the calendar year 2008.

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			Net Reinsurer				Ceded
	A.M. Best	S & P	Exposure as of		Percent of		Premiums		Percent of
(dollars in thousands)	Rating	Rating	12/31/2008		Total		Written		Total
Munich Re America	A+	AA-	$	59,716	15.9	%	$	23,909	14.3	%
Swiss Re / Westport Ins. Corp.	A+	A+	41,660		11.1	%	8,125		4.8	%
Endurance Re	A	A	40,632		10.8	%	14,750		8.8	%
Axis Re	A	A	32,743		8.7	%	14,931		8.9	%
General Cologne Re	A++	AAA	31,839		8.4	%	2,053		1.2	%
Berkley Insurance Co.	A+	A+	28,202		7.5	%	6,081		3.6	%
Toa-Re	A	A+	17,916		4.7	%	5,476		3.3	%
Lloyds of London	A	A+	15,184		4.0	%	16,319		9.7	%
Ace Property & Casualty	A+	A+	15,078		4.0	%	5,702		3.4	%
Transatlantic Re	A	AA-	14,892		4.0	%	8,558		5.1	%
All other reinsurers			78,513		20.9	%	61,809		36.9	%
Total ceded exposure			$	376,375	100.0	%	$	167,713	100.0	%

We utilize both treaty and facultative reinsurance coverage for our risks. Treaty coverage refers to a reinsurance contract that is applied to a group or class of business where all the risks written meet the criteria for that class.  Facultative coverage is applied to individual risks as opposed to a group or class of business. It is used for a variety of reasons including supplementing the limits provided by the treaty coverage or covering risks or perils excluded from treaty reinsurance.

                Much of our reinsurance is purchased on an excess of loss basis. Under an excess of loss arrangement, we retain losses on a risk up to a specified amount and the reinsurers assume any losses above that amount. We may choose to participate in the reinsurance layers purchased by retaining a percentage of the layer.  It is common to find conditions in excess of loss covers such as occurrence limits, aggregate limits and reinstatement premium charges. Occurrence limits cap our recovery for multiple losses caused by the same event.  Aggregate limits cap our recovery for all losses ceded during the contract term.  We may be required to pay additional premium to reinstate or have access to use the reinsurance limits for potential future recoveries during the same contract year.  Our property and surety treaties tend to include reinstatement provisions.

We analyze our reinsurance covers in conjunction with our three segments: property, casualty and surety.

                In the property segment, the reinsurance structure is divided into three categories: commercial property, catastrophe earthquake and catastrophe other than earthquake, which could include such events as hurricanes, windstorm, hailstorms, explosions, severe winter weather, fires, etc.

Commercial Property Reinsurance

Our commercial property treaty renews annually on January 1.  In 2009, 2008, 2007, and 2006, for most risks, we retain the first $1.0 million in losses.  We purchase treaty reinsurance for the next $9.0 million in limit.  We retain $600,000 within the treaty.  In 2006, we retained $1.0 million within the treaty.

The marine treaty renews May 1 annually.  For marine exposures, we retain the first $1.0 million in losses.  Reinsurance covers 100 percent of the next $39.0 million.  For the 2007 treaty, we retained the first $1.0 million in losses and purchased coverage for 100 percent of the next $29.0 million.  For the 2006 treaty, we retained the first $0.5 million in losses.  We purchased $19.5 million of reinsurance and retained $0.4 million within the treaty structure.

Property Reinsurance- Catastrophe (CAT) Coverage

                Our property catastrophe reinsurance reduces the financial impact a catastrophe could have on our property segment.  Catastrophes involve multiple claims and policyholders.  Reinsurance limits purchased fluctuate due to changes in the number of policies we insure, reinsurance costs, insurance company surplus levels, and our risk appetite.  In addition, we monitor the expected rate of return for each of our catastrophe lines of business.  At high rates of return, we grow the book of business and may purchase additional reinsurance depending on our capital position.  As the rate of return decreases, we shrink the book and may purchase less reinsurance.  For the last three years, we have maintained a $25.0 million first dollar retention.  For 2009, we purchased $350.0 million in limit above our retention.  We purchased $375.0 million in limit in 2008 which decreased to $350.0 million at July 1, 2008.  In 2007, we purchased $475.0 million in catastrophe reinsurance which decreased to $425.0 million at July 1, 2007.  These CAT limits are in addition to the per-occurrence coverage provided by facultative and other treaty coverages.  We have participated in the catastrophe layers purchased by retaining a percentage of each layer throughout this period.  Our participation has varied based on price and the amount of risk transferred by each layer.

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                Our property catastrophe program continues to be on an excess of loss basis.   It attaches after all other reinsurance has been considered.   Although covered in one program, limits and attachment points differ for California earthquakes and all other perils. The following charts use information from our catastrophe modeling software to illustrate our net retention resulting from particular events that would generate the listed levels of gross losses:

Catastrophe - California Earthquake
(in millions)
		2008				2007				2006
Projected		Ceded		Net		Ceded		Net		Ceded		Net
Gross Loss		Losses		Losses		Losses		Losses		Losses		Losses
$	50	$	7	$	43	$	6	$	44	$	21	$	29
100		50		50		52		48		51		49
200		139		61		139		61		135		65
400		321		79		320		80		299		101

Catastrophe - Other (Earthquake outside of California, Wind, etc.)
(in millions)
		2008				2007				2006
Projected		Ceded		Net		Ceded		Net		Ceded		Net
Gross Loss		Losses		Losses		Losses		Losses		Losses		Losses
$	25	$	6	$	19	$	6	$	19	$	18	$	7
50		29		21		29		21		41		9
100		73		27		76		24		84		16
200		162		38		163		37		168		32

                These tables were generated using theoretical probabilities of events occurring in areas where our portfolio of currently in-force policies could generate the level of loss shown. Actual results could vary significantly from these tables as the actual nature or severity of a particular event cannot be predicted with any reasonable degree of accuracy.  Reinsurance limits are purchased based on the anticipated losses to large events.  The largest losses shown above are unlikely to occur based on the probability of those events occurring.  However, there is a remote chance that a larger event could occur.  If the actual event losses are larger than anticipated, we could retain additional losses above the limit of our catastrophe reinsurance.

                Our catastrophe program includes one prepaid reinstatement for the first two layers of coverage, up to $100 million, for a catastrophe other than California earthquake.  If a loss does occur, reinstatement must be purchased for the remaining limits.  For a California earthquake, there is a prepaid reinstatement for the $50.0 million excess $50.0 million layer (placed at 77 percent) and a reinstatement must be purchased for the remaining limits.

                We continuously monitor and quantify our exposure to catastrophes, including earthquakes, hurricanes, terrorist acts, and other catastrophic events.  In the normal course of business, we manage our concentrations of exposures to catastrophic events, primarily by limiting concentrations of exposure to acceptable levels and by purchasing reinsurance.  Exposure and coverage detail is recorded for each risk location.  We quantify and monitor the total policy limit insured in each region.  In addition, we use third party catastrophe exposure models and an internally developed analysis to assess each risk and ensure we include an appropriate charge for assumed catastrophe risks.  Catastrophe exposure modeling is inherently uncertain due to the model’s reliance on an infrequent observation of actual events and exposure data, increasing the importance of capturing accurate policy coverage data.  The model results are used both in the underwriting analysis of individual risks, and at a corporate level for the aggregate book of catastrophe-exposed business. From both perspectives, we consider the potential loss produced by individual events that represent moderate-to-high loss potential at varying return periods and magnitudes. In calculating potential losses, we select appropriate assumptions, including but not limited to loss amplification and storm surge.  We establish risk tolerances at the portfolio level based on market conditions, the level of reinsurance available, changes to the assumptions in the catastrophe models, rating agency capital constraints, underwriting guidelines and coverages, and internal preferences.  Our risk tolerances for each type of catastrophe, and for all perils in aggregate, change over time as these internal and external conditions change.

Casualty Reinsurance

                Our 2009 casualty reinsurance includes both excess of loss treaties and quota share treaties, as was the case in 2008, and 2007.  Annually on January 1, we place a Combined Casualty Treaty that incorporates coverage for a majority of our casualty lines.  In 2009, we added transportation to the treaty effective May 1, 2009.  Our first dollar retention on those lines of

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business covered ranges from $0.5 million to $1.0 million.  Considering our participation in the reinsurance layers placed, our retention on a full limits loss ranges from $0.5 million to $1.5 million.  Maximum reinsurance limits purchased are $10.0 million inclusive of our retention for the last three years.  With respect to our 2008 Combined Casualty Treaty, we retained the initial $0.5 million to $1.0 million in loss.  Our total retention considering participation in the reinsurance layers purchased ranged from $1.3 million to $1.4 million depending on the type of policy.  This was also the case in 2007.  For our transportation coverage, the separate treaty renews on May 1 annually.  In 2008, we retained the first $0.5 million in loss.  We purchased between $1.5 million and $4.5 million of reinsurance limit depending on the type of risk for the last three years.  Our total retention inclusive of treaty participation ranged from $0.6 million and $1.0 million.  We also retained the first $0.5 million in loss in our 2007 treaty.  Our total retention inclusive of treaty participation ranged from $0.6 million and $0.9 million.  For the 2006 treaty, our first dollar retention was $0.5 million and we placed 100 percent of the reinsurance limits purchased.

Our executive products group (EPG) treaty renews on July 1 annually.  We have purchased quota share treaties over the last three years and have varied our percentage of participation.  In 2008, our reinsurance limit increased to $25.0 million.  Our maximum retained loss on a policy does not exceed $7.5 million.  In 2007 and 2006, we purchased reinsurance limits up to $20.0 million.  In 2007 and 2006, our maximum retained loss on any EPG policy was $6.0 million and $4.0 million, respectively.

Surety Reinsurance

                Our surety reinsurance treaty renews on April 1 annually.  The treaty is on an excess of loss basis.  In 2008, we purchased reinsurance limits of $49.0 million above our $1.0 million first dollar retention.  Within the reinsurance treaty, we participate up to a maximum retention of $6.3 million for any one principal.  We purchased $34.0 million of reinsurance limit in 2007 above our first dollar retention of $1.0 million.  Our maximum retention considering treaty participation was $8.0 million.  In 2006, we purchased $24.0 million in limit with a $7.0 million maximum retention inclusive our first dollar retention of $1.0 million.  For a majority of risks, our potential net loss did not exceed $2.0 million.

                During 2008, we purchased a separate quota share treaty for our new fidelity product line.  We retain up to $3.8 million in losses with a limit of $25.0 million.  This treaty has a renewal date of March 1, 2010.

Marketing and Distribution

                We distribute our coverages primarily through branch offices throughout the country that market to wholesale and retail brokers and through independent agents.  We also market through agencies and more recently through e-commerce channels.

Broker Business

                The largest volume of broker-generated premium is in our commercial property, general liability, commercial surety, commercial umbrella and commercial automobile coverages. This business is produced through wholesale and retail brokers who are not affiliated with us.

Independent Agent Business

                Our surety segment offers its business through a variety of independent agents. Additionally, we write program business, such as at-home business and personal umbrella, through independent agents. Homeowners and dwelling fire is produced through independent agents in Hawaii. Each of these programs involves detailed eligibility criteria, which are incorporated into strict underwriting guidelines, and prequalification of each risk using a system accessible by the independent agent. The independent agent cannot bind the risk unless they receive approval through our system.

                Underwriting Agents

                We contract with certain underwriting agencies who have limited authority to bind or underwrite business on our behalf.  The underwriting agreements involve strict underwriting guidelines and the agents are subject to audits upon request.  These agencies may receive some compensation through contingent profit commission.

E-commerce

                We are actively employing e-commerce to produce and efficiently process and service business, including package policies for limited service motel/hotel operations, restaurant/bar/tavern operations and at-home businesses, small commercial and personal umbrella risks and surety bonding.

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Environmental, Asbestos, and Mass Tort Exposures

                We are subject to environmental site cleanup, asbestos removal, and mass tort claims and exposures through our commercial umbrella, general liability, and discontinued assumed casualty reinsurance lines of business. The majority of the exposure is in the excess layers of our commercial umbrella and assumed reinsurance books of business.

                The following table represents inception-to-date paid and unpaid environmental, asbestos, and mass tort claims data (including incurred but not reported losses) as of December 31, 2008, 2007, and 2006:

	Inception-to-date at
	December 31,
(dollars in thousands)	2008			2007			2006
Loss and Loss Adjustment Expense (LAE) payments
Gross	$	70,210		$	56,060		$	53,323
Ceded	(39,143		)	(30,607		)	(29,853		)
Net	$	31,067		$	25,453		$	23,470
Unpaid losses and LAE at end of year
Gross	$	65,583		$	67,891		$	48,541
Ceded	(20,407		)	(29,198		)	(25,720		)
Net	$	45,176		$	38,693		$	22,821

              Our environmental, asbestos and mass tort exposure is limited, relative to other insurers, as a result of entering the affected liability lines after the insurance industry had already recognized environmental and asbestos exposure as a problem and adopted appropriate coverage exclusions.  During 2008, payment activity was more than we experienced in 2007, which was not surprising given the increased amount of case reserve activity during 2007.  However, we did not observe a corresponding decrease in case reserves, as gross case reserves decreased by only $4.8 million while net case reserves increased by about $0.5 million.  Much of the reported adverse development can be tied to a small number of claims.  Two related asbestos claims from our assumed reinsurance book accounted for $2.7 million in gross emergence and $2.1 million in net emergence with large payments being made.  A mass tort claim from accident year 2005 against an insured hotel involving carbon monoxide discharge accounted for another $1.6 million direct and $1.0 million net.  In light of these developments and a few additional reported claims, we decided to strengthen our incurred but not reported (IBNR) position.

                During 2007, while payment activity was less than we experienced in 2006, we experienced an unusual amount of case reserve activity. About two-thirds of the increase in net reserves was from case reserve adjustments. A $4.8 million case reserve increase was posted due to a reversal of a previous court decision for a claim involving pollution during the late 1980s. In addition, an insurance company we reinsured in the early 1980s and that went into liquidation in 1986, reported a number of claims in 2007. The largest of these involves asbestos. Because of this situation, we posted total net case reserves of $2.9 million. Also, a $2.2 million reserve adjustment was made on a 1983 asbestos related claim because the coverage layers below our excess policy had been exhausted. In addition to these case reserve increases, we made a minor adjustment in our emergence pattern assumptions that resulted in an increase in our total reserve position relative to industry benchmarks.

                While our environmental exposure is limited, the ultimate liability for this exposure is difficult to assess because of the extensive and complicated litigation involved in the settlement of claims and evolving legislation on such issues as joint and several liability, retroactive liability, and standards of cleanup. Additionally, we participate primarily in the excess layers of coverage, where accurate estimates of ultimate loss are more difficult to derive than for primary coverage.

Losses and Settlement Expenses

Overview

Loss and loss adjustment expense (LAE) reserves represent our best estimate of ultimate amounts for losses and related settlement expenses from claims that have been reported but not paid, and those losses that have occurred but have not yet been reported to us. Loss reserves do not represent an exact calculation of liability, but instead represent our estimates, generally utilizing individual claim estimates and actuarial expertise and estimation techniques at a given accounting date. The loss reserve estimates are expectations of what ultimate settlement and administration of claims will cost upon final resolution. These estimates are based on facts and circumstances then known to us, review of historical settlement patterns, estimates of

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trends in claims frequency and severity, projections of loss costs, expected interpretations of legal theories of liability, and many other factors. In establishing reserves, we also take into account estimated recoveries, reinsurance, salvage, and subrogation. The reserves are reviewed regularly by a team of actuaries we employ.

The process of estimating loss reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both internal and external events, such as changes in claims handling procedures, claim personnel, economic inflation, legal trends, and legislative changes, among others. The impact of many of these items on ultimate costs for loss and LAE is difficult to estimate. Loss reserve estimations also differ significantly by coverage due to differences in claim complexity, the volume of claims, the policy limits written, the terms and conditions of the underlying policies, the potential severity of individual claims, the determination of occurrence date for a claim, and reporting lags (the time between the occurrence of the policyholder event and when it is actually reported to the insurer). Informed judgment is applied throughout the process. We continually refine our loss reserve estimates as historical loss experience develops and additional claims are reported and settled. We rigorously attempt to consider all significant facts and circumstances known at the time loss reserves are established.

Due to inherent uncertainty underlying loss reserve estimates, including but not limited to the future settlement environment, final resolution of the estimated liability may be different from that anticipated at the reporting date. Therefore, actual paid losses in the future may yield a materially different amount than currently reserved — favorable and unfavorable.

The amount by which estimated losses differ from those originally reported for a period is known as “development.” Development is unfavorable when the losses ultimately settle for more than the levels at which they were reserved or subsequent estimates indicate a basis for reserve increases on unresolved claims. Development is favorable when losses ultimately settle for less than the amount reserved or subsequent estimates indicate a basis for reducing loss reserves on unresolved claims. We reflect favorable or unfavorable developments of loss reserves in the results of operations in the period the estimates are changed.

We record two categories of loss and LAE reserves — case-specific reserves and IBNR reserves.

Within a reasonable period of time after a claim is reported, our claim department completes an initial investigation and establishes a case reserve. This case-specific reserve is an estimate of the ultimate amount we will have to pay for the claim, including related legal expenses and other costs associated with resolving and settling a particular claim. The estimate reflects all of the current information available regarding the claim, the informed judgment of our professional claim personnel, our reserving practices and experience, and the knowledge of such personnel regarding the nature and value of the specific type of claim. During the life cycle of a particular claim, more information may materialize that causes us to revise the estimate of the ultimate value of the claim either upward or downward. We may determine that it is appropriate to pay portions of the reserve to the claimant or related settlement expenses before final resolution of the claim. The amount of the individual claim reserve will be adjusted accordingly and is based on the most recent information available.

We establish IBNR reserves to estimate the amount we will have to pay for claims that have occurred, but have not yet been reported to us; claims that have been reported to us that may ultimately be paid out differently than expected by our case-specific reserves; and claims that have been paid and closed, but may reopen and require future payment.

Our IBNR reserving process involves three steps including an initial IBNR generation process that is prospective in nature; a loss and LAE reserve estimation process that occurs retrospectively; and a subsequent discussion and reconciliation between our prospective and retrospective IBNR estimates which includes changes in our provisions for IBNR where deemed appropriate. These three processes are discussed in more detail in the following sections.

LAE represents the cost involved in adjusting and administering losses from policies we issued. The LAE reserves are frequently separated into two components: allocated and unallocated. Allocated loss adjustment expense (ALAE) reserves represent an estimate of claims settlement expenses that can be identified with a specific claim or case. Examples of ALAE would be the hiring of an outside adjuster to investigate a claim or an outside attorney to defend our insured. The claims professional typically estimates this cost separately from the loss component in the case reserve. Unallocated loss adjustment expense (ULAE) reserves represent an estimate of claims settlement expenses that cannot be identified with a specific claim. An example of ULAE would be the cost of an internal claims examiner to manage or investigate a reported claim.

                All decisions regarding our best estimate of ultimate loss and LAE reserves are made by our Loss Reserve Committee (LRC). The LRC is made up of various members of the management team including the chief executive officer, chief operating officer, chief financial officer, chief actuary, general counsel and other selected executives. We do not use discounting (recognition of the time value of money) in reporting our estimated reserves for losses and settlement expenses. Based on current assumptions used in calculating reserves, we believe that our overall reserve levels at December 31, 2008, make a reasonable provision to meet our future obligations.

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Net loss and loss adjustment reserves by product line at year-end 2008 and 2007 were as follows:

	2008						2007
(as of December 31, in $ thousands)
Product Line	Case		IBNR		Total		Case		IBNR		Total
Casualty segment net loss and ALAE reserves
Commercial umbrella	$	3,878	$	24,569	$	28,447	$	7,051	$	32,666	$	39,717
Personal umbrella	16,591		35,717		52,308		19,101		31,498		50,599
General liability	89,094		250,640		339,734		84,222		242,754		326,976
Transportation	58,806		10,701		69,507		59,569		10,209		69,778
Executive products	9,143		30,470		39,613		4,291		26,185		30,476
Other casualty	35,933		71,299		107,232		34,984		70,074		105,058
Property segment net loss and ALAE reserves
Difference in conditions	516		6,062		6,578		617		6,372		6,989
Marine	18,080		16,092		34,172		10,420		10,337		20,757
Other property	25,358		9,821		35,179		21,946		13,378		35,324
Surety segment net loss and ALAE reserves	4,365		11,347		15,712		4,759		14,564		19,323
Latent liability net loss and ALAE reserves	21,605		23,571		45,176		21,103		17,590		38,693
Total net loss and ALAE reserves	283,369		490,289		773,658		268,063		475,627		743,690
ULAE reserves	—		35,369		35,369		—		31,238		31,238
Total net loss and LAE reserves	$	283,369	$	525,658	$	809,027	$	268,063	$	506,865	$	774,928

Initial IBNR Generation Process

Initial carried IBNR reserves are determined through a reserve generation process. The intent of this process is to establish an initial total reserve that will provide a reasonable provision for the ultimate value of all unpaid loss and ALAE liabilities. For most casualty and surety products, this process involves the use of an initial loss and ALAE ratio that is applied to the earned premium for a given period. The result is our best initial estimate of the expected amount of ultimate loss and ALAE for the period by product. Paid and case reserves are subtracted from this initial estimate of ultimate loss and ALAE to determine a carried IBNR reserve.

                For most property products, we use an alternative method of determining an appropriate provision for initial IBNR. Since this segment is characterized by a shorter period of time between claim occurrence and claim settlement, the IBNR reserve is determined by an initial loss percentage applied to the rolling 12 month’s premium earned. No deductions for paid or case reserves are made. This alternative method of determining initial IBNR reacts more quickly to the actual loss emergence and is more appropriate for our property products where final claim resolution occurs quickly.

                We do not reserve for natural or man-made catastrophes until an event has occurred.  Shortly after such occurrence, we review insured locations exposed to the event, model loss estimates of the event based on our own exposures, and industry loss estimates of the event, and we consider our knowledge of frequency and severity from early claim reports to determine an appropriate reserve for the catastrophe.  These reserves are reviewed frequently based on loss reports and appropriate changes to our estimates are made to reflect any new information as it arises.

The initial loss and ALAE ratios that are applied to earned premium are reviewed at least semi-annually. Prospective estimates are made based on historical loss experience adjusted for mix and price change and loss cost inflation. The initial loss and ALAE ratios also reflect some provision for estimation risk. We consider estimation risk by segment and product line. A segment with greater overall volatility and uncertainty has greater estimation risk. Characteristics of segments and products with higher estimation risk, include those exhibiting, but not limited to, the following characteristics:

·        significant changes in underlying policy terms and conditions,

·        a new business or one experiencing significant growth and/or high turnover,

·        small volume or lacking internal data requiring significant reliance on external data,

·        longer emergence patterns with exposures to latent unforeseen mass tort,

·        high severity and/or low frequency,

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·        operational processes undergoing significant change, and/or

·        high sensitivity to significant swings in loss trends or economic change.

                Following is a table of significant risk factors by major product line.  We distinguish between loss ratio risk and reserve estimation risk.  Loss ratio risk refers to the possible dispersion of loss ratios from year to year due to inherent volatility in the business such as high severity or aggregating exposures.  Reserve estimation risk recognizes the difficulty in estimating a given year’s ultimate loss liability.  As an example, our property catastrophe business (identified below as “Difference in conditions”) has significant variance in year-over-year results; however its reserving estimation risk is relatively low.

Significant Risk Factors

Product line	Length of Reserve Tail	Emergence patterns relied upon	Other risk factors	Expected loss ratio variability	Reserve estimation variability
Commercial umbrella	Long	Internal	Low frequency High severity Loss trend volatility Unforeseen tort potential Exposure changes/mix	High	High
Personal umbrella	Medium	Internal	Low frequency	Medium	Medium
General liability	Long	Internal	Exposure growth/mixUnforeseen tort potential	Medium	High
Transportation	Medium	Internal	High severity Exposure growth/mix	Medium	Medium
Executive products	Long	Internal &significant external reliances	Low frequency High severity Loss trend volatility Economic volatility Unforeseen tort potential Small volume	High	High
Other casualty	Medium	Internal & external	Small volume	Medium	Medium
Difference in conditions	Short	Internal	Catastrophe aggregation exposure Low frequency High severity	High	Medium
Marine	Medium	Significant external reliances	New business Small volume	High	High
Other property	Short	Internal	Catastrophe aggregation exposure	Medium	Low
Surety	Medium	Internal & external reliances	Economic volatilityUniqueness of exposure	Medium	Medium
Runoff including asbestos & environmental	Long	Internal & external reliances	Loss trend volatility Mass tort/latent exposure	High	High

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                The historical and prospective loss and ALAE estimates along with the risks listed are the basis for determining our initial and subsequent carried reserves. Adjustments in the initial loss ratio by product and segment are made where necessary and reflect updated assumptions regarding loss experience, loss trends, price changes, and prevailing risk factors. The LRC makes all final decisions regarding changes in the initial loss and ALAE ratios.

Loss and LAE Reserve Estimation Process

A full analysis of our loss reserves takes place at least semi-annually. The purpose of these analyses is to provide validation of our carried loss reserves. Estimates of the expected value of the unpaid loss and LAE are derived using actuarial methodologies. These estimates are then compared to the carried loss reserves to determine the appropriateness of the current reserve balance.

The process of estimating ultimate payment for claims and claims expenses begins with the collection and analysis of current and historical claim data. Data on individual reported claims including paid amounts and individual claim adjuster estimates are grouped by common characteristics. There is judgment involved in this grouping. Considerations when grouping data include the volume of the data available, the credibility of the data available, the homogeneity of the risks in each cohort, and both settlement and payment pattern consistency. We use this data to determine historical claim reporting and payment patterns which are used in the analysis of ultimate claim liabilities. For portions of the business without sufficiently large numbers of policies or that have not accumulated sufficient historical statistics, our own data is supplemented with external or industry average data as available and when appropriate. For our executive products and marine business, we utilize external data extensively.

In addition to the review of historical claim reporting and payment patterns, we also incorporate an estimate of expected losses relative to premium by year into the analysis. The expected losses are based on a review of historical loss performance, trends in frequency and severity, and price level changes. The estimation of expected losses is subject to judgment including consideration given to internal and industry data available, growth and policy turnover, changes in policy limits, changes in underlying policy provisions, changes in legal and regulatory interpretations of policy provisions, and changes in reinsurance structure.

We use historical development patterns, estimations of the expected loss ratios, and standard actuarial methods to derive an estimate of the ultimate level of loss and LAE payments necessary to settle all the claims occurring as of the end of the evaluation period. Once an estimate of the ultimate level of claim payments has been derived, the amount of paid loss and LAE and case reserve through the evaluation date is subtracted to reveal the resulting level of IBNR.

                Our reserve processes include multiple standard actuarial methods for determining estimates of IBNR reserves. Other supplementary methodologies are incorporated as deemed necessary. Mass tort and latent liabilities are examples of exposures where supplementary methodologies are used. Each method produces an estimate of ultimate loss by accident year. We review all of these various estimates and the actuaries assign weight to each based on the characteristics of the product being reviewed. The result is a single actuarial point estimate by product, by accident year.

The methodologies we have chosen to incorporate are a function of data availability and appropriately reflective of our own book of business.  There are a number of additional actuarial methods that are available but are not currently being utilized because of data constraints or because the methods were either deemed redundant or not predictive for our book of business.  From time to time, we evaluate the need to add supplementary methodologies.  New methods are incorporated if it is believed that they improve the estimate of our ultimate loss and LAE liability.  All of the actuarial methods tend to converge to the same estimate as an accident year matures.  Our core methodologies are listed below with a short description and their relative strengths and weaknesses:

                Paid Loss Development — Historical payment patterns for prior claims are used to estimate future payment patterns for current claims.  These patterns are applied to current payments by accident year to yield expected ultimate loss.

                Strengths:  The method reflects only the claim dollars that have been paid and is not subject to case-basis reserve changes or changes in case reserve practices.

                Weaknesses:  External claims environment changes can impact the rate at which claims are settled and losses paid (e.g., increase in attorney involvement or legal precedent).  Adjustments to reflect changes in payment patterns on a prospective basis are difficult to quantify.  For losses that have occurred recently, payments can be minimal and thus early estimates are subject to significant instability.

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Incurred Loss Development — Historical case-incurred patterns (paid losses plus case reserves) for past claims are used to estimate future case-incurred amounts for current claims.  These patterns are applied to current case-incurred losses by accident year to yield an expected ultimate loss.

                Strengths:  Losses are reported more quickly than paid, therefore, the estimates stabilize sooner.  The method reflects more information (claims department case reserve) in the analysis than the paid loss development method.

                Weaknesses:  Method involves additional estimation risk if significant changes to case reserving practices have occurred.

                Case Reserve Development — Patterns of historical development in reported losses relative to historical case reserves are determined. These patterns are applied to current case reserves by accident year and the result is combined with paid losses to yield an expected ultimate loss.

                Strengths:  Like the incurred development method, this method benefits from using the additional information available in case reserves that is not available from paid losses only. It also can provide a more reasonable estimate than other methods when the proportion of claims still open for an accident year is unusually high or low.

                Weaknesses:  It is subject to the risk of changes in case reserving practices or philosophy. It may provide unstable estimates when an accident year is immature and more of the IBNR is expected to come from unreported claims rather than development on reported claims.

Expected Loss Ratio — Historical loss ratios, in combination with projections of frequency and severity trends as well as estimates of price and exposure changes, are analyzed to produce an estimate of the expected loss ratio for each accident year.  The expected loss ratio is then applied to the earned premium for each year to estimate the expected ultimate losses.  The current accident year expected loss ratio is also used as the input in the determination of the prospective loss and ALAE ratio used in our initial IBNR generation process.

                Strengths:  Reflects an estimate independent of how losses are emerging on either a paid or a case reserve basis.  Method is particularly useful in the absence of historical development patterns or where losses take a long time to emerge.

                Weaknesses:  Ignores how losses are actually emerging and thus produces the same estimate of ultimate loss regardless of favorable/unfavorable emergence.

                Paid and Incurred Bornhuetter/Ferguson (BF) — This approach blends the expected loss ratio method with either the paid or incurred loss development method.  In effect, the BF methods produce weighted average indications for each accident year.  As an example, if the current accident year for commercial automobile liability is estimated to be 20 percent paid, then the paid loss development method would receive a weight of 20 percent, and the expected loss ratio method would receive an 80 percent weight.  Over time, this method will converge with the ultimate estimated in the respective loss development method.

                Strengths:  Reflects actual emergence that is favorable/unfavorable, but assumes remaining emergence will continue as previously expected.   Does not overreact to the early emergence (or lack of emergence) where patterns are most unstable.

                Weaknesses:  Could potentially understate favorable or unfavorable development by putting some weight on the expected loss ratio.

                In most cases, multiple estimation methods will be valid for the particular facts and circumstances of the claim liabilities being evaluated.  Each estimation method has its own set of assumption variables and its own advantages and disadvantages, with no single estimation method being better than the others in all situations and no one set of assumption variables being meaningful for all product line components.  The relative strengths and weaknesses of the particular estimation methods, when applied to a particular group of claims, can also change over time; therefore, the weight given to each estimation method will likely change by accident year and with each evaluation.

                The actuarial point estimates typically follow a progression that places significant weight on the BF methods when accident years are younger and claims emergence is immature.  As accident years mature and claims emerge over time, increasing weight is placed on the incurred development method, the paid development method, and the case reserve development method.  For product lines with faster loss emergence, the progression to greater weight on the incurred and paid development methods occurs more quickly.

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For our long- and medium-tail products, the BF methods are typically given the most weight for the first 36 months of evaluation.  These methods are also predominant for the first 12 months of evaluation for short-tail lines.  Beyond these time periods, our actuaries apply their professional judgment when weighting the estimates from the various methods deployed.

Judgment can supersede this natural progression if risk factors and assumptions change, or if a situation occurs that amplifies a particular strength or weakness of a methodology.  Extreme projections are critically analyzed and may be adjusted, given less credence, or discarded all together.  Internal documentation is maintained that records any substantial changes in methods or assumptions from one loss reserve study to another.

                Our estimates of ultimate loss and LAE reserves are subject to change as additional data emerges. This could occur as a result of change in loss development patterns, a revision in expected loss ratios, the emergence of exceptional loss activity, a change in weightings between actuarial methods, the addition of new actuarial methodologies or new information that merits inclusion, or the emergence of internal variables or external factors that would alter our view.

                There is uncertainty in the estimates of ultimate losses. Significant risk factors to the reserve estimate include, but are not limited to, unforeseen or unquantifiable changes in:

·loss payment patterns,

·loss reporting patterns,

·frequency and severity trends,

·underlying policy terms and conditions,

·business or exposure mix,

·operational or internal process changes affecting timing of recording transactions,

·regulatory and legal environment, and/or

·economic environment.

                Our actuaries engage in discussions with senior management, underwriting, and the claims department on a regular basis to attempt to ascertain any substantial changes in operations or other assumptions that are necessary to consider in the reserving analysis.

                A considerable degree of judgment in the evaluation of all these factors is involved in the analysis of reserves. The human element in the application of judgment is unavoidable when faced with material uncertainty. Different experts will choose different assumptions when faced with such uncertainty, based on their individual backgrounds, professional experiences, and areas of focus. Hence, the estimate selected by various qualified experts may differ materially from each other. We consider this uncertainty by examining our historic reserve accuracy and through an internal peer review process.

                Given the substantial impact of the reserve estimates on our financial statements, we subject the reserving process to significant diagnostic testing and reasonability checks. We have incorporated data validity checks and balances into our front-end processes.  Data anomalies are researched and explained to reach a comfort level with the data and results.   Leading indicators such as actual versus expected emergence and other diagnostics are also incorporated into the reserving processes.

Determination of Our Best Estimate

                Upon completion of our full loss and LAE estimation analysis, the results are discussed with the LRC.  As part of this discussion, the analysis supporting an indicated point estimate of the IBNR loss reserve by product is reviewed.  The actuaries also present explanations supporting any changes to the underlying assumptions used to calculate the indicated point estimate.  Quarterly, we also consider the actual loss emergence as compared to the expected loss emergence derived from the last full loss and LAE analyses.  A review of the resulting variance between the indicated reserves and the carried reserves determined from the initial IBNR generation process takes place.  After discussion of these analyses and all relevant risk factors, the LRC determines whether the reserve balances require adjustment.

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As a predominantly excess and surplus lines and specialty insurer servicing niche markets, we believe there are several reasons to carry — on an overall basis — reserves above the actuarial point estimate.  We believe we are subject to above average variation in estimates and that this variation is not symmetrical around the actuarial point estimate.

One reason for the variation is the above-average policyholder turnover and changes in the underlying mix of exposures typical of an excess and surplus lines business.  This constant change can cause estimates based on prior experience to be less reliable than estimates for more stable, admitted books of business.  Also, as a niche market writer, there is little industry-level information for direct comparisons of current and prior experience and other reserving parameters.  These unknowns create greater-than-average variation in the actuarial point estimates.

Actuarial methods attempt to quantify future events. Insurance companies are subject to unique exposures that are difficult to foresee at the point coverage is initiated and, often, many years subsequent. Judicial and regulatory bodies involved in interpretation of insurance contracts have increasingly found opportunities to expand coverage beyond that which was intended or contemplated at the time the policy was issued.  Many of these policies are issued on an “all risk” and occurrence basis.  Aggressive plaintiff attorneys have often sought coverage beyond the insurer’s original intent.  Some examples would be the industry’s ongoing asbestos and environmental litigation, court interpretations of exclusionary language on mold and construction defect, and debates over wind versus flood as the cause of loss from major hurricane events.

We believe that because of the inherent variation and the likelihood that there are unforeseen and under-quantified liabilities absent from the actuarial estimate, it is prudent to carry loss reserves above the actuarial point estimate.  Most of our variance between the carried reserve and the actuarial point estimate is in the most recent accident years for our casualty segment where the most significant estimation risks reside. These estimation risks are considered when setting the initial loss ratio for the product and segment.  In the cases where these risks fail to materialize, favorable loss development will likely occur over subsequent accounting periods.  It is also possible that the risks materialize above the amount we considered when booking our initial loss reserves.  In this case, unfavorable loss development is likely to occur over subsequent accounting periods.

Our best estimate of our loss and LAE reserves may change depending on a revision in the actuarial point estimate, the actuary’s certainty in the estimates and processes, and our overall view of the underlying risks. From time to time, we benchmark our reserving policies and procedures and refine them by adopting industry best practices where appropriate.   A detailed, ground-up analysis of the actuarial estimation risks associated with each of our products and segments, including an assessment of industry information, is performed annually.

Loss reserve estimates are subject to a high degree of variability due to the inherent uncertainty of ultimate settlement values. Periodic adjustments to these estimates will likely occur as the actual loss emergence reveals itself over time. We believe our loss reserving processes reflect industry best practices and our methodologies result in a reasonable provision for reserves as of December 31, 2008.

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Reserve Sensitivities

There are three major parameters that have significant influence on our actuarial estimates of ultimate liabilities by product.  They are the actual losses that are reported, the expected loss emergence pattern, and the expected loss ratios used in the analyses.  If the actual losses reported do not emerge as expected, it may cause us to challenge all or some of our previous assumptions.  We may change expected loss emergence patterns, the expected loss ratios used in our analysis, and/or the weights we place on a given actuarial method.  The impact will be much greater and more leveraged for products with longer emergence patterns.  Our general liability product is an example of a product with a relatively long emergence pattern.  We have constructed a chart below that illustrates the sensitivity of our general liability reserve estimates for these key parameters.   We believe the scenarios to be reasonable as similar favorable variations have occurred in recent years. In particular, our actual general liability loss emergence in 2008 was very favorable. The numbers below are the resulting change in estimated ultimate loss and ALAE in millions of dollars as of December 31, 2008 as a result of the change in the parameter shown.

	Result from favorable			Result from unfavorable
(in millions)	change in parameter			change in the parameter
+/-5 point change in expected loss ratio for all accident years	$	(16.4	)	$	16.4
+/-10% change in expected emergence patterns	$	(6.6	)	$	6.2
+/-25% change in actual loss emergence over a calendar year	$	(13.1	)	$	13.2
Simultaneous change in expected loss ratio (5pts), expected emergence patterns (10%), and actual loss emergence (25%).	$	(35.2	)	$	36.4

There are often significant inter-relationships between our reserving assumptions that have offsetting or compounding effects on the reserve estimate.  Thus, in almost all cases, it is impossible to discretely measure the effect of a single assumption or construct a meaningful sensitivity expectation that holds true in all cases.  The scenario above is representative of general liability, one of our largest, and longest-tailed, products.  It is unlikely that all of our products would have variations as wide as illustrated in the example.  It is also unlikely that all of our products would simultaneously experience favorable or unfavorable loss development in the same direction or at their extremes during a calendar year.  Because our portfolio is made up of a diversified mix of products, there would ordinarily be some offsetting favorable and unfavorable emergence by product as actual losses start to emerge and our loss estimates become more refined.

It is difficult for us to predict whether the favorable loss development observed in 2006 through 2008 will continue for any of our products in the future.  We have reviewed historical data detailing the development of our total balance sheet reserves for each of the last 10 years.  Based on this analysis and our understanding of loss reserve uncertainty, we believe fluctuations will occur in our estimate of ultimate reserve liabilities over time.  Over the next calendar year, given our current exposure level and product mix, it would be reasonably likely for us to observe loss reserve development relating to prior years’ estimates across all of our products ranging from approximately 8 percent ($65 million) favorable to 4 percent ($32 million) unfavorable.

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Historical Loss and LAE Development

                The table which follows is a reconciliation of our unpaid losses and settlement expenses (LAE) for the years 2008, 2007, and 2006.

	Year Ended December 31,
(Dollars in thousands)	2008			2007			2006
Unpaid losses and LAE at beginning of year:
Gross	$	1,192,178		$	1,318,777		$	1,331,866
Ceded	(417,250		)	(525,671		)	(593,209		)
Net	$	774,928		$	793,106		$	738,657
Increase (decrease) in incurred losses and LAE:
Current accident year	$	309,512		$	296,047		$	300,292
Prior accident years	(62,338		)	(105,179		)	(43,403		)
Total incurred	$	247,174		$	190,868		$	256,889
Loss and LAE payments for claims incurred:
Current accident year	$	(51,599	)	$	(46,598	)	$	(47,994	)
Prior accident years	(161,476		)	(162,448		)	(154,446		)
Total paid	$	(213,075	)	$	(209,046	)	$	(202,440	)
Net unpaid losses and LAE at end of year	$	809,027		$	774,928		$	793,106
Unpaid losses and LAE at end of year:
Gross	$	1,159,311		$	1,192,178		$	1,318,777
Ceded	(350,284		)	(417,250		)	(525,671		)
Net	$	809,027		$	774,928		$	793,106

                The deviations from our initial reserve estimates appeared as changes in our ultimate loss estimates as we updated those estimates through our reserve analysis process. The recognition of the changes in initial reserve estimates occurred over time as claims were reported, initial case reserves were established, initial reserves were reviewed in light of additional information, and ultimate payments were made on the collective set of claims incurred as of that evaluation date. The new information on the ultimate settlement value of claims is therefore continually updated and revised as this process takes place until all claims in a defined set of claims are settled. As a relatively small insurer, our experience will ordinarily exhibit fluctuations from period to period. While we attempt to identify and react to systematic changes in the loss environment, we also must consider the volume of experience directly available to us, and interpret any particular period’s indications with a realistic technical understanding of the reliability of those observations.

                The table below summarizes our prior accident years’ loss reserve development by segment for 2008, 2007, and 2006:

(in thousands)	2008			2007			2006
(Favorable)/Unfavorable reserve development by segment
Casualty	$	(50,562	)	$	(87,397	)	$	(40,030	)
Property	(6,646		)	(6,690		)	(1,784		)
Surety	(5,130		)	(11,092		)	(1,589		)
Total	$	(62,338	)	$	(105,179	)	$	(43,403	)

A discussion of significant components of reserve development for the three most recent calendar years follows:

2008.  During 2008, we experienced favorable loss emergence from prior years’ reserve estimates across all of our segments.  For our casualty segment, we experienced $50.6 million of favorable development, predominantly from the accident years of 2002-2006.  In retrospect, the expected loss ratios initially used to set booked reserves for these accident years have proven to be conservative, which has resulted in loss emergence significantly lower than expected.  This is particularly true for our general liability, personal umbrella, and commercial umbrella products which experienced favorable loss development of $33.1 million, $12.7 million, and $11.8 million, respectively.  The construction class was the largest contributor to the favorable emergence in the general liability product.  In addition, our program business experienced $9.3 million of unfavorable prior years’ loss development during the year, mostly isolated in accident years 2004-2007.   Our experience in the liquor liability class has been particularly adverse.  In the past, we relied on external loss development patterns that have not

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proven predictive of actual emergence. As a result, this class is being re-underwritten and we implemented a more stringent reserving approach in 2008.

           Our property segment realized $6.6 million of favorable loss development in 2008.  Most of this emergence was in accident years 2005-2007.  The construction and fire products were the drivers of the favorable emergence recording $4.4 million and $4.2 million, respectively.  The construction business has been in run-off for three years and recent experience has been much better than expected with a significant reduction in both frequency and severity of claims.  Only a handful of contracts remain open and we have observed little new activity from this product line.  Our fire product saw significant favorable emergence from the 2007 accident year, as our year-end 2007 reserves have developed more favorably than originally estimated.

Our surety segment experienced $5.1 million of favorable emergence.  Almost all of the favorable emergence is from the 2007 accident year.  Very little observed loss severity in the commercial surety product resulted in $1.7 million of favorable emergence.  Continued improvement in our contract surety loss ratio resulting from past re-underwriting of the business led to $2.5 million of favorable loss reserve development.

2007.  We periodically review our loss reserve estimates and underlying actuarial reserving methodologies in order to assess their accuracy and suitability, and to benchmark our reserving practices against industry best practices. A detailed assessment of recent trends and reserve risk factors was undertaken in 2007. As part of our reviews, we performed a more detailed, ground-up analysis of the actuarial estimation risks associated with each of our products and segments, including an assessment of industry information.

Our analyses also revealed that our quarterly actuarial reserve estimates over recent historical periods had shown a downward trend as a result of a moderating loss trend environment, improvements in policy terms and conditions and a favorable underlying exposure mix that occurred during the hard market period from 2001 through 2004.

Based on this review, we made certain refinements to our reserving methodologies to include a more detailed consideration of the impact of risk factors on total recorded reserves through increased internal dialogue among the claim, underwriting, risk management and actuarial departments, greater transparency of the actuarial process and results, and improved reserving diagnostics. Overall, these enhancements and improved information provide better and faster feedback to management regarding loss development resulting in greater overall confidence in the actuarial estimates. This and the increased stability in our business in the last few years diminished the needed level of carried reserves above the actuarial point estimate. We believe that these reserve methodology enhancements improved the overall accuracy of our best estimate of loss and LAE reserves. Over half of the favorable prior years’ loss development was the result of this detailed assessment and resulting changes in our booked reserves.

Our casualty segment was most impacted by prior years’ loss development realizing a total of $87.4 million of favorable emergence. All casualty products were impacted by the enhanced risk assessment previously mentioned. Our general liability, transportation, personal umbrella, and professional liability products realized favorable development of $42.5 million, $19.6 million, $10.5 million, and $8.1 million, respectively. This favorable emergence was concentrated in accident years 2004-2006. As a result of significant favorable loss development observed over the past several years for our general liability product, we reassessed the expected loss ratios used in our actuarial analysis and subsequently lowered them for the construction classes. For our transportation and personal umbrella products, we reassessed and subsequently lowered the loss development factors in our analysis reflecting our observation that the emergence patterns were more favorable than previously anticipated. Finally, our professional liability products realized actual loss emergence much more favorably than expected.

The property segment realized $6.7 million of favorable prior years’ development. The favorable emergence was realized across almost all of our property products, predominantly in accident years 2005 and 2006. We also executed a favorable reinsurance commutation impacting accident years prior to 2000.

The surety segment realized $11.1 million of favorable prior years’ development. Almost all of the development was the result of the risk reassessment and reflection of significantly lower reserve risk after achieving settlement with the larger banks involved in the CMC litigation (see note 10 to our audited consolidated financial statements included in our 2008 Financial Report to Shareholders, attached as Exhibit 13 and incorporated by reference herein, for more details).

2006.  During 2006, we continued to experience favorable loss development and a reduction in prior years’ loss reserve estimates. Pricing increased substantially and policy terms and conditions became more favorable for most of our products during the 2001-2004 policy years. Many of the improvements in market conditions were difficult to quantify at the time of the original estimate. Our significant growth in premium and exposures made precise quantification of these changes even more challenging. In 2006, losses continued to emerge on the prior accident years much more favorably than we expected

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when making our original estimates. We experienced favorable development of $43.4 million in aggregate on prior years’ estimates.

Of this decrease to prior years’ loss reserve estimates, approximately $40.0 million occurred in the casualty segment. The development is primarily from our general liability, executive products liability, and employer’s indemnity products. In our general liability product we experienced $25.4 million of favorable development. Most of this development came from the 2004 and 2005 accident years. As part of our normal reserving process, we reviewed the expected loss ratios used in several of our reserving methods. This review confirmed the favorable emergence from 2002-2005 accident years. As a result of this study, the expected loss ratios were reduced for 2004-2006 with the most significant change occurring to the 2005 accident year. Approximately $15.4 million of the favorable general liability development can be attributed to this update in expected loss ratios. The remaining portion of the decrease in prior year’s loss reserve estimate was the result of the continued favorable loss emergence and the natural progression of shifting more weight to our incurred and paid development methods as accident years get older. In our executive products liability business, we experienced $7.4 million of favorable development. Most of this change can be attributed to accident years 2001, 2003, and 2004. The estimates improved as a result of lower than expected loss severity in those accident years. For our employer’s indemnity product, we experienced $5.7 million of favorable development. We experienced significantly less loss emergence than expected for accident years prior to 2003 and benefited from favorable settlements on several claims in accident years 2001-2003.

Overall, our property and surety segments experienced relatively small changes in prior years’ estimates of reserves. However, we experienced $4.2 million of favorable development from 2004 and 2005 hurricane estimates. We also saw $7.2 million of unfavorable development on our construction product that is in runoff. Most of this development came from accident years 2002-2005. The construction emergence pattern revealed itself to be longer than originally anticipated and has not behaved consistent with reporting patterns expected from a property segment. We do not anticipate any further significant deterioration in our estimates.

                The following table presents the development of our balance sheet reserves from 1998 through 2008. The top line of the table shows the net reserves at the balance sheet date for each of the indicated periods. This represents the estimated amount of net losses and settlement expenses arising in all prior years that are unpaid at the balance sheet date, including losses that had been incurred but not yet reported to us. The lower portion of the table shows the re-estimated amount of the previously recorded gross and net reserves based on experience as of the end of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual periods.

                Adverse loss and LAE reserve development can be observed in the table for years ending 1999-2002 on a net basis, and 1999-2003 on a gross basis.  This development is related to unexpectedly large increases in loss frequency and severity and unquantifiable expansion of policy terms and conditions that took place in accident years 1997-2001 for our casualty segment.  These causes widely impacted the property and casualty insurance industry during this time as soft market conditions were prevalent.  These factors, combined with our rapid growth during 1999-2002, caused significant estimation risk, and thus had a related impact on our reserve liabilities for those years.

                As the table displays, variations exist between our cumulative loss experience on a gross and net basis, due to the application of reinsurance. On certain products, our net retention (after applying reinsurance) is significantly less than our gross retention (before applying reinsurance).  These differences in retention can cause a significant (leveraged) difference between loss reserve development on a net and gross basis.   Additionally, the relationship of our gross to net retention changes over time. For example, we changed underwriting criteria to increase gross retentions (gross policy limits) on certain products written in 1999 through 2001, while leaving net retention unchanged. These products contained gross retentions of up to $50.0 million, while the relating net retention remained at $0.5 million. Loss severity on certain of these products exceeded original expectations. As shown in the table that follows, on a re-estimated basis, this poor loss experience resulted in significant indicated gross deficiencies, with substantially less deficiency indicated on a net basis, as many losses were initially recorded at their full net retention. In 2002, we reduced our gross policy limits on many of these products to $15.0 million, while net retention increased to $1.0 million. As the relationship of our gross to net retention changes over time, re-estimation of loss reserves will result in variations between our cumulative loss experience on a gross and net basis.

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	Year Ended December 31,
(Dollars in thousands)	1998 & Prior			1999			2000			2001			2002			2003			2004			2005			2006			2007			2008
Net Liability for unpaid losses and Settlement expenses at end of the year	$	247,262		$	274,914		$	300,054		$	327,250		$	391,952		$	531,393		$	668,419		$	738,657		$	793,106		$	774,928		$	809,027
Paid cumulative as of:
One year later	53,892			65,216			92,788			98,953			94,465			129,899			137,870			154,446			162,448			161,484
Two years later	88,567			113,693			155,790			159,501			182,742			212,166			239,734			270,210			275,322
Three years later	114,465			149,989			192,630			211,075			234,231			273,019			324,284			353,793
Four years later	132,796			172,443			222,870			238,972			269,446			322,050			378,417
Five years later	145,888			191,229			237,464			260,618			300,238			357,239
Six years later	159,153			200,610			250,092			281,775			321,841
Seven years later	165,277			209,288			261,612			295,663
Eight years later	171,709			216,934			272,692
Nine years later	176,310			225,414
Ten years later	182,751
Liability re-estimated as of:
One year later	243,270			273,230			309,021			340,775			393,347			520,576			605,946			695,254			687,927			712,590
Two years later	233,041			263,122			301,172			335,772			394,297			485,146			577,709			636,356			637,117
Three years later	229,750			263,639			314,401			344,668			397,772			478,113			566,181			599,420
Four years later	217,476			262,156			319,923			355,997			409,597			490,022			549,795
Five years later	207,571			264,383			323,698			359,161			424,809			483,575
Six years later	205,563			264,569			323,642			377,264			422,027
Seven years later	204,002			264,305			340,498			379,229
Eight years later	204,597			280,666			342,024
Nine years later	219,304			281,020
Ten years later	219,987
Net cumulative redundancy (deficiency)	$	27,275		$	(6,106	)	$	(41,970	)	$	(51,979	)	$	(30,075	)	$	47,818		$	118,624		$	139,237		$	155,989		$	62,338
Gross liability	$	415,523		$	520,494		$	539,750		$	604,505		$	732,838		$	903,441		$	1,132,599		$	1,331,866		$	1,318,777		$	1,192,178		$	1,159,311
Reinsurance recoverable	(168,261		)	(245,580		)	(239,696		)	(277,255		)	(340,886		)	(372,048		)	(464,180		)	(593,209		)	(525,671		)	(417,250		)	(350,284		)
Net liability	$	247,262		$	274,914		$	300,054		$	327,250		$	391,952		$	531,393		$	668,419		$	738,657		$	793,106		$	774,928		$	809,027
Gross re-estimated liability	$	387,150		$	616,296		$	779,665		$	789,187		$	878,016		$	924,595		$	965,990		$	1,033,667		$	964,343		$	1,038,429
Re-estimated recoverable	(167,163		)	(335,276		)	(437,641		)	(409,958		)	(455,989		)	(441,020		)	(416,195		)	(434,247		)	(327,226		)	(325,839		)
Net re-estimated liability	$	219,987		$	281,020		$	342,024		$	379,229		$	422,027		$	483,575		$	549,795		$	599,420		$	637,117		$	712,590
Gross cumulative redundancy (deficiency)	$	28,373		$	(95,802	)	$	(239,915	)	$	(184,682	)	$	(145,178	)	$	(21,154	)	$	166,609		$	298,199		$	354,434		$	153,749

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Operating Ratios

Premiums to Surplus Ratio

The following table shows, for the periods indicated, our insurance subsidiaries’ statutory ratios of net premiums written to policyholders’ surplus. While there is no statutory requirement applicable to us that establishes a permissible net premiums written to surplus ratio, guidelines established by the National Association of Insurance Commissioners, or NAIC, provide that this ratio should generally be no greater than 3 to 1.  While the NAIC provides this general guideline, rating agencies often require a more conservative ratio to maintain strong or superior ratings.

	Year Ended December 31,
(Dollars in thousands)	2008		2007		2006		2005		2004
Statutory net premiums written	$	513,456	$	538,763	$	551,536	$	494,565	$	511,212
Policyholders’ surplus	678,041		752,004		746,905		690,547		605,967
Ratio	0.8 to 1		0.7 to 1		0.7 to 1		0.7 to 1		0.8 to 1

GAAP and Statutory Combined Ratios

Our underwriting experience is best indicated by our GAAP combined ratio, which is the sum of (a) the ratio of incurred losses and settlement expenses to net premiums earned (loss ratio) and (b) the ratio of policy acquisition costs and other operating expenses to net premiums earned (expense ratio).

	Year Ended December 31,
GAAP	2008	2007	2006	2005	2004
Loss ratio	46.7	35.1	48.4	51.1	59.9
Expense ratio	37.5	36.3	35.7	34.9	32.3
Combined ratio	84.2	71.4	84.1	86.0	92.2

We also calculate the statutory combined ratio, which is not indicative of GAAP underwriting income due to accounting for policy acquisition costs differently for statutory accounting purposes compared to GAAP. The statutory combined ratio is the sum of (a) the ratio of statutory loss and settlement expenses incurred to statutory net premiums earned (loss ratio) and (b) the ratio of statutory policy acquisition costs and other underwriting expenses to statutory net premiums written (expense ratio).

	Year Ended December 31,
Statutory	2008		2007		2006		2005		2004
Loss ratio	46.7		35.1		48.4		51.1		59.9
Expense ratio	39.0		38.2		35.6		35.6		33.9
Combined ratio	85.7		73.3		84.0		86.7		93.8
Industry combined ratio	104.0	(1)	95.5	(2)	92.4	(2)	101.2	(2)	98.9	(2)

(1)           Source:  Standard & Poor’s RatingsDirect.  Estimated for the year ended December 31, 2008.

(2)           Source:  A.M. Best Aggregate & Averages — Property-Casualty (2008 Edition) statutory basis.

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Investments

Oversight of our investment policies is conducted by our board of directors and officers. We follow an investment policy that is reviewed quarterly and revised periodically.

Our investment portfolio serves primarily as the funding source for loss reserves and secondly as a source of income and appreciation. Our investment strategy is based on preservation of capital as the first priority, with a secondary focus on generating total return. Investments of the highest quality and marketability are critical for preserving our claims-paying ability. Common stock investments are limited to securities listed on the national exchanges and rated by the Securities Valuation Office of the NAIC. Our portfolio contains no derivatives or off-balance sheet structured investments. In addition, we employ stringent diversification rules and balance our investment credit risk and related underwriting risks to minimize total potential exposure to any one security. Despite fluctuations of realized and unrealized gains and losses in the equity portfolio, our investment in equity securities as part of a long-term asset allocation strategy has contributed significantly to our historic growth in book value.

Our investments include fixed income debt securities, common stock equity securities, preferred stock equity securities, exchange traded funds (ETFs) and a high-yield municipal bond mutual fund.  Effective January 1, 2008, we determined the fair values of certain financial instruments based on the fair value hierarchy established in SFAS 157.  SFAS 157 requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputs that may be used to measure fair value.

Level 1: quoted price (unadjusted) in active markets for identical assets

Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument

Level 3: inputs to the valuation methodology are unobservable for the asset or liability

SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

To measure fair value, we obtain quoted market prices for our investment securities.  If a quoted market price is not available, we use quoted market prices of similar securities.

Assets measured at fair value on a recurring basis are summarized below:

	As of December 31, 2008,
	Fair Value Measurements Using
	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable
(in thousands)	Identical Assets		Inputs		Inputs
Description	(Level 1)		(Level 2)		(Level 3)		Total
Trading securities	$	—	$	10,020	$	—	$	10,020
Available-for-sale securities	286,790		1,224,215		—		1,511,005
Total	$	286,790	$	1,234,235	$	—	$	1,521,025

As noted in the above table, we did not have any assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as of December 31, 2008.

We continuously monitor the values of our investments in fixed income securities and equity securities for other-than-temporary impairment.  If this review suggests that a decline in fair value is other-than-temporary based upon many factors including the duration or significance of the unrealized loss, our carrying value in the investment is reduced to its fair value through an adjustment to earnings. In 2008, we recorded impairment losses totaling $76.2 million.  This was comprised of $12.0 million in our fixed income portfolio and $64.2 million in our equity portfolio.

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                The fixed income portfolio contained 229 unrealized loss positions as of December 31, 2008. The $31.3 million in associated unrealized losses for these 229 securities is 2.4 percent of the fixed income portfolio’s cost basis. Of these 229 securities, 33 have been in an unrealized loss position for more than 12 consecutive months and these collectively represent $9.5 million in unrealized losses.  All fixed income securities in the investment portfolio continue to pay the expected coupon payments under the contractual terms of the securities.  With respect to those fixed income securities which fall under the provisions of EITF 99-20: Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests that Continue to be Held by a Transferor in Securitized Financial Assets, all of our securitized financial assets are of a high credit quality and it is not probable that contractual cash flows will not be collected.  The fixed income unrealized losses can be primarily attributed to spreads widening in the corporate, municipal and mortgage backed security markets. We have the ability and intent to hold these securities to maturity. In addition, we continually monitor the credit quality of our fixed income investments to assess if it is probable that we will receive our contractual or estimated cash flows in the form of principal and interest. We consider price declines of securities in our other-than-temporary impairment analysis where such price declines provide evidence of declining credit quality, and we distinguish between price changes caused by credit deterioration, as opposed to rising interest rates.

Factors that we consider in the evaluation of credit quality include:

1.Changes in technology that may impair the earnings potential of the investment,

2.Discontinuance of a segment of the business that may affect the future earnings potential,

3.Reduction or elimination of dividends,

4.Specific concerns related to the issuer’s industry or geographic area of operation,

5.Significant or recurring operating losses, poor cash flows, and/or deteriorating liquidity ratios, and

6.Downgrade in credit quality by a major rating agency.

As of December 31, 2008, we held 33 common stock positions that were in unrealized loss positions. Unrealized losses on these securities totaled $27.3 million. Of the 33 common stock positions that were in an unrealized loss position, one has been in an unrealized loss position for more than 12 consecutive months, representing $4.2 million in unrealized losses.  We specifically review equity securities with unrealized losses greater than 12 months in duration as to the financial condition and future prospects of the issuers and the price volatility of the equity securities themselves.  At December 31, 2008, the one position in unrealized losses for greater than 12 months relates to an exchange traded mutual fund that is based on general market indices.  However, we have observed that none of these securities have declined by 20 percent or more from their cost basis for a continuous period of six months or more. We believe all of these positions have favorable long-term prospects and we believe that all unrealized loss positions will recover to our cost basis in a reasonable period of time.

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Fixed Income Securities

As of December 31, 2008, our fixed income portfolio had the following rating distributions:

FAIR VALUE		AAA		AA		A		BBB		BB or Below		Fair Value
Bonds:
	Corporate - financial	$	1,542	$	5,118	$	58,927	$	12,803	$	6	$	78,396
	All other corporate	1,595		1,755		120,795		48,755		2,959		175,859
	Financials - private placements	—		—		1,619		7,894		—		9,513
	All other corporates - private placements	—		—		7,578		1,540		—		9,118
	U.S. govt. agency (GSE)	311,224		265		—		—		—		311,489
	Tax-exempt municipal securities	57,026		290,284		85,429		21,140		—		453,879
Structured:
	GSE - RMBS	$	170,537	$	2,024	$	—	$	—	$	—	$	172,561
	Non-GSE RMBS - prime	—		—		—		—		—		—
	Non-GSE RMBS - Alt A	—		—		—		—		—		—
	Non-GSE RMBS - subprime	—		—		—		—		—		—
	ABS - home equity	2,529		—		—		—		—		2,529
	ABS - credit cards	339		—		—		—		—		339
	ABS - auto loans	3,646		—		—		153		—		3,799
	All other ABS	14,539		—		—		—		—		14,539
	CMBS	43,635		—		—		—		—		43,635
	CDOs/CLOs	—		—		—		—		—		—
		$	606,612	$	299,446	$	274,348	$	92,285	$	2,965	$	1,275,656

                Our fixed income portfolio comprised 77 percent of our total 2008 portfolio, versus 75 percent of the total at December 31, 2007, and 74 percent of the total as of December 31, 2006. As of December 31, 2008, our fixed income portfolio contained 48 percent AAA-rated securities, 23 percent AA-rated securities, 22 percent A-rated securities, and 7 percent BBB-rated or lower securities.

As of December 31, 2008, the duration of the fixed income portfolio was 4.4 years.  Our fixed income portfolio remained diversified with investments in treasury, government sponsored agency, corporate, municipal, mortgage-backed, and asset-backed securities.  All fixed income securities in the investment portfolio continue to pay the expected coupon payments under the contractual terms of the securities. In selecting the maturity of securities in which we invest, we consider the relationship between the duration of our fixed income investments and the duration of our liabilities, including the expected ultimate payout patterns of our reserves. We believe that both liquidity and interest rate risk can be minimized by such asset/liability management.

                Our mortgage-backed securities (MBS) portfolio is comprised of residential MBS investments. As of December 31, 2008, MBS investments totaled $172.6 million (14 percent) of the fixed income portfolio compared to $205.7 million (15 percent) as of December 31, 2007.

                We believe MBS investments add diversification, liquidity, credit quality and additional yield to our portfolio. Our objective for the MBS portfolio is to provide reasonable cash flow stability and increased yield. This sector experienced unusually high volatility given the concerns over housing prices and general economic conditions. The MBS portfolio includes collateralized mortgage obligations (CMOs) and mortgage-backed pass-through securities. A mortgage pass-through is a security consisting of a pool of residential mortgage loans. All payments of principal and interest are passed through to investors each month. A CMO is a mortgage-backed security with a fixed maturity. This can eliminate the risks associated with prepayment because each security is divided into maturity classes that are paid off in order. Our MBS portfolio does not include interest-only securities, principal-only securities or other MBS investments which may exhibit extreme market volatility.

                Our asset-backed securities (ABS) portfolio is comprised mostly of rate reduction utility bonds, among others. As of December 31, 2008, ABS/CMBS (commercial mortgage-backed securities) investments were $64.8 million (5 percent) of the fixed income portfolio, compared to $97.7 million (7 percent) as of December 31, 2007. CMBS made up

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$43.6 million (67 percent) of the ABS/CMBS portfolio compared to $61.5 million (63 percent) at December 31, 2007.  The entire CMBS portfolio was rated AAA as of December 31, 2008.

We define subprime mortgages as loans which include one or more of the following: a weak credit score (FICO score of less than 640), high debt-to-income ratio, high loan-to-value ratio, or undocumented income.  Our exposure to subprime lending is limited to investments within the fixed income investment portfolio which contains securities collateralized by mortgages that have characteristics of subprime lending such as home equity mortgages.  These investments are in the form of asset-backed securities collateralized by subprime mortgages and collateralized mortgage obligations backed by alternative documentation mortgages.  The total carrying value of these investments is less than $3 million comprising less than 1 percent of our total fixed income portfolio.  The credit rating of all of these securities was AAA as of December 31, 2008 and reflects our practice of minimizing exposure to low quality (subprime type) credit risk.  In addition, all of the securities containing subprime collateral were originated before 2005.  We did not recognize any impairment write downs in the investment portfolio due to subprime mortgages during the periods presented herein.

We have a significant allocation to municipal fixed income securities. As of December 31, 2008, the municipal bond component of the fixed income portfolio decreased $19.8 million, to $453.9 million and comprised 36 percent of our total fixed income portfolio, versus 34 percent of the fixed income portfolio at year-end 2007.

We believe municipal fixed income securities provide diversification, liquidity, credit quality and additional yield to our portfolio. Our objective for the municipal fixed income portfolio is to provide reasonable cash flow stability and increased after tax yield.  Our municipal fixed income portfolio is comprised of general obligation (GO) and revenue securities. The revenue sources include but are not limited to public improvement, school, transportation, colleges and universities, water and sewer.

As of December 31, 2008, approximately 55 percent of the municipal fixed income securities in the investment portfolio were GO and the remaining 45 percent were revenue fixed income.  Seventy-six percent of our municipal fixed income securities were rated AA or better, while 95 percent were rated A or better. We believe our municipal fixed income portfolio has very high credit quality.

As of December 31, 2008, our corporate debt portfolio totaled $272.9 million (21 percent) of the fixed income portfolio compared to $232.1 million (17 percent) as of December 31, 2007.  The corporate debt portfolio has an overall quality rating of single A, diversified amongst 102 issuers across 18 industries.

Corporate debt securities experienced large interest rate spread widening in 2008 as this market was directly impacted by the declining housing market, credit crisis and slowing economy.  We believe corporate debt investments add diversification, liquidity and additional yield to our portfolio.  With our high quality, diversified portfolio, the corporate debt investments will continue to be a significant part of our investment program and we believe it is probable that the securities in our portfolio will continue to receive contractual payments in the form of principal and interest.

During 2008, we allocated the majority of available cash flows to the purchase of fixed income securities. The mix of instruments within the portfolio is decided at the time of purchase on the basis of fundamental analysis and relative value.  As of December 31, 2008, 93 percent of the fixed income portfolio was rated A or better and 71 percent was rated AA or better.

We currently classify 3 percent of the securities in our fixed income portfolio as held-to-maturity, meaning they are carried at amortized cost and are intended to be held until their contractual maturity. Other portions of the fixed income portfolio are classified as available-for-sale (96 percent) or trading (1 percent) and are carried at fair value. As of December 31, 2008, we maintained $1.2 billion in fixed income securities within the available-for-sale and trading classifications. The available-for-sale portfolio provides an additional source of liquidity and can be used to address potential future changes in our asset/liability structure.

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Aggregate maturities for the fixed-income portfolio as of December 31, 2008, are as follows:

	Par		Amortized		Fair		Carrying
(thousands)	Value		Cost		Value		Value
2009	$	28,320	$	28,430	$	28,725	$	28,579
2010	32,225		32,690		32,635		32,586
2011	88,608		90,088		90,844		90,227
2012	67,443		68,616		70,091		69,928
2013	86,537		89,236		91,424		90,946
2014	74,598		78,023		78,888		78,851
2015	63,674		64,509		60,444		60,335
2016	41,840		42,895		41,900		41,900
2017	104,099		102,154		100,615		100,615
2018	159,138		160,340		157,255		157,254
2019	36,054		38,101		37,369		37,369
2020	38,932		39,990		39,779		39,779
2021	30,630		31,915		31,759		31,759
2022	94,937		95,699		94,979		94,979
2023	108,306		109,725		108,229		108,229
2024	7,791		8,029		7,957		7,957
2025	3,026		3,026		3,074		3,074
2026	0		0		0		0
2027	3,000		3,004		2,016		2,016
2028	7		7		7		7
2029	5		5		5		5
2030	6,489		6,502		5,609		5,609
2031	4,298		4,301		4,150		4,150
2032	7,687		7,755		7,806		7,806
2033	36,181		36,362		36,448		36,448
2034	17,506		17,587		17,621		17,621
2035	14,129		14,398		14,183		14,183
2036	40,368		40,403		40,809		40,809
2037	33,001		32,845		33,711		33,711
2038	17,886		17,814		17,596		17,596
2039	3,100		3,177		2,924		2,924
2040	8,000		7,931		7,000		7,000
2041	8,296		8,407		7,317		7,317
2042	200		200		158		158
2043	2,240		2,256		2,041		2,041
2044	0		0		0		0
2045	150		150		128		128
2046	115		109		84		84
2047	105		100		76		76
2048	0		0		0		0
2049	0		0		0		0
2050	0		0		0		0
	$	1,268,921	$	1,286,779	$	1,275,656	$	1,274,056

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Equity Securities

At December 31, 2008, our equity securities were valued at $286.8 million, a decrease of $106.9 million from the $393.7 million held at the end of 2007. During 2008, the pretax change in unrealized gains on equity securities was -$102.6 million. Equity securities represented 17 percent of cash and invested assets at the end of 2008, a decrease from the 21 percent at year-end 2007.  As of the year-end 2008, total equity investments held represented 41 percent of our shareholders’ equity. The securities within the equity portfolio remain primarily invested in large-cap issues with strong dividend performance.  In addition, we have investments in real estate investment trusts, ETFs, preferred stocks, and a high-yield municipal bond fund.  Our strategy remains one of value investing, with security selection taking precedence over market timing. A buy-and-hold strategy is used, minimizing both transaction costs and taxes.  In 2008, we recorded impairment losses of $64.2 million on our equity securities.  The impairments were the result of our belief that the securities were not likely to recover in a reasonable period of time.

The following table illustrates the distribution by sector of our equity portfolio as of December 31, 2008, including fair value, cost basis, and unrealized gains and losses:

							Net
	Cost		12/31/2008		% of Total		Unrealized
(in thousands)	Basis		Fair Value		Fair Value		Gain/Loss
Common stock:
Consumer discretionary	$	18,265	$	14,700	5.1	%	$	(3,565	)
Consumer staples	11,492		22,113		7.7	%	10,621
Energy	11,171		22,181		7.7	%	11,010
Financials	17,549		20,406		7.1	%	2,857
Healthcare	10,395		18,439		6.4	%	8,044
Industrials	15,560		19,249		6.7	%	3,689
Information technology	13,005		14,807		5.2	%	1,802
Materials	4,329		3,284		1.2	%	(1,045		)
REITs	4,771		4,833		1.7	%	62
Telecommunications	4,408		8,950		3.1	%	4,542
Utilities	41,980		52,495		18.3	%	10,515
ETFs	53,556		40,111		14.0	%	(13,445		)
High-yield muni fund	33,341		33,341		11.6	%	—
Preferred stock	11,461		11,881		4.2	%	420
Total	$	251,283	$	286,790	100	%	$	35,507

As of December 31, 2008, our common stock portfolio totaled $201.5 million (70 percent) of the equity portfolio compared to $322.7 million (82 percent) as of December 31, 2007.  The decline in value of our common stock portfolio in 2008 was primarily due to an investment decision to reduce our common stock exposure as well as a negative return in the asset class.

Our common stock portfolio consists largely of large cap, value oriented, dividend paying securities.  We employ a long term, buy and hold strategy that has provided superior returns over the last 10 years.  While we anticipate continued volatility, we believe an equity allocation provides certain diversification and return benefits over the long term.  The strategy provides above-market dividend yields with less volatility than the market.  The beta of our equity portfolio is 0.7.

In 2008, we added two ETFs to our equity portfolio.  As of December 31, 2008, our ETF investment totaled $40.1 million (14 percent) of the equity portfolio compared to $2.6 million (1 percent) as of December 31, 2007.  The ETF investments add diversification, liquidity and increased return potential to our portfolio. In 2008, the ETFs outperformed the overall market but still contributed to the negative performance of the equity portfolio.  We believe that ETF securities will be an important part of our investment program going forward.  Our current ETFs contain large-cap securities that match our overall equity investment philosophy of providing superior dividend yields with less volatility than the market.  These ETFs track various indices and have returns for 2008 consistent with the benchmark indices they follow.

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As of December 31, 2008, our investment in preferred stock securities totaled $11.9 million (4 percent) of the equity portfolio compared to $34.2 million (9 percent) as of December 31, 2007.  Preferred stocks are primarily issued by companies in the financial sector and were negatively affected by this year’s credit crisis.

As of December 31, 2008, our investment in the high-yield municipal bond fund totaled $33.3 million (12 percent) of the equity portfolio compared to $34.3 million (9 percent) as of December 31, 2007. While this mutual fund is comprised of fixed income securities, as a mutual fund we treat it as an equity. In 2008, we recorded impairment losses of $18.6 million on the high-yield municipal bond fund due to our belief that the fund is unlikely to completely recover in value in a reasonable period of time and related changes in our intent to hold this security until recovery.  The holdings are comprised of lower quality investment grade and below investment grade tax-exempt securities. Sectors include healthcare, airports, tobacco, and infrastructure securities among other. The fund continues to make dividend payments and default rates of the bonds held in the fund remain below 1%. This market has been hurt by the flight to quality and overall liquidity in the municipal bond markets.

We had short-term investments and fixed income securities maturing within one year of $126.6 million at year-end 2008. This total represented 8 percent of cash and invested assets versus 5 percent the prior year.  Our short-term investments consist of money market funds.

Our investment results are summarized in the following table:

	Year ended December 31,
(in thousands)	2008			2007			2006			2005			2004
Average Invested Assets (1)	$	1,749,303		$	1,834,009		$	1,763,016		$	1,633,755		$	1,451,539
Net Investment Income (2)(3)	78,986			78,901			71,325			61,641			54,087
Net Realized Gains/(Losses) (3)	(46,738		)	28,966			31,045			16,354			13,365
Change in Unrealized Appreciation/(Depreciation) (3)(4)	(123,607		)	(14,650		)	34,395			(35,788		)	13,200
Annualized Return on Average Invested Assets	-5.2		%	5.1		%	7.8		%	2.6		%	5.6		%

(1) Average of amounts at beginning and end of each year.

(2) Investment income, net of investment expenses.

(3) Before income taxes.

(4) Relates to available-for-sale fixed income and equity securities.

Regulation

State and Federal Legislation

As an insurance holding company, we, as well as our insurance company subsidiaries, are subject to regulation by the states and territories in which the insurance subsidiaries are domiciled or transact business. Holding company registration in each insurer’s state of domicile requires periodic reporting to the state regulatory authority of the financial, operational and management data of the insurers within the holding company system. All transactions within a holding company system affecting insurers must have fair and reasonable terms, and the insurer’s policyholder surplus following any transaction must be both reasonable in relation to its outstanding liabilities and adequate for its needs. Notice to regulators is required prior to the consummation of certain transactions affecting insurance company subsidiaries of the holding company system.

The insurance holding company laws also require that ordinary dividends be reported to the insurer’s domiciliary regulator prior to payment of the dividend and that extraordinary dividends may not be paid without such regulator’s prior approval. An extraordinary dividend is generally defined under Illinois law as a dividend that, together with all other dividends made within the past 12 months, exceeds the greater of 100 percent of the insurer’s statutory net income for the most recent calendar year, or 10 percent of its statutory policyholders’ surplus as of the preceding year end. Insurance regulators have broad powers to prevent the reduction of statutory surplus to inadequate levels, and there is no assurance that extraordinary dividend payments would be permitted.

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Other regulations impose restrictions on the amount and type of investments our insurance company subsidiaries may have. Regulations designed to ensure financial solvency of insurers and to require fair and adequate treatment and service for policyholders are enforced by filing, reporting and examination requirements. Marketplace oversight is conducted by monitoring and periodically examining trade practices, approving policy forms, licensing of agents and brokers, and requiring the filing and in some cases, approval, of premiums and commission rates to ensure they are fair and equitable. Such restrictions may limit the ability of our insurance company subsidiaries to introduce new coverages or implement desired changes to current premium rates or policy forms. Financial solvency is monitored by minimum reserve and capital requirements (including risk-based capital requirements), periodic reporting procedures (annually, quarterly, or more frequently if necessary), and periodic examinations.

The quarterly and annual financial reports to the states utilize statutory accounting principles that are different from GAAP, which show the business as a going concern. The statutory accounting principles used by regulators, in keeping with the intent to assure policyholder protection, are generally based on a solvency concept.

Many jurisdictions have laws and regulations that limit an insurer’s ability to withdraw from a particular market. For example, states may limit an insurer’s ability to cancel or not renew policies. Furthermore, certain states prohibit an insurer from withdrawing one or more lines of business from the state, except pursuant to a plan that is approved by the state insurance department. The state insurance department may disapprove a plan that may lead to marketplace disruption. Laws and regulations that limit cancellation and non-renewal and that subject program withdrawals to prior approval requirements may restrict our ability to exit unprofitable marketplaces in a timely manner.

In addition, state-level changes to the insurance regulatory environment are frequent, including changes caused by legislation, regulations by the state insurance regulators, and court rulings. For example, the Florida Supreme Court issued a case ruling in 2008 with the effect that surplus lines insurance in Florida is subject to the same regulation as admitted insurance in Florida, excluding rate regulation and certain other areas. Although not stated expressly in the ruling, it implies that surplus lines policy forms must be filed and approved by the Florida Office of Insurance Regulation (FOIR). In response, the FOIR has publicly stated that it disagrees with the ruling and its foundations and that the FOIR does not now nor has it ever required surplus lines insurers to comply with such form filing requirements. In early 2009, a bill was introduced in the Florida legislature to clarify the regulatory status of surplus lines insurance in Florida and provide that policy forms need not be filed and approved by the FOIR. Although the status of this situation is uncertain and at this stage we cannot predict if such legislation will become law or how this matter ultimately will be resolved, we believe it will not result in material negative consequences for us.

Virtually all states require licensed insurers to participate in various forms of guaranty associations in order to bear a portion of the loss suffered by the policyholders of insurance companies that become insolvent. Depending upon state law, licensed insurers can be assessed an amount that is generally equal to a small percentage of the annual premiums written for the relevant lines of insurance in that state to pay the claims of an insolvent insurer. These assessments may increase or decrease in the future, depending upon the rate of insolvencies of insurance companies. In some states, these assessments may be wholly or partially recovered through policy fees paid by insureds.

In addition, the insurance holding company laws require advance approval by state insurance commissioners of any change in control of an insurance company that is domiciled (or, in some cases, having such substantial business that it is deemed to be commercially domiciled) in that state. “Control” is generally presumed to exist through the ownership of 10 percent or more of the voting securities of a domestic insurance company or of any company that controls a domestic insurance company. In addition, insurance laws in many states contain provisions that require pre-notification to the insurance commissioners of a change in control of a non-domestic insurance company licensed in those states. Any future transactions that would constitute a change in control of our insurance company subsidiaries, including a change of control of us, would generally require the party acquiring control to obtain the prior approval by the insurance departments of the insurance company subsidiaries’ states of domicile or commercial domicile, if any, and may require preacquisition notification in applicable states that have adopted pre-acquisition notification provisions. Obtaining these approvals could result in a material delay of, or deter, any such transaction.

In addition to monitoring our existing regulatory obligations, we are also monitoring developments in the following areas to determine the potential effect on our business and to comply with our legal obligations.

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Troubled Asset Relief Program

In 2008, in response to market and banking turmoil, the federal government implemented the Troubled Asset Relief Program (TARP), which is a federal program of the Department of Treasury designed to strengthen U.S. financial institutions through purchasing or insuring troubled assets and equity. The TARP program contains restrictions and controls on participating entities, and may be amended in the future to contain additional restrictions in areas such as executive compensation. To the extent an insurance company participates in TARP, it will be subject to all applicable restrictive and control provision. We do not currently participate in TARP and do not anticipate electing to participate in the future.

Terrorism Insurance

After the events of September 11, 2001, the National Association of Insurance Commissioners (NAIC) urged states to grant conditional approval to commercial lines endorsements that excluded coverage for acts of terrorism consistent with language developed by the Insurance Services Office, Inc. (ISO). The ISO endorsement included certain coverage limitations. Many states allowed the endorsements for commercial lines, but rejected such exclusions for personal exposures.

On November 26, 2002, the federal Terrorism Risk Insurance Act of 2002 (TRIA) became law. TRIA was extended through December 31, 2007 and reauthorized through December 31, 2014. The act, as extended and amended, provides for a federal backstop for terrorism losses as defined by the act and certified by the Secretary of the Treasury in concurrence with the Secretary of State and the U.S. Attorney General. Under TRIA, coverage provided for losses caused by acts of foreign or domestic terrorism is partially reimbursed by the United States under a formula whereby the government pays 85 percent of covered terrorism losses exceeding a prescribed deductible to the insurance company providing the coverage. The deductible is 20 percent of gross earned premium net of a few excludable lines and the federal coverage is limited to $100 billion. Coverage under the act must be made available to policyholders, with certain specified exceptions, in commercial property and casualty policies. The immediate effect, as regards state regulation, was to nullify terrorism exclusions to the extent they exclude losses that would otherwise be covered under the act. We are in compliance with the requirements of TRIA and have made terrorism coverage available to applicable policyholders. Given the challenges associated with attempting to assess the possibility of future acts of terror exposures and assign an appropriate price to the risk, we have taken a conservative underwriting position on most of our affected coverages.

Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 presents a significant expansion of securities law regulation of corporate governance and compliance, accounting practices, reporting, and disclosure that affects publicly traded companies. The act, in part, sets forth requirements for certification by CEOs and CFOs of certain reports filed with the Securities and Exchange Commission (SEC), disclosures pertaining to the adoption of a code of ethics applicable to certain management personnel, and safeguards against actions to fraudulently influence, manipulate or mislead independent public or certified accountants of the issuer’s financial statements. It also provides stronger requirements for development and evaluation of internal control procedures, as well as provisions pertaining to a company’s audit committee of the board of directors. As required by the act and under the supervision from and participation of management, we annually complete an evaluation of our internal control system including all design, assessment, documentation, and testing phases. This evaluation is intended to identify any deficiencies, measure their materiality, and implement procedures, where necessary, to remediate them.

The annual certification of our CEO with respect to compliance with the New York Stock Exchange (NYSE) corporate governance listing standards has been submitted to the NYSE and the annual certifications of our CEO and CFO required by the Sarbanes-Oxley Act of 2002 with respect to our 2008 fiscal year have been filed with the SEC as an exhibit to our annual report on Form 10-K for 2008.

Federal Regulation of Insurance

The U.S. insurance industry is not currently subject to any significant amount of federal regulation, and instead is regulated principally at the state level. However, federal insurance legislation of various types is periodically

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proposed in Congress, and in 2007 several bills were introduced in Congress that would impact and regulate various aspects of the insurance industry. These proposed laws covered many areas, including amending and extending the current TRIA law, optional federal charter, streamlining state regulation of nonadmitted insurance, expanding the national flood insurance program, creating a national catastrophe insurance program, and ending the antitrust exemption for insurance companies. However, only the extension and amendment of the TRIA law was enacted.  In 2008, such proposals were limited, but we expect that the federal government’s reaction to the economic and financial market turmoil will include some type of federal oversight of the insurance industry, including possibly establishing a federal insurance charter and a federal Office of Insurance Information.  We cannot predict whether one or more of the other proposed bills will again be proposed or enacted or whether any significant federal involvement in insurance regulation will be implemented in 2009 or later, or the impact of any such laws or regulation on our company. We will continue to monitor all significant federal insurance legislation.

Corporate Compliance

We have a code of conduct, corporate governance guidelines, and compliance manual, which provide directors, officers, and employees with guidance and requirements for complying with a variety of federal and state laws and company policies. Electronic versions of these documents, as well as the following documents, are, or will be, available on our web site (www.rlicorp.com): 2008 summary annual report; 2008 financial report; 2009 proxy statement; annual report on Form 10-K for 2008; and charters of the executive resources, audit, finance and investment, strategy, and nominating/corporate governance committees of our board of directors. Printed copies of these documents will be made available upon request without charge to any shareholder.

Licenses and Trademarks

We enter into various license arrangements with third parties and vendors on a regular basis for various goods and services.  We have a software license and services agreement with Risk Management Solutions, Inc. for the modeling of natural hazard catastrophes. The license is renewed on an annual basis. RLI Insurance Company has a perpetual license with AIG Technology Enterprises, Inc. for policy management, claims processing, premium accounting, file maintenance, financial/management reporting, reinsurance processing, and statistical reporting. We also enter into other software licensing agreements in the ordinary course of business.

We obtained U.S. federal service mark registration of our corporate logo “RLI” and several other company service mark and trade names with the U.S. Patent and Trademark Office. Such registrations protect the marks nationwide from deceptively similar use. The duration of these registrations is 10 years unless renewed.  We monitor our trademarks and service marks and protect them from unauthorized use as necessary.

Employees

As of December 31, 2008, we employed a total of 783 associates. Of the 783 total associates, 65 were part-time and 718 were full-time.

Forward Looking Statements

Forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 appear throughout this report. These statements relate to our current expectations, beliefs, intentions, goals or strategies regarding the future and are based on certain underlying assumptions by us. These forward looking statements generally include words such as “expect,” “will,” “should,” “anticipate,” “believe,” and similar expressions.  Such assumptions are, in turn, based on information available and internal estimates and analyses of general economic conditions, competitive factors, conditions specific to the property and casualty insurance industry, claims development, and the impact thereof on our loss reserves, the adequacy of our reinsurance programs, developments in the securities market and the impact on our investment portfolio, regulatory changes and conditions, and other factors and are subject to various risks, uncertainties, and other factors, including, without limitation those set forth below in “Item 1A Risk Factors.”  Actual results could differ materially from those expressed in, or implied by, these forward looking statements. We assume no obligation to update any such statements.  You should review the various risks, uncertainties, and other factors listed from time to time in our Securities and Exchange Commission filings.

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Item 1A.  Risk Factors

Our results of operations and revenues may fluctuate as a result of many factors, including cyclical changes in the insurance industry, which may cause the price of our securities to be volatile.

The results of operations of companies in the property and casualty insurance industry historically have been subject to significant fluctuations and uncertainties. Our profitability can be affected significantly by:

·competitive pressures impacting our ability to retain business at an adequate rate;

·rising levels of loss costs that we cannot anticipate at the time we price our coverages;

·volatile and unpredictable developments, including man-made, weather-related and other natural catastrophes or terrorist attacks;

·changes in the level of reinsurance capacity;

·changes in the amount of loss reserves resulting from new types of claims and new or changing judicial interpretations relating to the scope of insurers’ liabilities;

·fluctuations in equity markets and interest rates, inflationary pressures and other changes in the investment   environment, which affect returns on invested assets and may impact the ultimate payout of losses; and

·adverse conditions in the financial services industry which can make access to capital more difficult.

In addition, the demand for property and casualty insurance can vary significantly, rising as the overall level of economic activity increases and falling as that activity decreases, causing our revenues to fluctuate. These fluctuations in results of operations and revenues may cause the price of our securities to be volatile.

Catastrophic losses, including those caused by natural disasters, such as earthquakes and hurricanes, or man-made events such as terrorist attacks, are inherently unpredictable and could cause us to suffer material financial losses.

One of the largest risks of loss we face in the ordinary course of our business is property damage resulting from catastrophic events, particularly earthquakes on the West Coast and hurricanes and tropical storms affecting the continental U.S. or Hawaii.  Most of our past catastrophe-related claims have resulted from earthquakes and hurricanes. For example, we incurred a pre-tax net loss of $64.3 million related to the 1994 Northridge earthquake. In recent years, hurricanes have had a significant impact on our results.  In 2008, we incurred a pre-tax loss of $24.0 million on hurricanes Ike and Gustav.  We incurred a pre-tax loss of $22.5 million from the 2005 hurricanes, Katrina, Rita, and Wilma.  Catastrophes can also be caused by various events, including windstorms, hailstorms, explosions, severe winter weather, and fires and may include terrorist events such as the attacks on the World Trade Center and the Pentagon on September 11, 2001.

The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to fairly specific geographic areas; however, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. Catastrophes can cause losses in a variety of our property and casualty segments, and it is possible that a catastrophic event or multiple catastrophic events could cause us to suffer material financial losses.

Actual insured losses may be greater than our loss reserves, which would negatively impact our profitability.

Significant periods of time often elapse between the occurrence of an insured loss, the reporting of the loss to us and our payment of that loss. To recognize liabilities for unpaid losses, we establish reserves as balance sheet liabilities representing estimates of amounts needed to pay reported and unreported losses and the related loss adjustment expenses. Loss reserves are just an estimate of what we anticipate the ultimate costs of claims to be and do not represent an exact calculation of liability. Estimating loss reserves is a difficult and complex process involving many variables and subjective judgments. As part of the reserving process, we review historical data and consider the impact of various factors such as:

·loss emergence patterns;

·underlying policy terms and conditions;

·business and exposure mix;

·trends in claim frequency and severity;

·changes in operations;

·emerging economic and social trends;

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·inflation; and

·changes in the regulatory and litigation environments.

This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. It also assumes that adequate historical or other data exists upon which to make these judgments. There is no precise method, however, for evaluating the impact of any specific factor on the adequacy of reserves, and actual results are likely to differ from original estimates. If the actual amount of insured losses is greater than the amount we have reserved for these losses, our profitability could suffer.

We may suffer losses from litigation, which could materially and adversely affect our financial condition and business operations.

As is typical in our industry, we face risks associated with litigation.  For example, we are currently involved in a complex litigation arising out of an equipment and vehicle leasing program of Commercial Money Center (CMC). We have reached settlements with all five investor banks that made claims under the lease bonds issued by RLI and expect the remaining CMC-related litigation involving us to be concluded in 2009.  We were also a defendant in complex private litigation brought against insurance brokers and insurance companies alleging injury from the payment of contingent commissions by insurers to brokers.  We were released from the suit without payment of any settlement fees in 2007 but paid significant legal expenses in defending ourselves.  Litigation is subject to inherent uncertainties, and if there were an outcome unfavorable to us in another matter, there exists the possibility of a material adverse impact on our results of operations in the period in which the outcome occurs.  Please refer to Item 3, Legal Proceedings.

Our reinsurers may not pay on losses in a timely fashion, or at all, which may increase our costs.

We purchase reinsurance by transferring part of the risk we have assumed (known as ceding) to a reinsurance company in exchange for part of the premium we receive in connection with the risk. Although reinsurance makes the reinsurer liable to us to the extent the risk is transferred or ceded to the reinsurer, it does not relieve us (the reinsured) of our liability to our policyholders. Accordingly, we bear credit risk with respect to our reinsurers. That is, our reinsurers may not pay claims made by us on a timely basis, or they may not pay some or all of these claims, for a variety of reasons. Either of these events would increase our costs and could have a materially adverse effect on our business.

If we cannot obtain adequate reinsurance protection for the risks we have underwritten, we may be exposed to greater losses from these risks or we may reduce the amount of business we underwrite, which will reduce our revenues.

Market conditions beyond our control determine the availability and cost of the reinsurance protection that we purchase. In addition, the historical results of reinsurance programs and the availability of capital also affect the availability of reinsurance. Our reinsurance facilities are generally subject to annual renewal. We cannot be sure that we can maintain our current reinsurance facilities or that we can obtain other reinsurance facilities in adequate amounts and at favorable rates.  If we are unable to renew our expiring facilities or to obtain new reinsurance facilities on terms we deem acceptable, either our net exposures would increase - which could increase our costs - or, if we were unwilling to bear an increase in net exposures, we would have to reduce the level of our underwriting commitments - especially catastrophe exposed risks - which would reduce our revenues.

Our investment results and, therefore, our financial condition may be impacted by changes in the business, financial condition or operating results of the entities in which we invest, as well as changes in interest rates, government monetary policies, general economic conditions, liquidity and overall market conditions.

We invest the premiums we receive from customers until they are needed to pay policyholder claims or until they are recognized as profits. At December 31, 2008, our investment portfolio consisted of $1.3 billion in fixed income securities, $286.8 million in equity securities and $98.0 million in short-term investments. For the 12 months ended December 31, 2008, we experienced a $124.0 million pre-tax unrealized loss on our investment portfolio. For the fiscal year ended December 31, 2007, we experienced $14.7 million in pre-tax unrealized losses on our investment portfolio. The 2008 and 2007 losses primarily reflect the unprecedented levels of volatility and disruptions in the overall stock and bond markets. Fluctuations in the value of our investment portfolio can occur as a result of changes in the business, financial condition or operating results of the entities in which we invest, as well as changes in interest rates, government monetary policies, liquidity of holdings and general economic conditions. These fluctuations may, in turn, negatively impact our financial condition and impair our ability to raise capital, if needed.

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We compete with a large number of companies in the insurance industry for underwriting revenues.

We compete with a large number of other companies in our selected lines of business. We face competition both from specialty insurance companies, underwriting agencies and intermediaries, as well as diversified financial services companies that are significantly larger than we are and that have significantly greater financial, marketing, management and other resources than we do. Some of these competitors also have significantly greater experience and market recognition than we do. We may incur increased costs in competing for underwriting revenues. If we are unable to compete effectively in the markets in which we operate or to expand our operations into new markets, our underwriting revenues may decline, as well as overall business results.

A number of new, proposed or potential legislative or industry developments could further increase competition in our industry. These developments include:

·an increase in capital-raising by companies in our lines of business, which could result in new entrants to our markets and an excess of capital in the industry;

·the deregulation of commercial insurance lines in certain states and the possibility of federal regulatory reform of the insurance industry, which could increase competition from standard carriers for our excess and surplus lines of insurance business;

·programs in which state-sponsored entities provide property insurance in catastrophe-prone areas or other “alternative markets” types of coverage; and

·changing practices caused by the Internet, which may lead to greater competition in the insurance business.

New competition from these developments could cause the supply and/or demand for insurance or reinsurance to change, which could affect our ability to price our coverages at attractive rates and thereby adversely affect our underwriting results.

A downgrade in our ratings from A.M. Best, Standard & Poor’s, or Moody’s could negatively affect our business.

Ratings are a critical factor in establishing the competitive position of insurance companies. Our insurance companies are rated by A.M. Best, Standard & Poor’s, and Moody’s. A.M. Best, Standard & Poor’s and Moody’s ratings reflect their opinions of an insurance company’s and an insurance holding company’s financial strength, operating performance, strategic position and ability to meet its obligations to policyholders, and are not evaluations directed to investors. Our ratings are subject to periodic review by such firms, and we cannot assure the continued maintenance of our current ratings. All of our ratings were reviewed during 2008. A.M. Best reaffirmed its “A+, Superior” rating for the combined entity of RLI Insurance Company, Mt. Hawley Insurance Company, and RLI Indemnity Company (RLI Group). Standard and Poor’s reaffirmed our “A+, Strong” rating for the group.  Moody’s reaffirmed our group rating of “A2, Good” for RLI Group.  Because these ratings have become an increasingly important factor in establishing the competitive position of insurance companies, if our ratings are reduced from their current levels by any of A.M. Best, Standard & Poor’s or Moody’s, our competitive position in the industry, and therefore our business, could be adversely affected. A significant downgrade could result in a substantial loss of business as policyholders might move to other companies with higher claims-paying and financial strength ratings.

We are subject to extensive governmental regulation, which may adversely affect our ability to achieve our business objectives. Moreover, if we fail to comply with these regulations, we may be subject to penalties, including fines and suspensions, which may adversely affect our financial condition and results of operations.

We are subject to extensive governmental regulation and supervision. Most insurance regulations are designed to protect the interests of policyholders rather than shareholders and other investors. These regulations, generally administered by a department of insurance in each state in which we do business, relate to, among other things:

·approval of policy forms and premium rates;

·      standards of solvency, including risk-based capital measurements;

·      licensing of insurers and their producers;

·      restrictions on the nature, quality and concentration of investments;

·      restrictions on the ability of our insurance company subsidiaries to pay dividends to us;

·      restrictions on transactions between insurance company subsidiaries and their affiliates;

·      restrictions on the size of risks insurable under a single policy;

·      requiring deposits for the benefit of policyholders;

·      requiring certain methods of accounting;

·      periodic examinations of our operations and finances;

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·prescribing the form and content of records of financial condition required to be filed; and

·requiring reserves for unearned premium, losses and other purposes.

State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives.

In addition, regulatory authorities have relatively broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. In some instances, we follow practices based on our interpretations of regulations or practices that we believe may be generally followed by the industry. These practices may turn out to be different from the interpretations of regulatory authorities. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or otherwise penalize us. This could adversely affect our ability to operate our business. Further, changes in the level of regulation of the insurance industry or changes in laws or regulations themselves or interpretations by regulatory authorities could adversely affect our ability to operate our business.

In addition to regulations specific to the insurance industry, including principally the insurance laws of Illinois, where we are based, as a public company we are also subject to regulation by the U. S. Securities and Exchange Commission and the New York Stock Exchange, each of which regulate many areas such as financial and business disclosures, corporate governance, and shareholder matters.  We are also subject to the corporation laws of Illinois, where we and each of our four insurance company subsidiaries are incorporated.  We monitor these laws, regulations and rules on an ongoing basis, and make appropriate changes as necessary.  Implementing such changes may require adjustments to our business methods, increase our costs and other changes that could cause us to be less competitive in our industry.

We may be unable to attract and retain qualified key employees.

We depend on our ability to attract and retain qualified executive officers, experienced underwriting talent and other skilled employees who are knowledgeable about our business. If we cannot attract or retain top-performing executive officers, underwriters, and other personnel, or if the quality of their performance decreases, we may be unable to maintain our current competitive position in the specialized markets in which we operate and be unable to expand our operations into new markets.

We are an insurance holding company and, therefore, may not be able to receive dividends from our insurance subsidiaries in needed amounts.

RLI Corp. is the holding company for our three principal insurance operating companies.  At the holding company level, our principal assets are the shares of capital stock of our insurance company subsidiaries. We may rely on dividends from our insurance company subsidiaries to meet our obligations for paying principal and interest on outstanding debt obligations, dividends to shareholders and corporate expenses. The payment of dividends by our insurance company subsidiaries will depend on the surplus and future earnings of these subsidiaries and is also subject to regulatory restrictions. The maximum dividend distribution in a rolling 12-month period is limited by Illinois law to the greater of 10 percent of RLI Insurance Company’s policyholder surplus as of December 31 of the preceding year or their net income for the 12-month period ending December 31 of the preceding year. These levels may be exceeded in some cases with prior approval from the Illinois Department of Insurance.  The maximum dividend distribution that can be paid by RLI Insurance Company during 2009 without prior insurance department approval is $67.8 million, or 10 percent of RLI Insurance Company’s 2008 policyholder surplus. As a result, we may not be able to receive dividends from our subsidiaries at times and in amounts necessary to meet our debt service obligations or to pay dividends to our shareholders or corporate expenses. During 2008, RLI Insurance Company paid total dividends of $70.0 million to RLI Corp.

Anti-takeover provisions affecting us could prevent or delay a change of control that is beneficial to you.

Provisions of our articles of incorporation and by-laws, and provisions of applicable Illinois law and applicable federal and state regulations may discourage, delay or prevent a merger, tender offer or other change of control that holders of our securities may consider favorable. Certain of these provisions impose various procedural and other

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requirements that could make it more difficult for shareholders to effect certain corporate actions. These provisions could:

·have the effect of delaying, deferring or preventing a change in control of us;

·discourage bids for our securities at a premium over the market price;

·adversely affect the market price of, and the voting and other rights of the holders of, our securities; or

·impede the ability of the holders of our securities to change our management.

Breaches or interruptions of our computer systems could adversely affect our financial condition and results of operations.

We rely on multiple computer systems to issue policies, pay claims, run modeling functions, and complete various internal processes.  These systems may be exposed to unplanned interruption, unreliability, and data breaches.

Any such issues could materially impact our company, including the impairment of information availability, compromise of system integrity/accuracy, reduction of our volume of transactions, and interruption of our general business.  Although we believe we currently have adequate safeguards in place, we cannot guarantee that such problems will never occur.  If they do, interruption to our business and related costs could be significant, which could impair our profitability.

We may not be able to effectively start up or integrate a new product opportunity.

Our ability to grow our business depends in part on our creation, implementation and acquisition of new insurance products that are profitable and fit within our business model.  New product launches are subject to many obstacles, including ensuring we have sufficient business and systems processes, determining appropriate pricing, assessing opportunity costs and regulatory burdens, and planning for internal infrastructure needs.  If we cannot accurately assess and overcome these obstacles or we improperly implement new insurance products, our ability to grow organically and profitably will be impaired.

Access to capital and market liquidity has generally been more difficult and may adversely affect our ability to take advantage of business opportunities as they arise.

Our ability to grow our business depends in part on our ability to access capital when needed.  Because of adverse conditions in the financial services industry, access to capital has generally become more difficult.  In addition, we cannot predict the extent and duration of current economic and market disruptions, the impact of government interventions (including, among other things, TARP, the current economic stimulus package, etc.) into the market to address these disruptions, and their combined impact on our industry, business and investment portfolios.

Item 1B. Unresolved Staff Comments

                None

Item 2.  Properties

                We own six commercial buildings in Peoria, Illinois.  Our primary building is a two-story 80,000 square foot office building, which serves as our corporate headquarters.  Located on the same 20.6 acre campus is a 24,000 square foot building which is used by two branch offices of RLI Insurance Company and a supporting department. We also own a 25,400 square foot multi-story building used for record storage, a training center and office space.  Our corporate campus also includes a 12,800 square foot building used as storage for furniture and equipment and for office space.  The final structure is a 15,000 square foot office building, of which 10,000 square feet is leased. We share ownership with Maui Jim, Inc. of a 16,800 square foot airplane hangar located at the Greater Peoria Regional Airport.

Most of our branch offices and other company operations lease office space throughout the country.

Item 3.  Legal Proceedings

                We are the plaintiff and a defendant in an action captioned RLI Insurance Co. v. Commercial Money Center (“CMC”), which was filed in U.S. District Court, Southern District of California (San Diego) on February 1, 2002.

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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. We 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 here as the “investor banks.” The litigation arises out of the equipment and vehicle leasing program of CMC. CMC originated leases, procured bonds pertaining to the performance of obligations of each lessee under each lease, and then formed “pools” of such leases that it marketed to banks and other institutional investors. We sued for rescission and/or exoneration of the bonds we issued to CMC and sale and servicing agreements we entered into with CMC and the investor banks, which had invested in CMC’s equipment leasing program. We contend we were 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). We also sued for declaratory relief to determine our rights and obligations, if any, under the instruments. Each investor bank disputes our claims for relief. CMC is currently in Chapter 7 bankruptcy proceedings.

           Between the dates of April 4 and April 18, 2002, each investor bank subsequently filed a complaint against us in various state courts, which we removed to U.S. District Courts. Each investor bank sued us on certain bonds we issued to CMC as well as a sale and servicing agreement between the investor bank, CMC and us. Each investor bank sued for breach of contract, bad faith and other extra-contractual theories. We have answered and denied each investor bank’s claim to entitlement to relief. The investor banks claimed entitlement to aggregate payment of approximately $53 million under either the surety bonds or the sale and servicing agreements, plus unknown extra-contractual damages, attorney’s fees and interest. On October 25, 2002, the judicial panel for multi-district litigation (“MDL Panel”) transferred 23 actions pending in five federal districts involving numerous investor banks, five insurance companies and CMC to the Federal District Court for the Northern District of Ohio for consolidated pre-trial proceedings, assigning the litigation to the Honorable Kathleen O’Malley.

In the third quarter of 2005, we reached a confidential settlement agreement with Lakeland Bank. This settlement ended our litigation with Lakeland, but did not resolve our pending litigation with the four other investor banks. The settlement with Lakeland related to surety bonds representing approximately 17 percent of the amount to which the five investor banks had claimed entitlement. The settlement did not have a material adverse effect on our financial statements taken as a whole. In addition, in August 2005, the Federal District Court denied outright the investor banks’ motion for judgment on the pleadings and subsequently ordered all remaining cases to mandatory mediation. Mediations held in January 2006 between us and each of the four remaining investor banks did not resolve the claims of those investor banks. In September 2006, the Court issued a case management order governing expert witness discovery and future motion practice. In the second quarter of 2007, we reached a confidential settlement agreement with Sky Bank. In the third quarter of 2007, we reached a confidential settlement agreement with Ameriana Bank. These settlements ended our litigation with Sky Bank and Ameriana Bank but did not resolve our pending litigation with the remaining two investor banks (Bank of Waukegan and Atlantic Coast Federal, whose initial bond penal sum claims total approximately $9.3 million). The settlements with Sky Bank and Ameriana Bank related to surety bonds representing approximately 66 percent of the amount to which the five investor banks had claimed entitlement. In the first quarter of 2008, we reached a confidential settlement agreement with the Bank of Waukegan. In the fourth quarter of 2008, we reached a confidential settlement agreement with Atlantic Coast Federal Bank. The settlements with Bank of Waukegan and Atlantic Coast Federal related to surety bonds representing approximately 17 percent of the amount to which the five investor banks had claimed entitlement. With these latter two settlements, we have now reached settlements with each of the five investor banks that had claimed entitlement under the surety bonds issued by RLI.

                In addition, we are party to numerous claims and losses that arise in the normal course of our business. Many of such claims or losses involve claims under policies that we underwrite as an insurer. We believe that the resolution of these claims and losses will not have a material adverse effect on our financial condition, results of operations or cash flows. We are also involved in various other legal proceedings and litigation unrelated to our insurance business that arise in the ordinary course of business operations.   Management believes that any liabilities that may arise as a result of these legal matters will not have a material adverse effect on our financial condition or operating results.

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

                No matters were submitted by the Company to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

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PART II

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

(a)           Refer to the Corporate Data on page 64 of the 2008 Financial Report to Shareholders, attached as Exhibit 13 and incorporated by reference herein for information on the market on which our common stock is traded, holders of our common stock and dividends.

                Refer to Part III, Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters,” of this document for information on securities authorized for issuance under our equity compensation plan.

(b)           Not applicable.

(c)           Our common stock repurchase program, which authorized us to repurchase up to $100 million of our Company’s common stock, was initially approved by our Board of Directors on May 3, 2007.  On November 14, 2007, our Board of Directors increased the previously announced repurchase program by $100 million, for a total of $200 million of our common stock.  The repurchase program may be suspended or discontinued at any time without prior notice.  In light of market volatility in the second half of 2008, the repurchase program was suspended in the third quarter of 2008 and will remain suspended until conditions warrant its reactivation.

Item 6.  Selected Financial Data

                Refer to the Selected Financial Data on pages 62 through 63 of the 2008 Financial Report to Shareholders, attached as Exhibit 13 and incorporated by reference herein.

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

                Refer to the Management’s Discussion and Analysis of Financial Condition and Results of Operations on pages 1 through 27 of the 2008 Financial Report to Shareholders, attached as Exhibit 13 and incorporated by reference herein.  Certain accounting policies are viewed by Management to be “critical accounting policies.”  These policies relate to unpaid loss and settlement expenses, investment valuation, recoverability of reinsurance balances, deferred policy acquisition costs and deferred taxes. A detailed discussion of these critical accounting policies can be found on pages 3 through 8 of the 2008 Financial Report to Shareholders, attached as Exhibit 13 and incorporated by reference herein.

                Throughout this report (including portions incorporated by reference herein), we present our operations in the way we believe will be most meaningful, useful and transparent to anyone using this financial information to evaluate our performance. In addition to the GAAP presentation of net income and certain statutory reporting information, we show certain non-GAAP financial measures that are valuable in managing our business, including underwriting income, gross premiums written, net written premiums and combined ratios. A detailed discussion of these measures can be found on page 2 of the 2008 Financial Report to Shareholders, attached as Exhibit 13 and incorporated by reference herein.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

                Refer to the Management’s Discussion and Analysis of Financial Condition and Results of Operations on pages 1 through 27 of the 2008 Financial Report to Shareholders, attached as Exhibit 13 and incorporated by reference herein.

Item 8.  Financial Statements and Supplementary Data

                Refer to the consolidated financial statements and supplementary data included on pages 28 through 61 of the 2008 Financial Report to Shareholders, attached as Exhibit 13 and incorporated by reference herein.  (See also Index to Financial Statements and Schedules on page 46.)

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Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

                There were no changes in accountants or disagreements with accountants on any matters of accounting principles or practices or financial statement disclosure.

Item 9A. Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2008.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on our evaluation under the framework in Internal Control — Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2008.

Our internal control over financial reporting as of December 31, 2008 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report on page 58 of the 2008 Financial Report to Shareholders, attached as Exhibit 13.

There was no change in our internal control over financial reporting during our fourth fiscal quarter ended December 31, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Item 9B.  Other Information

                None

PART III

Items 10 to 14.

                Pursuant to General Instructions G(3) of Form 10-K, Items 10 to 14, inclusive, have not been restated or answered because the Company intends to file within 120 days after the close of its fiscal year with the Securities and Exchange Commission a definitive proxy statement pursuant to Regulation 14A under the Securities Exchange Act of 1934, which proxy statement involves the election of directors.  The information required in these items 10 to 14, inclusive, is incorporated by reference to that proxy statement.

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PART IV

Item 15. Exhibits and Financial Statement Schedules

(a)(l-2) Consolidated Financial Statements and Schedules.  See Index to Financial Statements and Schedules attached.

                (3) Exhibits.  See Exhibit Index on pages 57-58.

(b)           Exhibits.  See Exhibit Index on pages 57-58.

(c)Financial Statement Schedules.  The schedules included on attached pages 48 through 56 as required by Regulation S-X are excluded from the Company’s 2008 Financial Report to Shareholders.  See Index to Financial Statements and Schedules on page 46.  There is no other financial information required by Regulation S-X that is excluded from the Company’s 2008 Financial Report to Shareholders.

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SIGNATURES

                Pursuant to the requirements of Section 13 or 15(d) 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.

(Registrant)

By:	/s/Joseph E. Dondanville
	Joseph E. Dondanville
	Senior Vice President, Chief Financial Officer
Date:		February 25, 2009

                Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

By:	/s/Jonathan E. Michael
	Jonathan E. Michael, President, CEO
	(Principal Executive Officer)
Date:		February 25, 2009

By:	/s/Joseph E. Dondanville
	Joseph E. Dondanville, Senior Vice President
	Chief Financial Officer
	(Principal Financial Officer and Principal Accounting Officer)
Date:		February 25, 2009

By:	/s/Gerald D. Stephens
	Gerald D. Stephens, Director
Date:		February 25, 2009

By:	/s/Kaj Ahlmann
	Kaj Ahlmann, Director
Date:		February 25, 2009

By:	/s/Barbara R. Allen
	Barbara R. Allen, Director
Date:		February 25, 2009

By:	/s/John T. Baily
	John T. Baily, Director
Date:		February 25, 2009

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By:	/s/Richard H. Blum
	Richard H. Blum, Director
Date:		February 25, 2009

By:	/s/Jordan W. Graham
	Jordan W. Graham, Director
Date:		February 25, 2009

By:	/s/Gerald I. Lenrow
	Gerald I. Lenrow, Director
Date:		February 25, 2009

By:	/s/Charles M. Linke
	Charles M. Linke, Director
Date:		February 25, 2009

By:	/s/F. Lynn McPheeters
	F. Lynn McPheeters, Director
Date:		February 25, 2009

By:	/s/Jonathan E. Michael
	Jonathan E. Michael, Director
Date:		February 25, 2009

By:	/s/Edward F. Sutkowski
	Edward F. Sutkowski, Director
Date:		February 25, 2009

By:	/s/Robert O. Viets
	Robert O. Viets, Director
Date:		February 25, 2009

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INDEX TO FINANCIAL STATEMENTS AND SCHEDULES

		Reference (Page)
Data Submitted Herewith:
Report of Independent Registered Public Accounting Firm		47
Schedules:
I.	Summary of Investments - Other than Investments in Related Parties at December 31, 2008.	48
II.	Condensed Financial Information of Registrant, as of and for the three years ended December 31, 2008.	49-51
III.	Supplementary Insurance Information, as of and for the three years ended December 31, 2008.	52-53
IV.	Reinsurance for the three years ended December 31, 2008.	54
V.	Valuation and Qualifying Accounts for the three years ended December 31, 2008.	55
VI.	Supplementary Information Concerning Property-Casualty Insurance Operations for the three years ended December 31, 2008.	56

Schedules other than those listed are omitted for the reason that they are not required, are not applicable or that equivalent information has been included in the financial statements, and notes thereto, or elsewhere herein.

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders
RLI Corp.:

Under date of February 25, 2009, we reported on the consolidated balance sheets of RLI Corp. and Subsidiaries (the Company) as of December 31, 2008 and 2007, and the related consolidated statements of earnings and comprehensive earnings, cash flows, and shareholders’ equity for each of the years in the three-year period ended December 31, 2008, as contained in the 2008 Financial Report to Shareholders.  These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year ended December 31, 2008.  In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedules included in the annual report on Form 10-K for the year ended December 31, 2008.  These financial statement schedules are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statement schedules based on our audits.

In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

/s/ KPMG LLP

Chicago, Illinois
February 25, 2009

47

RLI CORP. AND SUBSIDIARIES

SCHEDULE I—SUMMARY OF INVESTMENTS—OTHER THAN INVESTMENTS

IN RELATED PARTIES

December 31, 2008

Column A	Column B		Column C		Column D
(in thousands)					Amount at
					which shown in
Type of Investment	Cost (1)		Fair Value		the balance sheet
Fixed maturities:
Bonds:
Available-for-sale
U.S. Government	$	6,596	$	7,065	$	7,065
U.S. Agencies	285,937		288,177		288,177
Mtge/ABS/CMO*	233,275		231,522		231,522
Corporate	287,557		270,164		270,164
States, political subdivisions, and revenues	423,311		427,287		427,287
Total available-for-sale	$	1,236,676	$	1,224,215	$	1,224,215
Held-to-maturity
U.S. Government	$	4,916	$	5,019	$	4,916
U.S. Agencies	8,960		9,916		8,960
State, political subdivisions, and revenues	25,945		26,486		25,945
Total held-to-maturity	$	39,821	$	41,421	$	39,821
Trading
U.S. Government	$	1,150	$	1,312	$	1,312
U.S. Agencies	0		0		0
Mtge/ABS/CMO*	6,097		5,881		5,881
Corporate	2,935		2,722		2,722
States, political subdivisions, and revenues	100		105		105
Total trading	$	10,282	$	10,020	$	10,020
Total fixed maturities	$	1,286,779	$	1,275,656	$	1,274,056
Equity securities, available-for-sale
Common stock
Public utilities	$	30,566	$	43,093	$	43,093
Banks, trusts and insurance companies	11,071		14,792		14,792
Industrial, miscellaneous and all other	198,185		217,024		217,024
Total common stock	$	239,822	$	274,909	$	274,909
Preferred Stock
Perpetual Preferred Stock	$	4,932	$	4,815	$	4,815
Redeemable Preferred Stock	6,529		7,066		7,066
Total preferred stock	$	11,461	$	11,881	$	11,881
Total equity securities	$	251,283	$	286,790	$	286,790
Short-term investments	$	97,982	$	97,982	$	97,982
Total investments	$	1,636,044	$	1,660,428	$	1,658,828

*Mortgage-backed, asset-backed & collaterialzed mortgage obligations.

(1)  Original cost of equity securities and, as to fixed maturities, original cost reduced by repayments and adjusted for amortization of premiums or accrual of discounts.

Note: See notes 1E and 2 of Notes to Consolidated Financial Statements, as attached in Exhibit 13.  See also the accompanying report of independent registered accounting firm on page 47 of this report.

48

RLI CORP. AND SUBSIDIARIES

SCHEDULE II—CONDENSED FINANCIAL INFORMATION OF REGISTRANT

(PARENT COMPANY)

CONDENSED BALANCE SHEETS

December 31,

(in thousands, except share data)	2008			2007
ASSETS
Cash	$	375		$	1
Short-term investments, at cost which approximates fair value	2,667			466
Investments in subsidiaries/investees, at equity value	795,211			863,744
Fixed income:
Available-for-sale, at fair value (amortized cost - $28,735 in 2008 and $30,013 in 2007)	28,925			30,293
Property and equipment, at cost, net of accumulated depreciation of $1,839 in 2008 and $1,570 in 2007	5,531			5,772
Deferred debt costs	540			647
Other assets	777			996
Total assets	$	834,026		$	901,919
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Accounts payable, affiliates	$	2,964		$	7,235
Dividends payable	6,109			5,561
Income taxes payable—current	1,244			82
Income taxes payable—deferred	12,204			11,255
Bonds payable, long-term debt	100,000			100,000
Interest payable, long-term debt	2,727			2,727
Other liabilities	624			637
Total liabilities	$	125,872		$	127,497
Shareholders’ equity:
Common stock ($1 par value, authorized 50,000,000 shares, issued 32,106,085 shares in 2008 and 31,869,596 shares in 2007)	$	32,106		$	31,870
Paid in capital	196,989			192,446
Accumulated other comprehensive earnings, net of tax	15,130			95,701
Retained earnings	807,195			749,767
Deferred compensation	8,312			7,980
Treasury shares at cost (10,631,656 shares in 2008 and 9,714,456 shares in 2007)	(351,578		)	(303,342		)
Total shareholders’ equity	$	708,154		$	774,422
Total liabilities and shareholders’ equity	$	834,026		$	901,919

See Notes to Consolidated Financial Statements, as attached in Exhibit 13.  See also the accompanying report of independent registered accounting firm on page 47 of this report.

49

RLI CORP. AND SUBSIDIARIES

SCHEDULE II—CONDENSED FINANCIAL INFORMATION OF REGISTRANT

(PARENT COMPANY)—(continued)

CONDENSED STATEMENTS OF EARNINGS AND COMPREHENSIVE EARNINGS

Years ended December 31,

(in thousands)	2008			2007			2006
Net investment income	$	1,739		$	1,649		$	913
Net realized investment gains	72			364			24,417
Equity in earnings of unconsolidated investees	4,844			7,315			13,702
Selling, general and administrative expenses	(6,853		)	(9,474		)	(8,070		)
Interest expense on debt	(6,046		)	(6,040		)	(6,040		)
Earnings (loss) before income taxes	(6,244		)	(6,186		)	24,922
Income tax expense (benefit)	(5,750		)	(2,665		)	7,477
Net earnings (loss) before equity in net earnings of subsidiaries	(494		)	(3,521		)	17,445
Equity in net earnings of subsidiaries	79,170			179,388			117,194
Net earnings	$	78,676		$	175,867		$	134,639
Other comprehensive earnings (loss), net of tax
Unrealized gains on securities:
Unrealized holding gains (losses) arising during the period	$	(33	)	$	322		$	837
Less: reclassification adjustment for gains included in net earnings	(25		)	(140		)	(2,896		)
Other comprehensive earnings (loss)-parent only	(58		)	182			(2,059		)
Equity in other comprehensive earnings (loss) of subsidiaries/investees	(80,513		)	(9,626		)	24,419
Other comprehensive earnings (loss)	(80,571		)	(9,444		)	22,360
Comprehensive earnings (loss)	$	(1,895	)	$	166,423		$	156,999

See Notes to Consolidated Financial Statements, as attached in Exhibit 13.  See also the accompanying report of independent registered accounting firm on page 47 of this report.

50

RLI CORP. AND SUBSIDIARIES

SCHEDULE II—CONDENSED FINANCIAL INFORMATION OF REGISTRANT

(PARENT COMPANY)—(continued)

CONDENSED STATEMENTS OF CASH FLOWS

Years ended December 31,

(in thousands)	2008			2007			2006
Cash flows from operating activities
Earnings (loss) before equity in net earnings of subsidiaries	$	(494	)	$	(3,521	)	$	17,445
Adjustments to reconcile net losses to net cash provided by (used in) operating activities:
Net realized investment gains	(72		)	(364		)	(24,417		)
Depreciation	269			267			261
Other items, net	2,823			1,258			(695		)
Change in:
Affiliate balances payable	(4,271		)	5,565			(822		)
Federal income taxes	7,193			(4,794		)	6,656
Stock option excess tax benefit	(4,929		)	(2,042		)	(2,930		)
Changes in investment in unconsolidated investees:
Undistributed earnings	(4,844		)	(7,315		)	(13,702		)
Dividends received	3,960			5,940			16,500
Net cash provided by (used in) operating activities	(365		)	(5,006		)	(1,704		)
Cash flows from investing activities
Purchase of:
Fixed income, available-for-sale	(30,932		)	(47,376		)	0
Equity securities, available-for-sale	0			0			(64,180		)
Short-term investments, net	(4,700		)	0			(33,502		)
Property and equipment	(28		)	(15		)	(20		)
Sale of:
Fixed income, available-for-sale	0			7,410			0
Equity securities, available-for-sale	0			0			106,353
Short-term investments, net	0			33,784			0
Investment in unconsolidated investee	0			0			32,499
Call or maturity of:
Fixed income, available-for-sale	32,225			10,000			0
Cash dividends received-subsidiaries	70,000			149,722			10,928
Net cash provided by (used in) investing activities	66,565			153,525			52,078
Cash flows from financing activities
Stock option excess tax benefit	4,929			2,042			2,930
Proceeds from stock option exercises	(150		)	2,952			3,254
Treasury shares purchased	(47,904		)	(131,827		)	(37,600		)
Cash dividends paid	(22,701		)	(21,699		)	(19,007		)
Net cash used in financing activities	(65,826		)	(148,532		)	(50,423		)
Net (decrease) increase in cash	374			(13		)	(49		)
Cash at beginning of year	1			14			63
Cash at end of year	$	375		$	1		$	14

Interest paid on outstanding debt for 2008, 2007, and 2006 amounted to $6.0 million.  See Notes to Consolidated Financial Statements, as attached in Exhibit 13.  See also the accompanying report of independent registered accounting firm on page 47 of this report.

51

RLI CORP. AND SUBSIDIARIES

SCHEDULE III—SUPPLEMENTARY INSURANCE INFORMATION

As of and for the years ended December 31, 2008, 2007, and 2006

									Incurred Losses
	Deferred policy		Unpaid losses		Unearned		Net		and settlement
(in thousands)	Acquisition		and settlement		premiums,		Premiums		expenses
Segment	Costs		expenses, gross		gross		Earned		current year
Year ended December 31, 2008
Casualty segment	$	31,685	$	1,035,309	$	193,984	$	313,481	$	220,442
Property segment	23,304		101,154		95,777		146,863		80,638
Surety segment	23,531		22,848		45,409		68,420		8,432
RLI Insurance Group	$	78,520	$	1,159,311	$	335,170	$	528,764	$	309,512
Year ended December 31, 2007
Casualty segment	$	35,141	$	1,064,966	$	216,589	$	343,402	$	223,352
Property segment	21,648		99,668		97,046		138,367		62,394
Surety segment	22,093		27,544		41,887		62,709		10,301
RLI Insurance Group	$	78,882	$	1,192,178	$	355,522	$	544,478	$	296,047
Year ended December 31, 2006
Casualty segment	$	33,958	$	1,153,509	$	241,900	$	348,217	$	217,956
Property segment	19,808		117,950		107,246		122,581		70,452
Surety segment	20,051		47,318		38,665		59,540		11,884
RLI Insurance Group	$	73,817	$	1,318,777	$	387,811	$	530,338	$	300,292

NOTE 1: Investment income is not allocated to the segments, therefore net investment income has not been provided.

See the accompanying report of independent registered accounting firm on page 47 of this report.

52

RLI CORP. AND SUBSIDIARIES

SCHEDULE III—SUPPLEMENTARY INSURANCE INFORMATION

(continued)

As of and for the years ended December 31, 2008, 2007, and 2006

(in thousands) Segment	Incurred losses and settlement expenses prior year			Policy acquisition costs		Other operating expenses		Net premiums written
Year ended December 31, 2008
Casualty segment	$	(50,562	)	$	76,592	$	20,501	$	295,942
Property segment	(6,646		)	47,491		9,568		146,089
Surety segment	(5,130		)	39,237		5,138		71,425
RLI Insurance Group	$	(62,338	)	$	163,320	$	35,207	$	513,456
Year ended December 31, 2007
Casualty segment	$	(87,397	)	$	79,618	$	25,967	$	335,401
Property segment	(6,690		)	41,841		10,253		137,419
Surety segment	(11,092		)	34,151		6,015		65,943
RLI Insurance Group	$	(105,179	)	$	155,610	$	42,235	$	538,763
Year ended December 31, 2006
Casualty segment	$	(40,030	)	$	75,972	$	25,926	$	349,834
Property segment	(1,784		)	37,590		11,335		139,061
Surety segment	(1,589		)	32,214		6,356		62,641
RLI Insurance Group	$	(43,403	)	$	145,776	$	43,617	$	551,536

See the accompanying report of independent registered accounting firm on page 47 of this report.

53

RLI CORP. AND SUBSIDIARIES

SCHEDULE IV—REINSURANCE

Years ended December 31, 2008, 2007, and 2006

(in thousands) Segment	Direct amount		Ceded to other companies		Assumed from other companies			Net amount		Percentage of amount assumed to net
2008
Casualty	$	429,987	$	111,982	$	(4,524	)	$	313,481	-1.4	%
Property	193,690		55,200		8,373			$	146,863	5.7	%
Surety	72,147		5,096		1,369			$	68,420	2.0	%
RLI Insurance Group  Premiums earned	$	695,824	$	172,278	$	5,218		$	528,764	1.0	%
2007
Casualty	$	484,996	$	144,502	$	2,908		$	343,402	0.8	%
Property	214,724		77,874		1,517			$	138,367	1.1	%
Surety	66,174		4,769		1,304			$	62,709	2.1	%
RLI Insurance Group  Premiums earned	$	765,894	$	227,145	$	5,729		$	544,478	1.1	%
2006
Casualty	$	510,840	$	165,813	$	3,190		$	348,217	0.9	%
Property	214,909		94,428		2,100			$	122,581	1.7	%
Surety	63,155		4,307		692			$	59,540	1.2	%
RLI Insurance Group Premiums earned	$	788,904	$	264,548	$	5,982		$	530,338	1.1	%

See the accompanying report of independent registered accounting firm on page 47 of this report.

54

RLI CORP. AND SUBSIDIARIES

SCHEDULE V—VALUATION AND QUALIFYING ACCOUNTS

Years ended December 31, 2008, 2007, and 2006

(in thousands)	Balance at beginning of period		Amounts charged to expense		Amounts recovered (written off)			Balance at end of period
2008 Allowance for uncollectible reinsurance	$	31,421	$	1,416	$	(3,626	)	$	29,211
2007 Allowance for uncollectible reinsurance	$	36,558	$	6,773	$	(11,910	)	$	31,421
2006 Allowance for uncollectible reinsurance	$	36,855	$	2,092	$	(2,389	)	$	36,558

See the accompanying report of independent registered accounting firm on page 47 of this report.

55

RLI CORP. AND SUBSIDIARIES

SCHEDULE VI—SUPPLEMENTARY INFORMATION CONCERNING

PROPERTY-CASUALTY INSURANCE OPERATIONS

Years ended December 31, 2008, 2007, and 2006

(in thousands)	Deferred Policy		Claims and		Unearned		Net		Net
Affiliation with	Acquisition		Claim Adjustment		Premiums,		Premiums		Investment
Registrant (1)	Costs		Expense Reserves		Gross		Earned		Income
2008	$	78,520	$	1,159,311	$	335,170	$	528,764	$	78,986
2007	$	78,882	$	1,192,178	$	355,522	$	544,478	$	78,901
2006	$	73,817	$	1,318,777	$	387,811	$	530,338	$	71,325

	Claims and Claim Adjustment
	Expenses Incurred Related to:					Amortization		Paid Claims and		Net
	Current		Prior			of Deferred		Claim Adjustment		Premiums
	Year		Year			Acquisition Costs		Expenses		Written
2008	$	309,512	$	(62,338	)	$	163,320	$	213,075	$	513,456
2007	$	296,047	$	(105,179	)	$	155,610	$	209,046	$	538,763
2006	$	300,292	$	(43,403	)	$	145,776	$	202,440	$	551,536

(1)Consolidated property-casualty insurance operations.

See the accompanying report of independent registered accounting firm on page 47 of this report.

56

EXHIBIT INDEX

Exhibit No.	Description of Document	Reference (page)
3.1	Amended and Restated Articles of Incorporation	Incorporated by reference to the Company’s Form 8-K filed May 8, 2008.
3.2	Restated By-Laws	Incorporated by reference to the Company’s Form 8-K filed November 18, 2008.
4.1	Senior Indenture dated as of December 9, 2003	Incorporated by reference to the Company’s Form 8-K filed December 10, 2003.
10.1	The RLI Corp. Directors’ Irrevocable Trust Agreement	Incorporated by reference to the Company’s Quarterly Form 10-Q for the Second Quarter ended June 30, 1993.
10.2	RLI Corp. Incentive Stock Option Plan	Incorporated by reference to Company’s Registration Statement on Form S-8 filed on March 11, 1996, File No. 333-01637.
10.3	Directors’ Stock Option Plan	Incorporated by reference to the Company’s Registration Statement on Form S-8 filed on June 6, 1997, File No. 333-28625.
10.5	RLI Corp. Nonemployee Directors’ Deferred Compensation Plan, as amended	Attached as Exhibit 10.5.
10.6	RLI Corp. Executive Deferred Compensation Plan, as amended	Attached as Exhibit 10.6.
10.7	Key Employee Excess Benefit Plan, as amended	Attached as Exhibit 10.7.
10.8	RLI Corp. Omnibus Stock Plan	Incorporated by reference to the Company’s Registration Statement on Form S-8 filed on May 31, 2005, File No. 333-125354.
10.9	RLI Incentive Compensation Plan, as amended	Attached as Exhibit 10.9.
11.0	Statement re: computation of per share earnings	Refer to the Note 1P, “Earnings per share,” on page 37 of the 2008 Financial Report to Shareholders, attached as Exhibit 13.
13.0	2008 Financial Report to Shareholders	Attached as Exhibit 13.

57

EXHIBIT INDEX

Exhibit No.	Description of Document	Reference Page
21.1	Subsidiaries of the Registrant	Page 59
23.1	Consent of KPMG LLP	Page 60
31.1	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Page 61
31.2	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Page 62
32.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Page 63
32.2	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Page 64

58

EX-10.5

Exhibit 10.5

RLI CORP.

NONEMPLOYEE DIRECTORS

DEFERRED COMPENSATION PLAN

(Restated as of January 1, 2009)

12/12/2008

RLI CORP. NONEMPLOYEE DIRECTORS

DEFERRED COMPENSATION PLAN

TABLE OF CONTENTS

				Page
ARTICLE 1	INTRODUCTION			1
1.1.	Establishment			1
1.2.	Purpose			1
1.3.	Definitions			1
	1.3.1.		Account	1
	1.3.2.		Affiliate	1
	1.3.3.		Beneficiary	1
	1.3.4.		Board	1
	1.3.5.		Code	1
	1.3.6.		Direct Compensation	2
	1.3.7.		Director	2
	1.3.8.		Employee	2
	1.3.9.		ERISA	2
	1.3.10.		Participant	2
	1.3.11.		Plan	2
	1.3.12.		Prior Agreement	2
	1.3.13.		RLI	2
	1.3.14.		RLI Stock	2
	1.3.15.		Successor Corporation	2
	1.3.16.		Termination of Service	2
	1.3.17.		Vested	2
	1.3.18.		Year	2
1.4.	Nonqualified Deferred Compensation			2
ARTICLE 2	PARTICIPATION			3
2.1.	Eligibility			3
2.2.	Enrollment			3
2.3.	Direct Compensation Deferrals			3
	2.3.1.		Elections	3
	2.3.2.		Elections Relate to Services Performed After the Election and Are Irrevocable	3
ARTICLE 3	ACCOUNTS			4
3.1.	Accounts			4
3.2.	Credits to Accounts			4
	3.2.1.	Direct Compensation Deferrals		4
	3.2.2.	Dividends and Other Adjustments		4
3.3.	Charges to Accounts			4
ARTICLE 4	BENEFITS			4
4.1.	Vesting			4
4.2.	Payment of Plan Benefits on Termination of Service - General Rule			4
4.3.	Changing Payment Elections			5
	4.3.1.	General Rule		5

1

	4.3.2.		Election upon Initial Plan Enrollment	5
	4.3.3.		Subsequent Election	5
4.4.	Special Rules			5
	4.4.1.		Specified Employee Exception	5
	4.4.2.		Cash-Out of Small Amounts	5
4.5.	Medium of Payments			6
4.6.	Delay in Distributions			6
4.7	Acceleration of Distributions			6
4.8	When a Payment is Deemed to be Made			7
ARTICLE 5	DEATH BENEFITS			8
5.1.	Death Benefits			8
	5.1.1.	Benefits When Participant Dies Before Commencement of Payments		8
	5.1.2.	Benefits When Participant Dies After Commencement of Payments		8
	5.1.3.	Medium of Payments		8
	5.1.4.	Cash-Out of Small Amounts		8
5.2.	Designation of Beneficiary			8
	5.2.1.	Persons Eligible to Designate		8
	5.2.2.	Form and Method of Designation		8
	5.2.3.	No Effective Designation		9
	5.2.4.	Successor Beneficiary		9
ARTICLE 6	PAYMENT PROCEDURES			9
6.1.	Application for Benefits			9
6.2.	Deferral of Payment			9
ARTICLE 7	ADMINISTRATION			10
7.1.	Administrator			10
	7.1.1.	Delegation		10
	7.1.2.	Automatic Removal		10
	7.1.3.	Conflict of Interest		10
	7.1.4.	Binding Effect		10
	7.1.5.	Third-Party Service Providers		10
7.2.	Benefits Not Transferable			10
7.3.	Benefits Not Secured			11
7.4.	RLI’s Obligations			11
7.5.	Withholding Taxes			11
7.6.	Service of Process			11
7.7.	Limitation on Liability			11
ARTICLE 8	AMENDMENT AND TERMINATION			11
8.1.	Amendment			11
8.2.	Termination			11
ARTICLE 9	MISCELLANEOUS			12
9.1.	Effect on Other Plans			12
9.2.	Effect on Service			12
9.3.	Disqualification			12
9.4.	Rules of Document Construction			12
9.5.	References to Laws			12

9.6.	Choice of Law	12
9.7.	Binding Effect	12

RLI CORP. NONEMPLOYEE DIRECTORS

DEFERRED COMPENSATION PLAN

ARTICLE 1

INTRODUCTION

1.1.Establishment.  RLI  established the RLI Corp. Nonemployee Directors Deferred Compensation Plan effective January 1, 2005.  Prior to that date, RLI provided similar deferred compensation opportunities to its Directors under certain Prior Agreements.  All obligations under the Prior Agreements (including any predecessor arrangements) will be satisfied under the Prior Agreements, rather than under this Plan.  RLI hereby restates the Plan, effective January 1, 2009, to comply with the requirements of the final regulations issued under Section 409A of the Code (“Section 409A”) on April 10, 2007.

This restatement applies to amounts deferred under the Plan on or after January 1, 2009 (the “Restatement Date”), and to the payment of all amounts deferred under the Plan (whether such amounts were deferred before, on, or after the Restatement Date) that have not yet been distributed as of the Restatement Date.  Except as set forth in Article 6, no amount deferred under the Plan is intended to be “grandfathered” under Section 409A.

The obligation of RLI to make payments under the Plan constitutes an unsecured (but legally enforceable) promise of RLI to make such payments and no person, including any Participant or Beneficiary, shall have any lien, prior claim or other security interest in any property of RLI as a result of the Plan.

1.2.Purpose.  The purpose of the Plan is to attract and retain qualified Directors and to provide them with an opportunity to save on a pre-tax basis and accumulate tax-deferred income to achieve their financial goals.

1.3.Definitions.  When the following terms are used herein with initial capital letters, they shall have the following meanings:

1.3.1.Account — the separate recordkeeping account (unfunded and unsecured) maintained for each Participant in connection with the Participant’s participation in the Plan.

1.3.2.Affiliate — a business entity which is under a “common control” with RLI or which is a member of an “affiliated service group” that includes RLI, as those terms are defined in Code § 414(b), (c) and (m).

1.3.3.Beneficiary — the person or persons designated as such under Sec. 5.2.

1.3.4.Board — the Board of Directors of RLI.

1.3.5.Code — the Internal Revenue Code of 1986, as the same may be amended from time to time.

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1.3.6.Direct Compensation — the total amounts, as determined by RLI, payable to a Director for services as a Director, whether payable in cash or in RLI Stock, but excluding amounts determined by RLI to be expense reimbursements.

1.3.7.Director — an individual who is a member of the Board but who is not an Employee of RLI or an Affiliate.

1.3.8.Employee —  a common-law employee of RLI or an Affiliate (while it is an Affiliate).

1.3.9.ERISA — the Employee Retirement Income Security Act of 1974, as the same may be amended from time to time.

1.3.10.Participant — a Director who enrolls as a Participant in the Plan under Sec. 2.2.

1.3.11.Plan — the unfunded deferred compensation plan that is set forth in this document, as the same may be amended from time to time.  The name of the Plan is the “RLI Corp. Nonemployee Directors Deferred Compensation Plan.”

1.3.12.Prior Agreement — an individual agreement entered into by a Director and RLI to provide deferred compensation opportunities to the Director.  In certain cases, such Prior Agreement was a successor to an earlier arrangement known as the Director Non-Qualified Deferred Compensation Plan.

1.3.13.RLI — RLI Corp. and any Successor Corporation.

1.3.14.RLI Stock — the common stock of RLI.

1.3.15.Successor Corporation — any entity that succeeds to the business of RLI through merger, consolidation, acquisition of all or substantially all of its assets, or any other means and which elects before or within a reasonable time after such succession, by appropriate action evidenced in writing, to continue the Plan.

1.3.16.Termination of Service —the Participant’s departure from the Board, unless the Director then becomes an Employee.  Notwithstanding the foregoing, a “Termination of Service” will be deemed not to have occurred if such departure would not be considered a “separation from service” under Code § 409A(a)(2)(A)(i) or any regulations or other guidance issued by the Treasury Department under Code § 409A.  In such case, a Termination of Service will be deemed to have occurred at the earliest time allowed under Code § 409A.

1.3.17.Vested — nonforfeitable.

1.3.18.Year — the calendar year.

1.4.Nonqualified Deferred Compensation.  The Plan is a nonqualified deferred compensation plan subject to Code § 409A.  To the extent any provision of the Plan does not satisfy the requirements contained in Code § 409A or in any regulations or other guidance issued by the Treasury Department under Code § 409A, such provision will be applied in a manner consistent with such requirements, regulations or guidance, notwithstanding any contrary provision of the Plan or any inconsistent election made by a Participant.

ARTICLE 2

PARTICIPATION

2.1.Eligibility.  All Directors will be eligible to participate in the Plan.  A Director may continue to participate in the Plan for so long as the Plan remains in effect and  remains a Director.

2.2.Enrollment.  A Director will be allowed to enroll in the Plan during the thirty (30) day period coinciding with and following the date the individual becomes a Director.  Such an enrollment will be effective as of the date it is made.  Thereafter, a Director may elect to enroll for a Year during the enrollment period established by RLI for such Year, which enrollment period will be a period of not less than thirty (30) days that ends not later than the last day of the prior Year.  Enrollment must be made in such manner and in accordance with such rules as may be prescribed for this purpose by RLI (including by means of a voice response or other electronic system under circumstances authorized by RLI).

2.3.Direct Compensation Deferrals.

2.3.1.Elections.  A Director may elect to reduce Direct Compensation by any whole percent, but not more than one-hundred percent (100%).  A separate reduction percentage may apply to the portion of a Director’s Direct Compensation that is payable in cash and to the portion that is payable in RLI Stock granted under the RLI Corp. Omnibus Stock Plan.  An election must be made in such manner and in accordance with such rules as may be prescribed for this purpose by RLI (including by means of a voice response or other electronic system under circumstances authorized by RLI).  An election must be made as part of the enrollment described in Sec. 2.2.

2.3.2.Elections Relate to Services Performed After the Election and Are Irrevocable.  An election will apply to all Direct Compensation attributable to services performed in a given Year, regardless of when such Direct Compensation would otherwise be provided to the Participant (for example, an election to defer an annual fee attributable to services performed in a given Year but payable in the next Year, must be made as part of the enrollment election made prior to the Year in which the services are performed).  However, an election will only be effective to defer Direct Compensation earned after the election is made, and not before.  For example, an election made in connection with a mid-year enrollment under Sec. 2.2 will only be effective for Direct Compensation attributable to services performed on and after the effective date of the enrollment as provided in Sec. 2.2.    An election will apply solely with respect to the given Year — that is, an election will not automatically be carried over and applied to the next Year.

In general, an election shall become irrevocable as of the last day of the enrollment period applicable to it.  However, if a Participant incurs an “unforeseeable emergency,” as defined in Section 4.8(h), or becomes entitled to receive a hardship distribution pursuant to Treas. Reg. Sec. 1.401(k)-1(d)(3) after the election otherwise becomes irrevocable, the election shall be cancelled as of the date on which the Participant is determined to have incurred the unforeseeable emergency or becomes eligible to receive the hardship distribution and no further deferrals will be made under it.  In addition, if a Participant becomes “disabled” (as defined below), RLI may, in its discretion, cancel the Participant’s election then in effect, provided that such cancellation is made no later than end of the Plan Year, or if later, the 15th day of the third month following the date on which the Participant becomes disabled, and provided further that RLI does not allow the Participant a direct or indirect election regarding the cancellation.  For purposes of the preceding sentence, “disability” means any medically determinable physical or mental impairment resulting in the Participant’s inability to perform the duties of the

Participant’s position or any substantially similar position, where such impairment can be expected to result in death or can be expected to last for a continuous period of not less than six months.

ARTICLE 3

ACCOUNTS

3.1.Accounts.  RLI shall establish and maintain a separate Account for each Participant.  The Account shall be for recordkeeping purposes only and shall not represent a trust fund or other segregation of assets for the benefit of the Participant.  The balance of each Participant’s Account will be maintained in full and fractional shares of RLI Stock.

3.2.Credits to Accounts.  Each Participant’s Account shall be credited from time to time as provided in this section.

3.2.1.Direct Compensation Deferrals.  The amount of each Direct Compensation cash payment or RLI Stock grant which the Participant has elected to defer under the Plan shall be credited to the Participant’s Account on, or as soon as administratively practicable after, the date it would otherwise be provided to the Participant.  Any cash amount shall be converted to RLI Stock credits, equal to the number of full and fractional shares that could be purchased with such amount on, or as soon as administratively feasible after, the date such amount is credited to the Participant’s Account.

3.2.2.Dividends and Other Adjustments.  The Participant’s Account shall be credited with additional RLI Stock credits, equal to the number of full and fractional shares of RLI Stock that could be purchased with any cash dividends which would be payable on the RLI Stock credited to the Participant’s Account.  For this purposes, the share price on, or as soon as administratively practicable after, the date the dividend is paid will be used.  The Account also will be adjusted for any stock split, redemption or similar event, in a manner determined to be reasonable by RLI.

3.3.Charges to Accounts.  As of the date any Plan benefit measured by the Account is paid to the Participant or the Participant’s Beneficiary, the Account shall be charged with the amount of such benefit payment.

ARTICLE 4

BENEFITS

4.1.Vesting.  The Participant’s Account shall be fully (100%) Vested.

4.2.Payment of Plan Benefits on Termination of Service - General Rule.  If the Participant has an Account balance at Termination of Service, RLI shall pay that balance to the Participant in five (5) annual installments, as follows:

(a)Time.  The first installment shall be paid on the January 1 following the Year in which the Participant’s Termination of Service occurs.  The remaining installments shall be paid on each subsequent January 1.

(b)Amount.  The amount of each installment shall be determined using a “fractional” method — by multiplying the Participant’s Account balance immediately before the installment payment date by a fraction, the numerator of which is one and the denominator of which is the number of installments remaining (including the installment in question).  The result shall be rounded down to the next lower full share of RLI Stock, except for the final installment, which shall be rounded up to the next higher full share of RLI Stock.

4.3.Changing Payment Elections.

4.3.1.General Rule.  A Participant may elect to change the number of annual installments the Participant receives under the Plan to ten (10) or fifteen (15) installments, subject to the rules below.  Any such election must be made in such manner and in accordance with such rules as may be prescribed for this purpose by RLI (including by means of a voice response or other electronic system under circumstances authorized by RLI).  The installments shall commence on the date specified in Sec. 4.2(a), unless otherwise postponed by this Article 4, and the amount of each installment shall be determined under the fractional method described in Sec. 4.2(b).

4.3.2.Election upon Initial Plan Enrollment.  An election to extend the number of installments may be made as part of the Participant’s initial enrollment in the Plan, as described in Sec. 2.3.

4.3.3.Subsequent Election .  If a Participant did not elect to extend the number of installments upon initial enrollment, or if the Participant wants to further change the number of installments after becoming a Participant, such Participant may elect to change the number of installments in accordance with the following rules:

(a)The election must be received by RLI in writing and in proper form and must not take effect for at least 12 months from the date on which it is submitted to RLI;

(b)The election must be submitted to RLI at least 12 months prior to the specified date of distribution; and

(c)The commencement of installments must be delayed at least five (5) years from the date payments would otherwise commence without this subsequent election.

4.4.Special Rules.

4.4.1.Specified Employee Exception.  If a Participant becomes an Employee and subsequently has a “separation of service” (within the meaning of Code § 409A(a)(2)(A)(i)), the initial installment (or lump-sum payment, if applicable) shall be delayed to the extent necessary to comply with Code § 409A(a)(2)(B)(i) or any regulations or other guidance issued by the Treasury Department thereunder.

4.4.2.Cash-Out of Small Amounts.  Any contrary provision or election notwithstanding, if the Participant’s Account balance is less than one hundred thousand dollars ($100,000) as of the date installments are to commence, the Account shall be paid to the Participant in a single lump-sum, as full settlement of all benefits due under the Plan; provided that, for purposes of applying the one hundred thousand dollar ($100,000) cash-out limit, all nonqualified deferred compensation amounts payable to

the Participant by RLI and its Affiliates shall be aggregated if and to the extent required under Code § 409A or any regulations or other guidance issued by the Treasury Department thereunder.

4.5.Medium of Payments.  All payments to a Participant shall be made in shares of RLI Stock.  Unless the shares have been registered under the Securities Act of 1933 (the “Act”), are otherwise exempt from the registration requirements of the Act, are the subject of a favorable no action letter issued by the Securities and Exchange Commission, or are the subject of an opinion of counsel acceptable to RLI to the effect that such shares are exempt from the registration requirements of the Act, the certificates representing such shares shall contain a legend precluding the transfer of such shares except in accordance with the provisions of Rule 144 of the Act, as the same may be amended from time to time.

4.6.Delay in Distributions.  A payment under the Plan may be delayed by RLI under any of the following circumstances so long as all payments to similarly situated Participants are treated on a reasonably consistent basis:

(a)RLI reasonably anticipates that if such payment were made as scheduled, RLI’s deduction with respect to such payment would not be permitted under Section 162(m) of the Code, provided that the payment is made either during the first Plan Year in which RLI reasonably anticipates, or should reasonably anticipate, that if the payment is made during such year, the deduction of such payment will not be barred by application of Section 162(m) or during the period beginning with the date of the Participant’s Termination of Employment and ending on the later of the last day of RLI’s fiscal year in which the Participant has a Termination of Employment or the 15th day of the third month following the Termination of Employment.

(b)RLI reasonably anticipates that the making of the payment will violate Federal securities laws or other applicable law, provided that the payment is made at the earliest date at which RLI reasonably anticipates that the making of the payment will not cause such violation.

(c)Upon such other events as determined by RLI and according to such terms as are consistent with Section 409A or are prescribed by the Commissioner of Internal Revenue.

4.7Acceleration of Distributions.  RLI may, in its discretion, distribute all or a portion of a Participant’s Accounts at an earlier time and in a different form than specified as otherwise provided in this Article 4, under the circumstances described below:

(a)As may be necessary to fulfill a Domestic Relations Order.  Distributions pursuant to a Domestic Relations Order shall be made according to administrative procedures established by RLI.

(b)To the extent reasonably necessary to avoid the violation of ethics laws or conflict of interest laws pursuant to Section 1.409A-3(j)(ii) of the Treasury regulations.

(c)To pay FICA on amounts deferred under the Plan and the income tax resulting from such payment.

(d)To pay the amount required to be included in income as a result of the Plan’s failure to comply with Section 409A.

(e)If RLI determines, in its discretion, that it is advisable to liquidate the Plan in connection with a termination of the Plan subject to the requirements of Section 409A.

(f)As satisfaction of a debt of the Participant to an Affiliate, where such debt is incurred in the ordinary course of the service relationship between the Affiliate and the Participant, the entire amount of the reduction in any Plan Year does not exceed $5,000, and the reduction is made at the same time and in the same amount as the debt otherwise would have been due and collected from the Participant.

(g)To pay state, local or foreign tax obligations that may arise with respect to amounts deferred under the Plan and the income tax resulting from such payment.

(h)If the Participant has an unforeseeable emergency.  For these purposes an “unforeseeable emergency” is a severe financial hardship to the Participant, resulting from an illness or accident of the Participant, the Participant’s spouse, the Beneficiary, or the Participant’s dependent (as defined in Section 152, without regard to Section 152(b)(1), (b)(2), and (d)(1)(B) of the Code); loss of the Participant’s property due to casualty (including the need to rebuild a home following damage to a home not otherwise covered by insurance); or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant.  For example, the imminent foreclosure of or eviction from the Participant’s primary residence may constitute an unforeseeable emergency.  In addition, the need to pay for medical expenses, including non-refundable deductibles, as well as for the cost of prescription drug medication, may constitute an unforeseeable emergency.  Finally, the need to pay for funeral expenses of a spouse, Beneficiary, or a dependent (as defined in Section 152, without regard to 152(b)(1), (b)(2), and (d)(1)(B) of the Code) may also constitute an unforeseeable emergency.  Except as otherwise provided in this paragraph (h), the purchase of a home and the payment of college tuition are not unforeseeable emergencies.  Whether a Participant is faced with an unforeseeable emergency permitting a distribution under this paragraph (h) is to be determined based on the relevant facts and circumstances of each case, but, in any case a distribution on account of an unforeseeable emergency may not be made to the extent that such emergency is or may be relieved through reimbursement or compensation from insurance or otherwise, by liquidation of the Participant’s assets, to the extent the liquidation of such assets would not cause severe financial hardship, or by cessation of Elective Deferrals.

Distributions because of an unforeseeable emergency must be limited to the amount reasonably necessary to satisfy the emergency need (which may include amounts necessary to pay any Federal, state, local, or foreign income taxes or penalties reasonably anticipated to result from the distribution).  A determination of the amounts reasonably necessary to satisfy the emergency need must take into account any additional compensation that is available due to cancellation of the Participant’s election as a result of this paragraph (h).

Notwithstanding anything in this Section 4.7 to the contrary, except for a Participant’s election to request a distribution due to an unforeseeable emergency under paragraph (h), above (which the Participant, in the Participant’s discretion, may elect to make or not make), RLI shall not provide the Participant with discretion or a direct or indirect election regarding whether a payment is accelerated pursuant to this Section 4.7.

4.8When a Payment is Deemed to be Made.  Any payment that is due to be distributed as of a particular date pursuant to the provisions of the Plan, will be deemed to be distributed as of that date if it is distributed on such date or a later date within the same calendar year, or, if later, by the 15th day of the third calendar month following the date, and the Participant is not permitted, directly or indirectly, to designate the calendar year of payment.  Further, a payment will be treated as made on a date if it is made no earlier than 30 days before the date, and the Participant is not permitted, directly or indirectly, to

designate the calendar year of payment.  For purposes of the foregoing, if the payment is required to be made during a period of time, the specified date is treated as the first day of the period of time.

ARTICLE 5

DEATH BENEFITS

5.1.Death Benefits.

5.1.1.Benefits When Participant Dies Before Commencement of Payments.  If the Participant dies before installments commence, the Participant’s Account balance shall be paid to the Participant’s Beneficiary as follows:

(a)If the Participant has made a valid election under Sec. 4.3, payments shall be made in ten (10) or fifteen (15) annual installments, as elected by the Participant.

(b)Otherwise, payments shall be made in five (5) annual installments.

The first installment shall be paid on the January 1 following the Year in which the Participant’s death occurs.  The remaining installments shall be paid on each subsequent January 1.  The amount of each installment shall be determined using the “fractional” method described in Sec. 4.2(b).

5.1.2.Benefits When Participant Dies After Commencement of Payments.  If the Participant dies after installments commence and the Participant has an Account balance at death, the remaining Account balance shall be paid to the Participant’s Beneficiary in the same manner as if the Participant were still living.

5.1.3.Medium of Payments.  All payments to a Beneficiary shall be made in shares of RLI Stock, subject to any legend precluding transfer that is required under Sec. 4.5.

5.1.4.Cash-Out of Small Amounts.  Any contrary provision or election notwithstanding, if the amount payable to the Beneficiary is less than one hundred thousand dollars ($100,000) as of the date installments are to commence, the benefit shall be paid to the Beneficiary in a single lump-sum, as full settlement of all benefits due under the Plan, subject, however, to any limitation on such cash-out under Code § 409A or any regulations or other guidance issued by the Treasury Department thereunder.

5.2.Designation of Beneficiary.

5.2.1.Persons Eligible to Designate.  Any Participant may designate a Beneficiary to receive any amount payable under the Plan as a result of the Participant’s death, provided that the Beneficiary survives the Participant.  The Beneficiary may be one or more persons, natural or otherwise.  By way of illustration, but not by way of limitation, the Beneficiary may be an individual, trustee, executor, or administrator.  A Participant may also change or revoke a designation previously made, without the consent of any Beneficiary named therein.

5.2.2.Form and Method of Designation.  Any designation or a revocation of a prior designation of Beneficiary shall be in writing on a form acceptable to RLI and shall be filed with RLI.  RLI and all other parties involved in making payment to a Beneficiary may rely on the latest Beneficiary designation on file

with RLI at the time of payment or may make payment pursuant to Sec. 5.2.3 if an effective designation is not on file, shall be fully protected in doing so, and shall have no liability whatsoever to any person making claim for such payment under a subsequently filed designation of Beneficiary or for any other reason.

5.2.3.No Effective Designation.  If there is not on file with RLI an effective designation of Beneficiary by a deceased Participant, the Beneficiary shall be the person or persons surviving the Participant in the first of the following classes in which there is a survivor, share and share alike:

(a)The Participant’s spouse.  (A “spouse” is a person of the opposite sex to whom the Participant is legally married, including a common-law spouse if the marriage was entered into in a state that recognizes common-law marriages and RLI has received acceptable proof and/or certification of common-law married status.)

(b)The Participant’s then living descendants, per stirpes.

(c)The individuals entitled to inherit the Participant’s property under the law of the state in which the Participant resides immediately before the Participant’s death, in the proportions determined under such law.

Determination of the identity of the Beneficiary in each case shall be made by RLI.

5.2.4.Successor Beneficiary.  If a Beneficiary who survives the Participant subsequently dies before receiving the complete payment to which the Beneficiary was entitled, the successor Beneficiary, determined in accordance with the provisions of this section, shall be entitled to the payments remaining.  The successor Beneficiary shall be the person or persons surviving the Beneficiary in the first of the following classes in which there is a survivor, share and share alike:

(a)The Beneficiary’s spouse.  (A “spouse” is a person of the opposite sex to whom the Beneficiary is legally married, including a common-law spouse if the marriage was entered into in a state that recognizes common-law marriages and RLI has received acceptable proof and/or certification of common-law married status.)

(b)The Beneficiary’s then living descendants, per stirpes.

(c)The individuals entitled to inherit the Beneficiary’s property under the law of the state in which the Beneficiary resides immediately before the Beneficiary’s death, in the proportions determined under such law.

ARTICLE 6

PAYMENT PROCEDURES

6.1.Application for Benefits.  Benefits shall be paid to Participants automatically (without a written request) at the time and in the manner specified in the Plan.  Benefits shall be paid to a Beneficiary upon RLI’s receipt of a written request for the benefits, including appropriate proof of the Participant’s death and the Beneficiary’s identity and right to payment.

6.2.Deferral of Payment.  If there is a dispute regarding a Plan benefit, RLI, in its sole discretion, may defer payment of the benefit until the dispute has been resolved.

ARTICLE 7

ADMINISTRATION

7.1.Administrator.  RLI shall be the administrator of the Plan.  RLI shall control and manage the administration and operation of the Plan and shall make all decisions and determinations incident thereto.  Except with respect to the ordinary day-to-day administration of the Plan, action on behalf of RLI must be taken by one of the following:

(a)The Board; or

(b)The Nominating/Corporate Governance Committee of the Board.

7.1.1.Delegation.  The ordinary day-to-day administration of the Plan may be delegated by the chief executive officer of RLI to an individual or a committee.  Such individual or committee shall have the authority to delegate or redelegate to one or more persons, jointly or severally, such functions assigned to such individual or committee as such individual or committee may from time to time deem advisable.

7.1.2.Automatic Removal.  If any individual or committee member to whom responsibility under the Plan is allocated is a director, officer or employee of RLI or an Affiliate when responsibility is so allocated, then such individual shall be automatically removed as a member of a committee at the earliest time such individual ceases to be a director, officer or employee of RLI or an Affiliate.  This removal shall occur automatically and without any requirement for action by RLI or any notice to the individual so removed.

7.1.3.Conflict of Interest.  If any individual or committee member to whom responsibility under the Plan is allocated is also a Participant or Beneficiary, such individual shall have no authority as such member with respect to any matter specifically affecting such Participant or Beneficiary’s individual interest hereunder (as distinguished from the interests of all Participants and Beneficiaries or a broad class of Participants and Beneficiaries), all such authority being reserved exclusively to the other members to the exclusion of such Participant or Beneficiary, and such Participant or Beneficiary shall act only in an individual capacity in connection with any such matter.

7.1.4.Binding Effect.  The determination of the Board or the Nominating/Corporate Governance Committee of the Board in any matter within its authority shall be binding and conclusive upon RLI and all persons having any right or benefit under the Plan.

7.1.5.Third-Party Service Providers.  RLI may from time to time appoint or contract with an administrator, recordkeeper or other third-party service provider for the Plan.  Any such administrator, recordkeeper or other third-party service provider will serve in a nondiscretionary capacity and will act in accordance with directions given and procedures established by RLI.

7.2.Benefits Not Transferable.  No Participant or Beneficiary shall have the power to transmit, alienate, dispose of, pledge or encumber any benefit payable under the Plan before its actual payment to the Participant or Beneficiary.  Any such effort by a Participant or Beneficiary to convey any interest in the Plan shall not be given effect under the Plan.  No benefit payable under the Plan shall be subject to

attachment, garnishment, execution following judgment or other legal process before its actual payment to the Participant or Beneficiary.

7.3.Benefits Not Secured.  The rights of each Participant and Beneficiary shall be solely those of an unsecured, general creditor of RLI.  No Participant or Beneficiary shall have any lien, prior claim or other security interest in any property of RLI.

7.4.RLI’s Obligations.  RLI shall provide the benefits under the Plan.  RLI’s obligation may be satisfied by distributions from a trust fund created and maintained by RLI, in its sole discretion, for such purpose.  However, the assets of any such trust fund shall be subject to claims by the general creditors of RLI in the event RLI is (i) unable to pay its debts as they become due, or (ii) is subject to a pending proceeding as a debtor under the United States Bankruptcy Code.

7.5.Withholding Taxes.  RLI shall have the right to withhold (and transmit to the proper taxing authority) such federal, state or local taxes as it may be required to withhold by applicable laws.  Such taxes may be withheld from any benefits due under the Plan or from any other compensation to which the Participant is entitled from RLI and its Affiliates.

7.6.Service of Process.  The chief executive officer of RLI is designated as the appropriate and exclusive agent for the receipt of service of process directed to the Plan in any legal proceeding, including arbitration, involving the Plan.

7.7.Limitation on Liability.  Neither RLI’s officers nor any member of its Board nor any individual or committee to whom RLI delegates responsibility under the Plan in any way secures or guarantees the payment of any benefit or amount which may become due and payable hereunder to or with respect to any Participant.  Each Participant and other person entitled at any time to payments hereunder shall look solely to the assets of RLI for such payments as an unsecured, general creditor.  After benefits have been paid to or with respect to a Participant and such payment purports to cover in full the benefit hereunder, such former Participant or other person(s), as the case may be, shall have no further right or interest in the other assets of RLI in connection with the Plan.  Neither RLI nor any of its officers nor any member of its Board nor any individual or committee to whom RLI delegates responsibility under the Plan shall be under any liability or responsibility for failure to effect any of the objectives or purposes of the Plan by reason of the insolvency of RLI.

ARTICLE 8

AMENDMENT AND TERMINATION

8.1.Amendment.  RLI reserves the power to amend the Plan either prospectively or retroactively or both, in any respect, by action of its Board; provided that, no amendment shall be effective to reduce or divest benefits payable with respect to the Account of any Participant or Beneficiary without consent.  No amendment of the Plan shall be effective unless it is in writing and signed on behalf of RLI by a person authorized to execute such writing.  No oral representation concerning the interpretation or effect of the Plan shall be effective to amend the Plan.

8.2.Termination.  RLI reserves the right to terminate the Plan at any time by action of its Board; provided that, the termination of the Plan shall not reduce or divest benefits payable with respect to the Account of any Participant or Beneficiary or negate the Participant’s or Beneficiary’s rights with respect

to such benefits.  Any such termination will be done in accordance with the requirements of Section 409A.

ARTICLE 9

MISCELLANEOUS

9.1.Effect on Other Plans.  This Plan shall not alter, enlarge or diminish any person’s rights or obligations under any other benefit plan maintained by RLI or any Affiliate.

9.2.Effect on Service.  Neither the terms of this Plan nor the benefits hereunder nor the continuance thereof shall be a term of the service of any Director.  RLI shall not be obliged to continue the Plan.  The terms of this Plan shall not give any Director the right to continue serving as a member of the Board, nor shall it create any obligation on the part of the Board to nominate any Director for reelection by RLI’s stockholders.

9.3.Disqualification.  Notwithstanding any other provision of the Plan or any designation made under the Plan, any individual who feloniously and intentionally kills a Participant shall be deemed for all purposes of the Plan and all elections and designations made under the Plan to have died before such Participant.  A final judgment of conviction of felonious and intentional killing is conclusive for this purpose.  In the absence of a conviction of felonious and intentional killing, RLI shall determine whether the killing was felonious and intentional for this purpose.

9.4.Rules of Document Construction.  Whenever appropriate, words used herein in the singular may be read in the plural, or words used herein in the plural may be read in the singular; and the words “hereof,” “herein” or “hereunder” or other similar compounds of the word “here” shall mean and refer to the entire Plan and not to any particular article, section or paragraph of the Plan unless the context clearly indicates to the contrary.  The titles given to the various articles and sections of the Plan are inserted for convenience of reference only and are not part of the Plan, and they shall not be considered in determining the purpose, meaning or intent of any provision hereof.  Written notification under the Plan shall include such other methods (for example, facsimile or e-mail) as RLI, in its sole discretion, may authorize from time to time.

9.5.References to Laws.  Any reference in the Plan to a statute shall be considered also to mean and refer to the applicable regulations for that statute. Any reference in the Plan to a statute or regulation shall be considered also to mean and refer to any subsequent amendment or replacement of that statute or regulation.

9.6.Choice of Law.  The Plan has been executed in the State of Illinois and has been drawn in conformity to the laws of that state and shall, except to the extent that federal law is controlling, be construed and enforced in accordance with the laws of the State of Illinois (without regard to its conflict of law principles).

9.7.Binding Effect.  The Plan shall be binding upon and inure to the benefit of the successors and assigns of RLI, and the Beneficiaries, personal representatives and heirs of the Participant.

IN WITNESS WHEREOF, RLI has cause the Plan to be executed by its duly authorized officers as of  the                  day of                             .

RLI CORP.
By:
	Its:
	And
By:
	Its:

EX-10.6

Exhibit 10.6

RLI CORP. EXECUTIVES

DEFERRED COMPENSATION PLAN

(Restated as of January 1, 2009)

12/12/2008

RLI CORP. EXECUTIVES

DEFERRED COMPENSATION PLAN

TABLE OF CONTENTS

				Page
ARTICLE 1		INTRODUCTION		1
	1.1.	Establishment		1
	1.2.	Purpose		1
	1.3.	Definitions		1
		1.3.1.	Account	1
		1.3.2.	Affiliate	1
		1.3.3.	Base Salary	1
		1.3.4.	Beneficiary	2
		1.3.5.	Board	2
		1.3.6.	Chief Executive Officer	2
		1.3.7.	Code	2
		1.3.8.	Committee	2
		1.3.9.	Deferral Eligible Amounts	2
		1.3.10.	Employee	2
		1.3.11.	ERISA	2
		1.3.12.	Incentive Compensation	2
		1.3.13.	Participant	2
		1.3.14.	Performance-Based Compensation	2
		1.3.15.	Plan	3
		1.3.16.	Prior Agreement	3
		1.3.17.	RLI	3
		1.3.18.	RLI Stock	3
		1.3.19.	Specified Employee	3
		1.3.20.	Successor Corporation	3
		1.3.21.	Termination of Employment	3
		1.3.22.	Vested	4
		1.3.23.	Year	4
	1.4.	“Top-Hat” Plan		4
ARTICLE 2		PARTICIPATION		4
	2.1.	Eligibility and Selection		4
	2.2.	Notification		4
	2.3.	Enrollment		4
	2.4.	Elective Deferrals		5
		2.4.1.	Elections	5
		2.4.2.	Elections Relate to Services Performed After the Election and Are Irrevocable	5
		2.4.3.	Limits	6
ARTICLE 3		ACCOUNTS		6
	3.1.	Accounts		6
	3.2.	Credits to Accounts		6
		3.2.1.	Elective Deferrals	6
		3.2.2.	Dividends and Other Adjustments	6

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	3.3.	Charges to Accounts		6
ARTICLE 4		BENEFITS		6
	4.1.	Vesting		6
	4.2.	Payment of Plan Benefits on Termination of Employment - General Rule		7
	4.3.	Changing Payment Elections		7
		4.3.1.	General Rule	7
		4.3.2.	Election upon Initial Plan Enrollment	7
		4.3.3.	Subsequent Election	7
	4.4.	Special Rules		7
		4.4.1.	Specified Employee Exception	7
		4.4.2.	Cash-Out of Small Amounts	8
	4.5.	Medium of Payments		8
	4.6.	Delay in Distributions		8
	4.7	Acceleration of Distributions		8
	4.8	When a Payment is Deemed to be Made		10
ARTICLE 5		DEATH BENEFITS		10
	5.1.	Death Benefits		10
		5.1.1.	Benefits When Participant Dies Before Commencement of Payments	10
		5.1.2.	Benefits When Participant Dies After Commencement of Payments	10
		5.1.3.	Medium of Payments	10
		5.1.4.	Cash-Out of Small Amounts	10
	5.2.	Designation of Beneficiary		10
		5.2.1.	Persons Eligible to Designate	10
		5.2.2.	Form and Method of Designation	11
		5.2.3.	No Effective Designation	11
		5.2.4.	Successor Beneficiary	11
ARTICLE 6		CLAIMS AND REVIEW PROCEDURES		12
	6.1.	Application for Benefits		12
	6.2.	Claims and Review Procedures		12
		6.2.1.	Initial Claim	12
		6.2.2.	Notice of Initial Adverse Determination	12
		6.2.3.	Request for Review	12
		6.2.4.	Claim on Review	13
		6.2.5.	Notice of Adverse Determination for Claim on Review	13
	6.3.	Claims Rules		13
	6.4.	Deadline to File Claim		14
	6.5.	Exhaustion of Administrative Remedies		14
	6.6.	Arbitration		14
	6.7.	Deadline to File an Arbitration Action		15
	6.8.	Knowledge of Fact by Participant Imputed to Beneficiary		15
	6.9.	Deferral of Payment		15
ARTICLE 7		ADMINISTRATION		15
	7.1.	Administrator		15
		7.1.1.	Delegation	15
		7.1.2.	Automatic Removal	15
		7.1.3.	Conflict of Interest	16

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		7.1.4.	Binding Effect	16
		7.1.5.	Third-Party Service Providers	16
	7.2.	Benefits Not Transferable		16
	7.3.	Benefits Not Secured		16
	7.4.	RLI’s Obligations		16
	7.5.	Withholding Taxes		16
	7.6.	Service of Process		16
	7.7.	Limitation on Liability		16
ARTICLE 8		AMENDMENT AND TERMINATION		17
	8.1.	Amendment		17
	8.2.	Termination		17
ARTICLE 9		MISCELLANEOUS		17
	9.1.	Effect on Other Plans		17
	9.2.	Effect on Employment		17
	9.3.	Disqualification		17
	9.4.	Rules of Document Construction		17
	9.5.	References to Laws		18
	9.6.	Choice of Law		18
	9.7.	Binding Effect		18

iii

RLI CORP. EXECUTIVES

DEFERRED COMPENSATION PLAN

ARTICLE 1

INTRODUCTION

1.1.Establishment.  RLI  established the RLI Corp. Executives Deferred Compensation Plan effective January 1, 2005.  Prior to that date, RLI provided similar deferred compensation opportunities to a select group of executives under certain Prior Agreements.  All obligations under the Prior Agreements (including any predecessor arrangements) will be satisfied under the Prior Agreements, rather than under this Plan.  RLI hereby restates the Plan, effective January 1, 2009, to comply with the requirements of the final regulations issued under Section 409A of the Code (“Section 409A”) on April 10, 2007.

This restatement applies, to amounts deferred under the Plan on or after January 1, 2009 (the “Restatement Date”), and to the payment of all amounts deferred under the Plan (whether such amounts were deferred before, on, or after the Restatement Date) that have not yet been distributed as of the Restatement Date.  Except as set forth in Article 6, no amount deferred under the Plan is intended to be “grandfathered” under Section 409A.

The obligation of RLI to make payments under the Plan constitutes an unsecured (but legally enforceable) promise of RLI to make such payments and no person, including any Participant or Beneficiary, shall have any lien, prior claim or other security interest in any property of RLI as a result of the Plan.

1.2.Purpose.  The purpose of the Plan is to attract and retain qualified executives and to provide them with an opportunity to save on a pre-tax basis and accumulate tax-deferred income to achieve their financial goals.

1.3.Definitions.  When the following terms are used herein with initial capital letters, they shall have the following meanings:

1.3.1.Account — the separate recordkeeping account (unfunded and unsecured) maintained for each Participant in connection with the Participant’s participation in the Plan.

1.3.2.Affiliate — a business entity which is under a “common control” with RLI or which is a member of an “affiliated service group” that includes RLI, as those terms are defined in Code § 414(b), (c) and (m).

1.3.3Base Salary — the Participant’s total salary and wages from all Affiliates, including any amount that would be included in the definition of Base Salary but for the individual’s election to defer some of such Participant’s salary pursuant to the Plan or any other deferred compensation plan established by an Affiliate; but excluding disability pay and any other remuneration paid by Affiliates, such as overtime, incentive compensation, stock options, distributions of compensation previously deferred, restricted stock, allowances for expenses (including moving, travel expenses, and automobile allowances), and fringe benefits whether payable in cash or in a form other than cash.  In the case of an individual in a plan sponsored by an Affiliate that is described in Section 401(k), 125 or 132(f) of the Code, the term Base Salary shall include any amount that would be included in the definition of Base

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Salary but for the individual’s election to reduce such individual’s salary and have the amount of the reduction contributed to or used to purchase benefits under such plan.

1.3.4.Beneficiary — the person or persons designated as such under Sec. 5.2.

1.3.5.Board — the Board of Directors of RLI.

1.3.6.Chief Executive Officer — the Chief Executive Officer of RLI.

1.3.7.Code — the Internal Revenue Code of 1986, as the same may be amended from time to time.

1.3.8.Committee — the Executive Resources Committee of the Board.

1.3.9.Deferral Eligible Amounts —with respect to a Participant for any period, means the sum of such Participant’s Base Salary and Incentive Compensation for such period.

1.3.10.Employee — a common-law employee of RLI or an Affiliate (while it is an Affiliate).

1.3.11.ERISA — the Employee Retirement Income Security Act of 1974, as the same may be amended from time to time.

1.3.12.Incentive Compensation — the total remuneration of the Participant of the Participant from all Affiliates under the various incentive compensation programs maintained by Affiliates, including, but not limited to, amounts received under the Market Value Potential (“MVP”) Executive Incentive Program and the Underwriting Profit Program (“UPP”), but excluding any other type of remuneration paid by Affiliates, such as Base Salary, overtime, stock options, distributions of compensation previously deferred, restricted stock, allowances for expenses, and fringe benefits.  The Committee, from time to time, shall designate those items of a Participant’s Compensation deemed to be Incentive Compensation.

1.3.13.Participant — an eligible Employee who enrolls as a Participant in the Plan under Sec. 2.3.  An Employee who becomes a Participant shall remain a Participant in the Plan until the earlier of the following:

(a)The complete payment of the Participant’s Account balance after the Participant’s Termination of Employment; or

(b)The Participant’s death.

1.3.14.Performance-Based Compensation —the Incentive Compensation of the Participant for a period where the amount of, or entitlement to, the Incentive Compensation is contingent on the satisfaction of pre-established organizational or individual performance criteria relating to a performance period of at least 12 consecutive months.  Organizational or individual performance criteria are considered pre-established if established in writing by no later than 90 days of the commencement period of service to which the criteria relate, provided that the outcome is substantially uncertain at the time the criteria are established.  Performance-Based Compensation may include payment based on performance criteria that are not approved by the Board or the Compensation Committee of the Board or by the stockholders of the Company.  Performance-Based Compensation does not include any amount or portion

2

of any amount that will be paid either regardless of performance, or based upon a level of performance that is substantially certain to be met at the time the criteria are established.

1.3.15.Plan — the unfunded deferred compensation plan that is set forth in this document, as the same may be amended from time to time.  The name of the Plan is the “RLI Corp. Executives Deferred Compensation Plan.”

1.3.16.Prior Agreement — an individual agreement entered into by an Employee and RLI to provide deferred compensation opportunities to the Employee.

1.3.17.RLI — RLI Corp. and any Successor Corporation.

1.3.18.RLI Stock — the common stock of RLI.

1.3.19.Specified Employee — means an employee of an Affiliate who is subject to the six-month delay rule described in Section 409A(2)(B)(i) of the Code.  RLI shall establish a written policy for identifying Specified Employees in a manner consistent with Section 409A, which policy may be amended by RLI from time to time as permitted by Section 409A.

1.3.20.Successor Corporation — any entity that succeeds to the business of RLI through merger, consolidation, acquisition of all or substantially all of its assets, or any other means and which elects before or within a reasonable time after such succession, by appropriate action evidenced in writing, to continue the Plan.

1.3.21.Termination of Employment —with respect to a Participant, means the Participant’s separation from service with all Affiliates, within the meaning of Section 409A(a)(2)(A)(i) of the Code and the regulations under such section.  Solely for this purpose, a Participant who is an eligible Employee will be considered to have a Termination of Employment when the Participant dies, retires, or otherwise has a termination of employment with all Affiliates.  The employment relationship is treated as continuing intact while the Participant is on military leave, sick leave, or other bona fide leave of absence if the period of such leave does not exceed six months, or if longer, so long as the individual retains a right to reemployment with an Affiliate under an applicable statute or by contract.  For purposes hereof, a leave of absence constitutes a bona fide leave of absence only if there is a reasonable expectation that the Participant will return to perform services for an Affiliate.  If the period of leave exceeds six months and the individual does not retain a right to reemployment under an applicable statute or by contract, the employment relationship is deemed to terminate on the first date immediately following such six-month period.  Notwithstanding the foregoing, where a leave of absence is due to any medically determinable physical or mental impairment that can be expected to last for a continuous period of not less than six months, where such impairment causes the employee to be unable to perform the duties of such employee’s position of employment or any substantially similar position of employment, RLI may substitute a 29-month period of absence for such six-month period.

Whether a termination of employment has occurred is determined based on whether the facts and circumstances indicate that the Affiliate and the Participant reasonably anticipated that no further services will be performed after a certain date or that the level of bona fide services the Participant will perform after such date will permanently decrease to no more than 49 percent of the average level of bona fide services performed over the immediately preceding 36-month period (or the full period of services if the Participant has been providing services for less than 36 months).

3

Notwithstanding anything in Section 1.3.2 to the contrary, in determining whether a Participant has had a Termination of Employment with an Affiliate, an entity’s status as an “Affiliate” shall be determined substituting “50 percent” for “80 percent” each place it appears in Section 1563(a)(1),(2), and (3) and in Treasury Regulation Section 1.414(c)-2.

RLI shall have discretion to determine whether a Participant has experienced a Termination of Employment in connection with an asset sale transaction entered into by RLI or an Affiliate, provided that such determination conforms to the requirements of Section 409A and the regulations and other guidance issued under such section, in which case RLI’s determination shall be binding on the Participant.

1.3.22.Vested — nonforfeitable.

1.3.23.Year — the calendar year.

1.4.“Top-Hat” Plan.  The Plan is intended to be a “top-hat” plan — that is, an unfunded plan maintained primarily for the purpose of providing deferred compensation for a select group of management or highly compensated individuals within the meaning of ERISA §§ 201(2), 301(a)(3) and 401(a)(1), which is exempt from Parts 2, 3 and 4 of Title I of ERISA.  The Plan also is a nonqualified deferred compensation plan subject to Code § 409A.  To the extent any provision of the Plan does not satisfy the requirements contained in Code § 409A or in any regulations or other guidance issued by the Treasury Department under Code § 409A, such provision will be applied in a manner consistent with such requirements, regulations or guidance, notwithstanding any contrary provision of the Plan or any inconsistent election made by a Participant.

ARTICLE 2

PARTICIPATION

2.1.Eligibility and Selection.  The following Employees shall be eligible to enroll as Participants in the Plan:

(a)Employees with the titles:  Chairman of the Board, Chief Executive Officer, President and Senior Vice President; and

(b)Such other Employees as the Committee, in its sole discretion, shall determine from time to time, provided that each such Employee must;

(1)Have the title of Vice President or above, and

(2)Be expected to have compensation in excess of the Code § 401(a)(17) limit in the Participant’s initial Year of eligibility.

2.2.Notification.  RLI shall provide each eligible Employee with (i) written notification of the Employee’s eligibility to participate in the Plan, and (ii) either copy of the Plan or written notification that such a copy is available upon request.

2.3.Enrollment.  An eligible Employee will be allowed to enroll in the Plan during the thirty (30) day period coinciding with and following the date the Employee is notified of the Employee’s eligibility to participate in accordance with Sec. 2.2.  Such an enrollment will be effective as of the date it is made.

4

Thereafter, an eligible Employee may elect to enroll for a Year during the enrollment period established by RLI for such Year, which enrollment period will be a period of not less than thirty (30) days that ends not later than the last day of the prior Year.  Enrollment must be made in such manner and in accordance with such rules as may be prescribed for this purpose by RLI (including by means of a voice response or other electronic system under circumstances authorized by RLI).

2.4.Elective Deferrals.

2.4.1.Elections.  A Participant may elect to reduce Deferral Eligible Amounts by any dollar amount or whole percent, but not more than one-hundred percent (100%).  A separate reduction amount or percentage may apply to base compensation and to bonuses.  An election must be made in such manner and in accordance with such rules as may be prescribed for this purpose by RLI (including by means of a voice response or other electronic system under circumstances authorized by RLI).  An election must be made as part of the enrollment described in Sec. 2.3.

2.4.2.Elections Relate to Services Performed After the Election and Are Irrevocable.  An election will apply to all Deferral Eligible Amounts attributable to services performed in a given Year, regardless of when such Deferral Eligible Amounts would otherwise be payable to the Participant (for example, an election to defer a bonus attributable to services performed in a given Year but payable in the next Year, must be made as part of the enrollment election made prior to the Year in which the services are performed).  However, an election will only be effective to defer Deferral Eligible Amounts earned after the election is made, and not before.  For example, an election made in connection with a mid-year enrollment under Sec. 2.3 will only be effective for Deferral Eligible Amounts attributable to services performed on and after the effective date of the enrollment as provided in Sec. 2.3.  An election will apply solely with respect to the given Year — that is, an election will not automatically be carried over and applied to the next Year.

Notwithstanding the foregoing, elections for Incentive Compensation that is Performance-Based Compensation must be completed and submitted to the Company not later than six months before the end of the performance period for the Incentive Compensation; provided, however, that in order for such an election to be valid, the a Participant must perform services continuously from the beginning of the performance period (or the date the performance criteria are established, if later) through the date the election is entered into, and provided further, that in no event may an election be effective to defer Incentive Compensation after the Incentive Compensation has become reasonably ascertainable.  For purposes hereof, if Incentive Compensation is a specific or calculable amount, the Incentive Compensation is readily ascertainable if and when the amount is first substantially certain to be paid.  If Incentive Compensation is not a specific or calculable amount, the Incentive Compensation, or any portion thereof, is readily ascertainable when the amount is both calculable and substantially certain to be paid.  Accordingly, in general, any minimum amount that is both calculable and substantially certain to be paid will be treated as readily ascertainable.

In general, an election shall become irrevocable as of the last day of the enrollment period applicable to it.  However, if a Participant incurs an “unforeseeable emergency,” as defined in Section 4.7(h), or becomes entitled to receive a hardship distribution pursuant to Treas. Reg. Sec. 1.401(k)-1(d)(3) after the election otherwise becomes irrevocable, the election shall be cancelled as of the date on which the Participant is determined to have incurred the unforeseeable emergency or becomes eligible to receive the hardship distribution and no further deferrals will be made under it.  In addition, if a Participant becomes “disabled” (as defined below), RLI may, in its discretion, cancel the Participant’s election then in effect, provided that such cancellation is made no later than end of the Plan Year, or if later, the 15th day of the third month following the date on which the Participant becomes disabled, and

5

provided further that RLI does not allow the Participant a direct or indirect election regarding the cancellation.  For purposes of the preceding sentence, “disability” means any medically determinable physical or mental impairment resulting in the Participant’s inability to perform the duties required by the Participant’s position or any substantially similar position, where such impairment can be expected to result in death or can be expected to last for a continuous period of not less than six months.

2.4.3.Limits.  RLI may, in its sole discretion, limit the minimum or maximum amount of deferrals that are allowed under the Plan by any Participant or any group of Participants, provided that such limit is established prior to the beginning of the Year or prior to enrollment of the affected Participant.

ARTICLE 3

ACCOUNTS

3.1.Accounts.  RLI shall establish and maintain a separate Account for each Participant.  The Account shall be for recordkeeping purposes only and shall not represent a trust fund or other segregation of assets for the benefit of the Participant.  The balance of each Participant’s Account will be maintained in full and fractional shares of RLI Stock.

3.2.Credits to Accounts.  Each Participant’s Account shall be credited from time to time as provided in this section.

3.2.1.Elective Deferrals.  Each Deferral Eligible Amount which the Participant has elected to defer under the Plan shall be credited to the Participant’s Account on, or as soon as administratively practicable after, the date it would otherwise be paid to the Participant.  The cash amount shall be converted to RLI Stock credits, equal to the number of full and fractional shares that could be purchased with such amount on, or as soon as administratively feasible after, the date such amount is credited to the Participant’s Account.

3.2.2.Dividends and Other Adjustments.  The Participant’s Account shall be credited with additional RLI Stock credits, equal to the number of full and fractional shares of RLI Stock that could be purchased with any cash dividends which would be payable on the RLI Stock credited to the Participant’s Account.  For this purposes, the share price on, or as soon as administratively practicable after, the date the dividend is paid will be used.  The Account also will be adjusted for any stock split, redemption or similar event, in a manner determined to be reasonable by RLI.

3.3.Charges to Accounts.  As of the date any Plan benefit measured by the Account is paid to the Participant or the Participant’s Beneficiary, the Account shall be charged with the amount of such benefit payment.

ARTICLE 4

BENEFITS

4.1.Vesting.  The Participant’s Account shall be fully (100%) Vested.

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4.2.Payment of Plan Benefits on Termination of Employment - General Rule.  If the Participant has an Account balance at Termination of Employment, RLI shall pay that balance to the Participant in five (5) annual installments, as follows:

(a)Time.  The first installment shall be paid on the January 1 following the Year in which the Participant’s Termination of Employment occurs.  The remaining installments shall be paid on each subsequent January 1.

(b)Amount.  The amount of each installment shall be determined using a “fractional” method — by multiplying the Participant’s Account balance immediately before the installment payment date by a fraction, the numerator of which is one and the denominator of which is the number of installments remaining (including the installment in question).  The result shall be rounded down to the next lower full share of RLI Stock, except for the final installment, which shall be rounded up to the next higher full share of RLI Stock.

4.3.Changing Payment Elections.

4.3.1.General Rule.  A Participant may elect to change the number of annual installments the Participant receives under the Plan to ten (10) or fifteen (15) installments, subject to the rules below.  Any such election must be made in such manner and in accordance with such rules as may be prescribed for this purpose by RLI (including by means of a voice response or other electronic system under circumstances authorized by RLI).  The installments shall commence on the date specified in Sec. 4.2(a), unless otherwise postponed by this Article 4, and the amount of each installment shall be determined under the fractional method described in Sec. 4.2(b).

4.3.2.Election upon Initial Plan Enrollment.  An election to extend the number of installments may be made as part of the Participant’s initial enrollment in the Plan, as described in Sec. 2.3.

4.3.3.Subsequent Election.  If a Participant did not elect to extend the number of installments upon initial enrollment, or if the Participant wants to further change the number of installments after becoming a Participant, such individual may elect to change the number of installments in accordance with the following rules:

(a)The election must be received by RLI in writing and in proper form and must not take effect for at least 12 months from the date on which it is submitted to RLI;

(b)The election must be submitted to RLI at least 12 months prior to the specified date of distribution; and

(c)The commencement of installments must be delayed at least five (5) years from the date payments would otherwise commence without this subsequent election.

4.4.Special Rules.

4.4.1.Specified Employee Exception.  If a Participant is a Specified Employee, the Participant’s initial installment (or lump-sum payment, if applicable) shall be delayed to the later of the January 1 following the Year in which the Participant’s Termination of Employment occurs or the first

7

day of the seventh month following the Participant’s Termination of Employment.  This delay shall not apply in the event of the Participant’s death.  Any remaining annual installments shall be paid as described in Sec. 4.2(a) and Sec. 5.1.

4.4.2.Cash-Out of Small Amounts.  Any contrary provision or election notwithstanding, if the Participant’s Account balance is less than one hundred thousand dollars ($100,000) as of the date installments are to commence, the Account shall be paid to the Participant in a single lump-sum, as full settlement of all benefits due under the Plan; provided that, for purposes of applying the one hundred thousand dollar ($100,000) cash-out limit, all nonqualified deferred compensation amounts payable to the Participant by RLI and its Affiliates shall be aggregated if and to the extent required under Code § 409A or any regulations or other guidance issued by the Treasury Department thereunder.

4.5.Medium of Payments.  All payments to a Participant shall be made in shares of RLI Stock.  Unless the shares have been registered under the Securities Act of 1933 (the “Act”), are otherwise exempt from the registration requirements of the Act, are the subject of a favorable no action letter issued by the Securities and Exchange Commission, or are the subject of an opinion of counsel acceptable to RLI to the effect that such shares are exempt from the registration requirements of the Act, the certificates representing such shares shall contain a legend precluding the transfer of such shares except in accordance with the provisions of Rule 144 of the Act, as the same may be amended from time to time.

4.6.Delay in Distributions.  A payment under the Plan may be delayed by RLI under any of the following circumstances so long as all payments to similarly situated Participants are treated on a reasonably consistent basis:

(a)RLI reasonably anticipates that if such payment were made as scheduled, RLI’s deduction with respect to such payment would not be permitted under Section 162(m) of the Code, provided that the payment is made either during the first Plan Year in which RLI reasonably anticipates, or should reasonably anticipate, that if the payment is made during such year, the deduction of such payment will not be barred by application of Section 162(m) or during the period beginning with the date of the Participant’s Termination of Employment and ending on the later of the last day of RLI’s fiscal year in which the Participant has a Termination of Employment or the 15th day of the third month following the Termination of Employment.

(b)RLI reasonably anticipates that the making of the payment will violate Federal securities laws or other applicable law, provided that the payment is made at the earliest date at which RLI reasonably anticipates that the making of the payment will not cause such violation.

(c)Upon such other events as determined by RLI and according to such terms as are consistent with Section 409A or are prescribed by the Commissioner of Internal Revenue.

4.7Acceleration of Distributions.  RLI may, in its discretion, distribute all or a portion of a Participant’s Accounts at an earlier time and in a different form than specified as otherwise provided in this Article 4, under the circumstances described below:

(a)As may be necessary to fulfill a Domestic Relations Order.  Distributions pursuant to a Domestic Relations Order shall be made according to administrative procedures established by RLI.

(b)To the extent reasonably necessary to avoid the violation of ethics laws or conflict of interest laws pursuant to Section 1.409A-3(j)(ii) of the Treasury regulations.

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(c)To pay FICA on amounts deferred under the Plan and the income tax resulting from such payment.

(d)To pay the amount required to be included in income as a result of the Plan’s failure to comply with Section 409A.

(e)If RLI determines, in its discretion, that it is advisable to liquidate the Plan in connection with a termination of the Plan subject to the requirements of Section 409A.

(f)As satisfaction of a debt of the Participant to an Affiliate, where such debt is incurred in the ordinary course of the service relationship between the Affiliate and the Participant, the entire amount of the reduction in any Plan Year does not exceed $5,000, and the reduction is made at the same time and in the same amount as the debt otherwise would have been due and collected from the Participant.

(g)To pay state, local or foreign tax obligations that may arise with respect to amounts deferred under the Plan and the income tax resulting from such payment.

(h)If the Participant has an unforeseeable emergency.  For these purposes an “unforeseeable emergency” is a severe financial hardship to the Participant, resulting from an illness or accident of the Participant, the Participant’s spouse, the Beneficiary, or the Participant’s dependent (as defined in Section 152, without regard to Section 152(b)(1), (b)(2), and (d)(1)(B) of the Code); loss of the Participant’s property due to casualty (including the need to rebuild a home following damage to a home not otherwise covered by insurance); or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant.  For example, the imminent foreclosure of or eviction from the Participant’s primary residence may constitute an unforeseeable emergency.  In addition, the need to pay for medical expenses, including non-refundable deductibles, as well as for the cost of prescription drug medication, may constitute an unforeseeable emergency.  Finally, the need to pay for funeral expenses of a spouse, Beneficiary, or a dependent (as defined in Section 152, without regard to 152(b)(1), (b)(2), and (d)(1)(B) of the Code) may also constitute an unforeseeable emergency.  Except as otherwise provided in this paragraph (h), the purchase of a home and the payment of college tuition are not unforeseeable emergencies.  Whether a Participant is faced with an unforeseeable emergency permitting a distribution under this paragraph (h) is to be determined based on the relevant facts and circumstances of each case, but, in any case a distribution on account of an unforeseeable emergency may not be made to the extent that such emergency is or may be relieved through reimbursement or compensation from insurance or otherwise, by liquidation of the Participant’s assets, to the extent the liquidation of such assets would not cause severe financial hardship, or by cessation of Elective Deferrals.

Distributions because of an unforeseeable emergency must be limited to the amount reasonably necessary to satisfy the emergency need (which may include amounts necessary to pay any Federal, state, local, or foreign income taxes or penalties reasonably anticipated to result from the distribution).  A determination of the amounts reasonably necessary to satisfy the emergency need must take into account any additional compensation that is available due to cancellation of the Participant’s election as a result of this paragraph (h).

Notwithstanding anything in this Section 4.7 to the contrary, except for a Participant’s election to request a distribution due to an unforeseeable emergency under paragraph (h), above (which the Participant, in the Participant’s discretion, may elect to make or not make), RLI shall

9

not provide the Participant with discretion or a direct or indirect election regarding whether a payment is accelerated pursuant to this Section 4.7.

4.8When a Payment is Deemed to be Made.  Any payment that is due to be distributed as of a particular date pursuant to the provisions of the Plan, will be deemed to be distributed as of that date if it is distributed on such date or a later date within the same calendar year, or, if later, by the 15th day of the third calendar month following the date, and the Participant is not permitted, directly or indirectly, to designate the calendar year of payment.  Further, a payment will be treated as made on a date if it is made no earlier than 30 days before the date, and the Participant is not permitted, directly or indirectly, to designate the calendar year of payment.  For purposes of the foregoing, if the payment is required to be made during a period of time, the specified date is treated as the first day of the period of time.

ARTICLE 5

DEATH BENEFITS

5.1.Death Benefits.

5.1.1.Benefits When Participant Dies Before Commencement of Payments.  If the Participant dies before installments commence, the Participant’s Account balance shall be paid to the Participant’s Beneficiary as follows:

(a)If the Participant has made a valid election under Sec. 4.4, payments shall be made in ten (10) or fifteen (15) annual installments, as elected by the Participant.

(b)Otherwise, payments shall be made in five (5) annual installments.

The first installment shall be paid on the January 1 following the Year in which the Participant’s death occurs.  The remaining installments shall be paid on each subsequent January 1.  The amount of each installment shall be determined using the “fractional” method described in Sec. 4.3(b).

5.1.2.Benefits When Participant Dies After Commencement of Payments.  If the Participant dies after installments commence and the Participant has an Account balance at death, the remaining Account balance shall be paid to the Participant’s Beneficiary in the same manner as if the Participant were still living.

5.1.3.Medium of Payments.  All payments to a Beneficiary shall be made in shares of RLI Stock, subject to any legend precluding transfer that is required under Sec. 4.6.

5.1.4.Cash-Out of Small Amounts.  Any contrary provision or election notwithstanding, if the amount payable to the Beneficiary is less than one hundred thousand dollars ($100,000) as of the date installments are to commence, the benefit shall be paid to the Beneficiary in a single lump-sum, as full settlement of all benefits due under the Plan, subject, however, to any limitation on such cash-out under Code § 409A or any regulations or other guidance issued by the Treasury Department thereunder.

5.2.Designation of Beneficiary.

5.2.1.Persons Eligible to Designate.  Any Participant may designate a Beneficiary to receive any amount payable under the Plan as a result of the Participant’s death, provided that the Beneficiary

10

survives the Participant.  The Beneficiary may be one or more persons, natural or otherwise.  By way of illustration, but not by way of limitation, the Beneficiary may be an individual, trustee, executor, or administrator.  A Participant may also change or revoke a designation previously made, without the consent of any Beneficiary named therein.

5.2.2.Form and Method of Designation.  Any designation or a revocation of a prior designation of Beneficiary shall be in writing on a form acceptable to RLI and shall be filed with RLI.  RLI and all other parties involved in making payment to a Beneficiary may rely on the latest Beneficiary designation on file with RLI at the time of payment or may make payment pursuant to Sec. 5.2.3 if an effective designation is not on file, shall be fully protected in doing so, and shall have no liability whatsoever to any person making claim for such payment under a subsequently filed designation of Beneficiary or for any other reason.

Notwithstanding any provision of this Sec. 5.2 to the contrary, any Beneficiary designation made under the Prior Agreements will continue in effect under this Plan until modified by the Participant pursuant to this Sec. 5.2.

5.2.3.No Effective Designation.  If there is not on file with RLI an effective designation of Beneficiary by a deceased Participant, the Beneficiary shall be the person or persons surviving the Participant in the first of the following classes in which there is a survivor, share and share alike:

(a)The Participant’s spouse.  (A “spouse” is a person of the opposite sex to whom the Participant is legally married, including a common-law spouse if the marriage was entered into in a state that recognizes common-law marriages and RLI has received acceptable proof and/or certification of common-law married status.)

(b)The Participant’s then living descendants, per stirpes.

(c)The Participant’s estate.

Determination of the identity of the Beneficiary in each case shall be made by RLI.

5.2.4.Successor Beneficiary.  If a Beneficiary who survives the Participant subsequently dies before receiving the complete payment to which the Beneficiary was entitled, the successor Beneficiary, determined in accordance with the provisions of this section, shall be entitled to the payments remaining. The successor Beneficiary shall be the person or persons surviving the Beneficiary in the first of the following classes in which there is a survivor, share and share alike:

(a)The Participant’s spouse.  (A “spouse” is a person of the opposite sex to whom the Participant is legally married, including a common-law spouse if the marriage was entered into in a state that recognizes common-law marriages and RLI has received acceptable proof and/or certification of common-law married status.)

(b)The Participant’s then living descendants, per stirpes.

(c)The Participant’s estate.

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ARTICLE 6

CLAIMS AND REVIEW PROCEDURES

6.1.Application for Benefits.  Benefits shall be paid to Participants automatically (without a written request) at the time and in the manner specified in the Plan.  Benefits shall be paid to a Beneficiary upon RLI’s receipt of a written request for the benefits, including appropriate proof of the Participant’s death and the Beneficiary’s identity and right to payment.  This written request shall be considered a claim for the purposes of this article.

6.2.Claims and Review Procedures.  The claims and review procedures set forth in this article shall be the mandatory claims and review procedures for the resolution of disputes and disposition of claims filed under the Plan.

6.2.1.Initial Claim.  An individual may, subject to any applicable deadline, file with the Committee a written claim for benefits under the Plan in a form and manner prescribed by RLI.

(a)If the claim is denied in whole or in part, the Committee shall notify the claimant of the adverse benefit determination within ninety (90) days after receipt of the claim.

(b)The ninety (90) day period for making the claim determination may be extended for ninety (90) days if the Committee determines that special circumstances require an extension of time for determination of the claim, provided that the Committee notifies the claimant, prior to the expiration of the initial ninety (90) day period, of the special circumstances requiring an extension and the date by which a claim determination is expected to be made.

6.2.2.Notice of Initial Adverse Determination.  A notice of an adverse determination shall set forth in a manner calculated to be understood by the claimant:

(a)The specific reasons for the adverse determination;

(b)References to the specific provisions of the Plan (or other applicable document) on which the adverse determination is based;

(c)A description of any additional material or information necessary to perfect the claim and an explanation of why such material or information is necessary; and

(d)A description of the claims review procedures, including the time limits applicable to such procedures.

6.2.3.Request for Review.  Within ninety (90) days after receipt of an initial adverse benefit determination notice, the claimant may file with the Board a written request for a review of the adverse determination and may, in connection therewith submit written comments, documents, records and other information relating to the claim benefits.  Any request for review of the initial adverse determination not filed within ninety (90) days after receipt of the initial adverse determination notice shall be untimely.

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6.2.4.Claim on Review.  If the claim, upon review, is denied in whole or in part, the Board shall notify the claimant of the adverse benefit determination within sixty (60) days after receipt of such a request for review.

(a)The sixty (60) day period for deciding the claim on review may be extended for sixty (60) days if the Board determines that special circumstances require an extension of time for determination of the claim, provided that the Board notifies the claimant, prior to the expiration of the initial sixty (60) day period, of the special circumstances requiring an extension and the date by which a claim determination is expected to be made.

(b)In the event that the time period is extended due to a claimant’s failure to submit information necessary to decide a claim on review, the claimant shall have sixty (60) days within which to provide the necessary information and the period for making the claim determination on review shall be tolled from the date on which the notification of the extension is sent to the claimant until the date on which the claimant responds to the request for additional information or, if earlier, the expiration of sixty (60) days.

(c)The Board’s review of a denied claim shall take into account all comments, documents, records, and other information submitted by the claimant relating to the claim, without regard to whether such information was submitted or considered in the initial benefit determination.

6.2.5.Notice of Adverse Determination for Claim on Review.  A notice of an adverse determination for a claim on review shall set forth in a manner calculated to be understood by the claimant:

(a)The specific reasons for the denial;

(b)References to the specific provisions of the Plan (or other applicable document) on which the adverse determination is based; and

(c)A statement that the claimant is entitled to receive, upon request and free of charge, reasonable access to, and copies of, all documents, records, and other information relevant to the claimant’s claim for benefits.

6.3.Claims Rules.

(a)No inquiry or question shall be deemed to be a claim or a request for a review of a denied claim unless made in accordance with the established claims and review procedures.  RLI may require that any claim for benefits and any request for a review of a denied claim be filed on forms to be furnished by RLI upon request.

(b)All decisions on claims and on requests for a review of denied claims shall be made by RLI.

(c)Claimants may be represented by a lawyer or other representative at their own expense, but RLI reserves the right to (i) require the claimant to furnish written authorization and (ii) establish reasonable procedures for determining whether an individual has been

13

authorized to act on behalf of a claimant.  A claimant’s representative shall be entitled to copies of all notices given to the claimant.

(d)The decision of RLI on a claim and on a request for a review of a denied claim may be provided to the claimant in electronic form instead of in writing at the discretion of RLI.

(e)In connection with the review of a denied claim, the claimant or the claimant’s representative shall be provided, upon request and free of charge, reasonable access to, and copies of, all documents, records, and other information relevant to the claimant’s claim for benefits.

(f)The time period within which a benefit determination will be made shall begin to run at the time a claim or request for review is filed in accordance with the claims and review procedures, without regard to whether all the information necessary to make a benefit determination accompanies the filing.

(g)The claims and review procedures shall be administered with appropriate safeguards so that benefit claim determinations are made in accordance with governing Plan documents and, where appropriate, the Plan provisions have been applied consistently with respect to similarly situated claimants.

(h)For the purpose of this article, a document, record, or other information shall be considered “relevant” if such document, record, or other information:  (i) was relied upon in making the benefit determination; (ii) was submitted, considered, or generated in the course of making the benefit determination, without regard to whether such document, record, or other information was relied upon in making the benefit determination; or (iii) demonstrates compliance with the administration processes and safeguards designed to ensure that the benefit claim determination was made in accordance with governing Plan documents and that, where appropriate, the Plan provisions have been applied consistently with respect to similarly situated claimants.

(i)RLI may, in its discretion, rely on any applicable statute of limitation or deadline as a basis for denial of any claim.

6.4.Deadline to File Claim.  To be considered timely under the Plan’s claims and review procedures, a claim must be filed with the Committee within one (1) year after the claimant knew or reasonably should have known of the principal facts upon which the claim is based.

6.5.Exhaustion of Administrative Remedies.  The exhaustion of the claims and review procedures is mandatory for resolving every claim and dispute arising under the Plan.  As to such claims and disputes no claimant shall be permitted to commence an arbitration action to recover Plan benefits or to enforce or clarify rights under the Plan or under any provision of the law, whether or not statutory, until the claims and review procedures set forth herein have been exhausted in their entirety.

6.6.Arbitration.  Any claim, dispute or other matter in question of any kind relating to the Plan which is not resolved by the claims and review procedures shall be settled by arbitration in accordance with the Federal Arbitration Act 9 U.S.C. §1, et seq.  Notice of demand for arbitration must be made in writing to the opposing party within the time period specified in Sec. 6.7.  In no event will a demand for arbitration be made after the date when the applicable statute of limitations would bar the institution of a

14

legal or equitable proceeding based on such claim, dispute or other matter in question.  The decision of the arbitrator(s) will be final and may be enforced in any court of competent jurisdiction.  The arbitrator(s) may award reasonable fees and expenses to the prevailing party in any dispute hereunder and will award reasonable fees and expenses in the event that the arbitrator(s) find that the losing party acted in bad faith or with intent to harass, hinder or delay the prevailing party in the exercise of its rights in connection with the matter under dispute.  The arbitration will take place in Peoria, Illinois, unless otherwise agreed by the parties.

6.7.Deadline to File an Arbitration Action.  No arbitration action to recover Plan benefits or to enforce or clarify rights under the Plan under or under any provision of the law, whether or not statutory, may be brought by any claimant on any matter pertaining to the Plan unless the action is commenced before the earlier of:

(a)Thirty (30) months after the claimant knew or reasonably should have known of the principal facts on which the claim is based, or

(b)Six (6) months after the claimant has exhausted the claims and review procedures.

6.8.Knowledge of Fact by Participant Imputed to Beneficiary.  Knowledge of all facts that a Participant knew or reasonably should have known shall be imputed to every claimant who is or claims to be a Beneficiary of the Participant or otherwise claims to derive an entitlement by reference to the Participant for the purpose of applying the previously specified periods.

6.9.Deferral of Payment.  If there is a dispute regarding a Plan benefit, RLI, in its sole discretion, may defer payment of the benefit until the dispute has been resolved.

ARTICLE 7

ADMINISTRATION

7.1.Administrator.  RLI shall be the administrator of the Plan.  RLI shall control and manage the administration and operation of the Plan and shall make all decisions and determinations incident thereto.  Except with respect to the ordinary day-to-day administration of the Plan, action on behalf of RLI must be taken by one of the following:

(a)The Board; or

(b)The Committee.

7.1.1.Delegation.  The ordinary day-to-day administration of the Plan may be delegated by the Chief Executive Officer to an individual or a committee.  Such individual or committee shall have the authority to delegate or redelegate to one or more persons, jointly or severally, such functions assigned to such individual or committee as such individual or committee may from time to time deem advisable.

7.1.2.Automatic Removal.  If any individual or committee member to whom responsibility under the Plan is allocated is a director, officer or employee of RLI when responsibility is so allocated, then such individual shall be automatically removed as a member of a committee at the earliest time such individual ceases to be a director, officer or employee of RLI.  This removal shall occur automatically and without any requirement for action by RLI or any notice to the individual so removed.

15

7.1.3.Conflict of Interest.  If any individual or committee member to whom responsibility under the Plan is allocated is also a Participant or Beneficiary, that individual or committee member shall have no authority as such member with respect to any matter specifically affecting such individual’s interest hereunder (as distinguished from the interests of all Participants and Beneficiaries or a broad class of Participants and Beneficiaries), all such authority being reserved exclusively to the other members to the exclusion of such individual, and such Participant or Beneficiary shall act only in an individual capacity in connection with any such matter.

7.1.4.Binding Effect.  The determination of the Board, the Committee or the Chief Executive Officer in any matter within its authority shall be binding and conclusive upon RLI and all persons having any right or benefit under the Plan.

7.1.5.Third-Party Service Providers.  RLI may from time to time appoint or contract with an administrator, record keeper or other third-party service provider for the Plan.  Any such administrator, record keeper or other third-party service provider will serve in a nondiscretionary capacity and will act in accordance with directions given and procedures established by RLI.

7.2.Benefits Not Transferable.  No Participant or Beneficiary shall have the power to transmit, alienate, dispose of, pledge or encumber any benefit payable under the Plan before its actual payment to the Participant or Beneficiary.  Any such effort by a Participant or Beneficiary to convey any interest in the Plan shall not be given effect under the Plan.  No benefit payable under the Plan shall be subject to attachment, garnishment, execution following judgment or other legal process before its actual payment to the Participant or Beneficiary.

7.3.Benefits Not Secured.  The rights of each Participant and Beneficiary shall be solely those of an unsecured, general creditor of RLI.  No Participant or Beneficiary shall have any lien, prior claim or other security interest in any property of RLI.

7.4.RLI’s Obligations.  RLI shall provide the benefits under the Plan.  RLI’s obligation may be satisfied by distributions from a trust fund created and maintained by RLI, in its sole discretion, for such purpose.  However, the assets of any such trust fund shall be subject to claims by the general creditors of RLI in the event RLI is (i) unable to pay its debts as they become due, or (ii) is subject to a pending proceeding as a debtor under the United States Bankruptcy Code.

7.5.Withholding Taxes.  RLI shall have the right to withhold (and transmit to the proper taxing authority) such federal, state or local taxes, including (but not limited to) FICA and FUTA taxes, as it may be required to withhold by applicable laws.  Such taxes may be withheld from any benefits due under the Plan or from any other compensation to which the Participant is entitled from RLI and its Affiliates.

7.6.Service of Process.  The Chief Executive Officer is designated as the appropriate and exclusive agent for the receipt of service of process directed to the Plan in any legal proceeding, including arbitration, involving the Plan.

7.7.Limitation on Liability.  Neither RLI’s officers nor any member of its Board nor any individual or committee to whom RLI delegates responsibility under the Plan in any way secures or guarantees the payment of any benefit or amount which may become due and payable hereunder to or with respect to any Participant.  Each Participant and other person entitled at any time to payments hereunder shall look

16

solely to the assets of RLI for such payments as an unsecured, general creditor.  After benefits have been paid to or with respect to a Participant and such payment purports to cover in full the benefit hereunder, such former Participant or other person(s), as the case may be, shall have no further right or interest in the other assets of RLI in connection with the Plan.  Neither RLI nor any of its officers nor any member of its Board nor any individual or committee to whom RLI delegates responsibility under the Plan shall be under any liability or responsibility for failure to effect any of the objectives or purposes of the Plan by reason of the insolvency of RLI.

ARTICLE 8

AMENDMENT AND TERMINATION

8.1.Amendment.  RLI reserves the power to amend the Plan either prospectively or retroactively or both, in any respect, by action of its Board; provided that, no amendment shall be effective to reduce or divest benefits payable with respect to the Account of any Participant or Beneficiary without consent.  No amendment of the Plan shall be effective unless it is in writing and signed on behalf of RLI by a person authorized to execute such writing.  No oral representation concerning the interpretation or effect of the Plan shall be effective to amend the Plan.

8.2.Termination.  RLI reserves the right to terminate the Plan at any time by action of its Board; provided that, the termination of the Plan shall not reduce or divest benefits payable with respect to the Account of any Participant or Beneficiary or negate the Participant’s or Beneficiary’s rights with respect to such benefits.  Any such termination will be done in accordance with the requirements of Section 409A.

ARTICLE 9

MISCELLANEOUS

9.1.Effect on Other Plans.  This Plan shall not alter, enlarge or diminish any person’s rights or obligations under any other benefit plan maintained by RLI or any Affiliate.

9.2.Effect on Employment.  Neither the terms of this Plan nor the benefits hereunder nor the continuance thereof shall be a term of the employment of any Employee.  RLI shall not be obliged to continue the Plan.  The terms of this Plan shall not give any Employee the right to be retained in the service of RLI or any Affiliate.

9.3.Disqualification.  Notwithstanding any other provision of the Plan or any designation made under the Plan, any individual who feloniously and intentionally kills a Participant shall be deemed for all purposes of the Plan and all elections and designations made under the Plan to have died before such Participant.  A final judgment of conviction of felonious and intentional killing is conclusive for this purpose.  In the absence of a conviction of felonious and intentional killing, RLI shall determine whether the killing was felonious and intentional for this purpose.

9.4.Rules of Document Construction.  Whenever appropriate, words used herein in the singular may be read in the plural, or words used herein in the plural may be read in the singular; and the words “hereof,” “herein” or “hereunder” or other similar compounds of the word “here” shall mean and refer to the entire Plan and not to any particular article, section or paragraph of the Plan unless the context clearly indicates to the contrary.  The titles given to the various articles and sections of the Plan are inserted for

17

convenience of reference only and are not part of the Plan, and they shall not be considered in determining the purpose, meaning or intent of any provision hereof.  Written notification under the Plan shall include such other methods (for example, facsimile or e-mail) as RLI, in its sole discretion, may authorize from time to time.

9.5.References to Laws.  Any reference in the Plan to a statute shall be considered also to mean and refer to the applicable regulations for that statute.  Any reference in the Plan to a statute or regulation shall be considered also to mean and refer to any subsequent amendment or replacement of that statute or regulation.

9.6.Choice of Law.   The Plan has been executed in the State of Illinois and has been drawn in conformity to the laws of that state and shall, except to the extent that federal law is controlling, be construed and enforced in accordance with the laws of the State of Illinois (without regard to its conflict of law principles).

9.7.Binding Effect.  The Plan shall be binding upon and inure to the benefit of the successors and assigns of RLI, and the Beneficiaries, personal representatives and heirs of the Participant.

IN WITNESS WHEREOF, RLI has cause the Plan to be executed by its duly authorized officers as of  the                  day of                             .

RLI CORP.
By:
	Its:
	And
By:
	Its:

18

EX-10.7

Exhibit 10.7

RLI CORP. KEY EMPLOYEES

EXCESS BENEFIT PLAN

(Restated as of January 1, 2009)

12/12/2008

RLI CORP.  KEY EMPLOYEES

EXCESS BENEFIT PLAN

TABLE OF CONTENTS

ARTICLE 1	INTRODUCTION		1
	1.1	Establishment	1
	1.2	Purpose	1
	1.3	Definitions	2
	1.4	Type of Plan	4
ARTICLE 2	PARTICIPATION		4
	2.1	Eligibility and Selection	4
	2.2	Notification	5
ARTICLE 3	ACCOUNTS		5
	3.1	Accounts	5
	3.2	Credits to Accounts	5
	3.3	Charges to Accounts	7
ARTICLE 4	BENEFITS		7
	4.1	Vesting	7
	4.2	Payment of Plan Benefits on Termination of Employment - General Rule	7
	4.3	Changing Payment Elections	7
	4.4	Special Rules	8
	4.5	Medium of Payments	8
	4.6.	Delay in Distributions	9
	4.7	Acceleration of Distributions	9
	4.8	When a Payment is Deemed to be Made	11
ARTICLE 5	DEATH BENEFITS		11
	5.1	Death Benefits	11
	5.2	Designation of Beneficiary	12
ARTICLE 6	CLAIMS AND REVIEW PROCEDURES		13
	6.1	Application for Benefits	13
	6.2	Claims and Review Procedures	13
	6.3	Claims Rules	14
	6.4	Deadline to File Claim	15
	6.5	Exhaustion of Administrative Remedies	16
	6.6	Arbitration	16
	6.7	Deadline to File an Arbitration Action	16
	6.8	Knowledge of Fact by Participant Imputed to Beneficiary	16
	6.9	Deferral of Payment	16

ARTICLE 7	ADMINISTRATION			16
	7.1		Administrator	16
	7.2		Benefits Not Transferable	17
	7.3		Benefits Not Secured	17
	7.4		RLI’s Obligations	17
	7.5		Withholding Taxes	18
	7.6		Service of Process	18
	7.7		Limitation on Liability	18
ARTICLE 8	AMENDMENT AND TERMINATION			18
	8.1		Amendment	18
	8.2		Termination	18
ARTICLE 9	MISCELLANEOUS			19
	9.1	Effect on Other Plans		19
	9.2	Effect on Employment		19
	9.3	Disqualification		19
	9.4	Rules of Document Construction		19
	9.5	References to Laws		19
	9.6	Choice of Law		19
	9.7	Binding Effect		19

RLI CORP. KEY EMPLOYEES
EXCESS BENEFIT PLAN

ARTICLE 1

INTRODUCTION

1.1Establishment.

1.1.1Establishment.  RLI established the RLI Corp. Key Employees Excess Benefit Plan effective January 1, 2004.  RLI hereby restates the Plan, effective January 1, 2009, to comply with the requirements of the final regulations issued under Section 409A of the Code on April 10, 2007.

1.1.2Transition Rules.

(a)Before 2004.  For Years ending before 2004, benefits for the Chairman of the Board and the Chief Executive Officer of RLI accrued under certain Prior Agreements, which restored contributions and forfeitures that could not be provided under the ESOP.

(b)For 2004.  For the 2004 Year, benefits for the Chairman of the Board and the Chief Executive Officer of RLI shall accrue under the Prior Agreements and under this Plan, as follows:

(1)ESOP.  Benefits to restore contributions and forfeitures that cannot be provided under the ESOP shall accrue under the Prior Agreements in accordance with the terms of the Prior Agreements.

(2)401k Plan.  Benefits to restore contributions and forfeitures that cannot be provided under the 401k Plan shall accrue under this Plan in accordance with the terms of this Plan.

(c)After 2004.  For Years commencing after 2004, benefits for the Chairman of the Board and the Chief Executive Officer of RLI shall accrue under this Plan to restore contributions and forfeitures that cannot be provided under both Qualified Plans, and no additional benefits shall accrue under the Prior Agreements.  All obligations under the Prior Agreements with respect to ESOP contributions and forfeitures for Years ending before 2005 shall be satisfied under the Prior Agreements, rather than under this Plan.

1.2Purpose.  The purpose of the Plan is to restore retirement benefits to those eligible Employees whose contributions and forfeitures under the Qualified Plans are reduced by the limitations imposed by the Code §§ 401(a)(17) and 415A or by reason of their electing to defer receipt of compensation that would otherwise be taken into account in calculating contributions and forfeitures under the Qualified Plans.

1.3Definitions.  When the following terms are used herein with initial capital letters, they shall have the following meanings:

1.3.1401k Plan — the RLI Corp 401k Plan, as the same may be amended from time to time.

1.3.2Account — the separate recordkeeping account (unfunded and unsecured) maintained for each Participant in connection with the Participant’s participation in the Plan.

1.3.3Affiliate — a business entity which is under a “common control” with RLI or which is a member of an “affiliated service group” that includes RLI, as those terms are defined in Code § 4l4(b), (c) and (m).

1.3.4Beneficiary — the person or persons designated as such under Sec. 5.2.

1.3.5Board — the Board of Directors of RLI.

1.3.6Code — the Internal Revenue Code of 1986, as the same may be amended from time to time.

1.3.7Committee — the Executive Resources Committee of the Board.

1.3.8Employee — a common-law employee of RLI or an Affiliate (while it is an Affiliate).

1.3.9Employer Provided Contribution — the amounts contributed to a Qualified Plan by RLI on behalf of a Participant, specifically:

(a)The “ESOP Contribution” as defined in the ESOP, and

(b)The “Basic Contribution” and “Profit Sharing Contribution” as defined in the 401k Plan.

Employer Provided Contributions do not include any “401k Contributions”, “401k Catch-Up Contributions”, “Rollover Contributions”, as defined in the 401k Plan, or any other amounts defined under or contributed to the Qualified Plans by the Participant.

1.3.10ERISA — the Employee Retirement Income Security Act of 1974, as the same may be amended from time to time.

1.3.11ESOP — the RLI Corp. Employee Stock Ownership Plan, as the same may be amended from time to time.

1.3.12Participant — an Employee who becomes a Participant in the Plan under Sec. 2.1.  An Employee who becomes a Participant shall remain a Participant in the Plan until the earlier of the following:

(a)The complete payment of the Participant’s Account balance after the Participant’s Termination of Employment; or

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(b)The Participant’s death.

1.3.13Plan — the unfunded deferred compensation plan that is set forth in this document, as the same may be amended from time to time.  The name of the Plan is the “RLI Corp. Key Employees Excess Benefit Plan.”

1.3.14Prior Agreement — an individual agreement entered into by an Employee and RLI before January 1, 2004, to provide key employee excess benefits to the Employee.

1.3.15Qualified Plans — the ESOP and the 401k Plan.

1.3.16RLI — RLI Corp.  and any Successor Employer.

1.3.17RLI Stock — the common stock of RLI.

1.3.18Specified Employee — means an employee of an Affiliate who is subject to the six-month delay rule described in Section 409A(2)(B)(i) of the Code.  RLI shall establish a written policy for identifying Specified Employees in a manner consistent with Section 409A, which policy may be amended by RLI from time to time as permitted by Section 409A.

1.3.19Successor Employer — any entity that succeeds to the business of RLI through merger, consolidation, acquisition of all or substantially all of its assets, or any other means and which elects before or within a reasonable time after such succession, by appropriate action evidenced in writing, to continue the Plan.

1.3.20Termination of Employment —with respect to a Participant, means the Participant’s separation from service with all Affiliates, within the meaning of Section 409A(a)(2)(A)(i) of the Code and the regulations under such section.  Solely for this purpose, a Participant who is an eligible Employee will be considered to have a Termination of Employment when the Participant dies, retires, or otherwise has a termination of employment with all Affiliates.  The employment relationship is treated as continuing intact while the Participant is on military leave, sick leave, or other bona fide leave of absence if the period of such leave does not exceed six months, or if longer, so long as the individual retains a right to reemployment with an Affiliate under an applicable statute or by contract.  For purposes hereof, a leave of absence constitutes a bona fide leave of absence only if there is a reasonable expectation that the Participant will return to perform services for an Affiliate.  If the period of leave exceeds six months and the individual does not retain a right to reemployment under an applicable statute or by contract, the employment relationship is deemed to terminate on the first date immediately following such six-month period.  Notwithstanding the foregoing, where a leave of absence is due to any medically determinable physical or mental impairment that can be expected to last for a continuous period of not less than six months, where such impairment causes the employee to be unable to perform the duties of the employee’s position of employment or any substantially similar position of employment, RLI may substitute a 29-month period of absence for such six-month period.

Whether a termination of employment has occurred is determined based on whether the facts and circumstances indicate that the Affiliate and the Participant reasonably anticipated that no further services will be performed after a certain date or that the level of bona fide services

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the Participant will perform after such date will permanently decrease to no more than 49 percent of the average level of bona fide services performed over the immediately preceding 36-month period (or the full period of services if the Participant has been providing services for less than 36 months).

Notwithstanding anything in Section 2.1.2 to the contrary, in determining whether a Participant has had a Termination of Employment with an Affiliate, an entity’s status as an “Affiliate” shall be determined substituting “50 percent” for “80 percent” each place it appears in Section 1563(a)(1),(2), and (3) and in Treasury Regulation Section 1.414(c)-2.

RLI shall have discretion to determine whether a Participant has experienced a Termination of Employment in connection with an asset sale transaction entered into by RLI or an Affiliate, provided that such determination conforms to the requirements of Section 409A and the regulations and other guidance issued under such section, in which case RLI’s determination shall be binding on the Participant.

1.3.21Vested — nonforfeitable.

1.3.22Year — the calendar year.

1.4Type of Plan.

1.4.1Top-Hat Plan.  The Plan is intended to be a “top-hat” plan - that is, an unfunded plan maintained primarily for the purpose of providing deferred compensation for a select group of management or highly compensated individuals within the meaning of ERISA §§ 201(2), 301(a)(3) and 401(a)(1), which is exempt from Parts 2, 3 and 4 of Title I of ERISA.

1.4.2Separate Excess Benefit Plan.  To the extent that a separable part of the Plan is maintained for the purpose of providing benefits for eligible Employees in excess of the limitations on contributions and benefits imposed by Code § 415, that part shall be treated as a separate plan which in an “excess benefit plan” within the meaning of ERISA § 3(36) and which is exempt from the participation, vesting, benefit accrual, funding and fiduciary provisions of ERISA.

1.4.3Nonqualified Deferred Compensation Plan.  The Plan also is a nonqualified deferred compensation plan subject to Code § 409A.  To the extent any provision of the Plan does not satisfy the requirements contained in Code § 409A or in any regulations or other guidance issued by the Treasury Department under Code § 409A, such provision will be applied in a manner consistent with such requirements, regulations or guidance, notwithstanding any contrary provision of the Plan or any inconsistent election made by a Participant.

ARTICLE 2

PARTICIPATION

2.1Eligibility and Selection.  The Committee, in its sole discretion, shall determine from time to time the Employees who will be Participants in the Plan, provided that each such Employee must:

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(a)Have the title of Vice President or above, and

(b)Be expected to have compensation in excess of the Code § 401 (a)(17) limit in the Participant’s initial year of participation.

An employee selected by the Committee will become a Participant on the January 1 following the date the Participant is selected by the Committee.  However, for the 2004 Year, each selected Employee shall become a Participant on January 1, 2004.

2.2Notification.  RLI shall provide each Participant with (i) written notification of the Participant’s participation in the Plan, and (ii) either a copy of the Plan or written notification that such a copy is available upon request.

ARTICLE 3

ACCOUNTS

3.1Accounts.  RLI shall establish and maintain a separate Account for each Participant.  The Account shall be for recordkeeping purposes only and shall not represent a trust fund or other segregation of assets for the benefit of the Participant.  The balance of each Participant’s Account will be maintained in full and fractional shares of RLI Stock.

3.2Credits to Accounts.  Each Participant’s Account shall be credited from time to time as provided in this section.

3.2.1Contribution Credits.

(a)Amount.  A Participant’s contribution credit for a Year with respect to each Qualified Plan is an amount equal to A minus B, where:

“A” =The amount of Employer Provided Contributions that would have been contributed to the Qualified Plan on behalf of the Participant for the Year if such Employer Provided Contributions were determined without regard to:

(i)The limit on compensation taken into account under the Qualified Plan under Code § 401(a)(17);

(ii)The limit on annual additions under the Qualified Plan under Code § 415(c); and

(iii)The exclusion of amounts deferred by the Participant under the RLI Executives Deferred Compensation Plan from the compensation base used to determine the Employer Provided Contributions under the Qualified Plan.

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“B” =The amount of Employer Provided Contributions actually contributed to the Qualified Plan on behalf-of the Participant for the Year.

(b)Time.  The amount of the Participant’s contribution credit for the Year with respect to each Qualified Plan shall be credited to the Participant’s Account on, or as soon as administratively practicable after, the date such amount would otherwise have been contributed to the Qualified Plan.  The amount shall be converted to RLI Stock credits, equal to the number of full and fractional shares that could be purchased with such amount on, or as soon as administratively feasible after, the date such amount is credited to the Participant’s Account.

(c)2004 Transition.  Notwithstanding the foregoing, the contribution credits for the 2004 Year for any Participant who was covered under a Prior Agreement shall be limited to the amount determined with respect to the 401(k) Plan.  No contribution credits shall be added to such Participant’s Account under this Plan for the 2004 Year with respect to the ESOP.

3.2.2Forfeitures.

(a)Amount.  A Participant’s forfeiture credit for a Year with respect to each Qualified Plan is an amount equal to A minus B, where:

“A” =The amount of forfeitures that would have been allocated to the Participant’s account under the Qualified Plan for the Year if such allocation were determined without regard to:

(i)The limit on compensation taken into account under the Qualified Plan under Code § 401 (a)(17);

(ii)The limit on annual additions under the Qualified Plan under Code § 415(c); and

(iii)The exclusion of amounts deferred by the Participant under the RLI Corp. Executives Deferred Compensation Plan from the compensation base used to allocate forfeitures under the Qualified Plan.

“B” =The amount of forfeitures actually allocated to the Participant’s account under the Qualified Plan for the Year.

(b)Time.  The amount of the Participant’s forfeiture credit for the Year with respect to each Qualified Plan shall be credited to the Participant’s Account on, or as soon as administratively practicable after, the date such amount would otherwise have been allocated under the Qualified Plan.  The amount shall be converted to RLI Stock credits, equal to the number of full and fractional shares that could be purchased with such amount on, or as soon as administratively feasible after, the date such amount is credited to the Participant’s Account.

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(c)2004 Transition.  Notwithstanding the foregoing, the forfeiture credits for the 2004 Year for any Participant who was covered under a Prior Agreement shall be limited to the amount determined with respect to the 401(k) Plan, No forfeiture credits shall be added to such Participant’s Account under this Plan for the 2004 Year with respect to the ESOP.

3.2.3Dividends and Other Adjustments.  The Participant’s Account shall be credited with additional RLI Stock credits, equal to the number of full and fractional shares of RLI Stock that could be purchased with any cash dividends which would be payable on the RLI Stock credited to the Participant’s Account.  For this purpose, the share price on, or as soon as administratively practicable after, the date the dividend is paid will be used.  The Account also will be adjusted for any stock split, redemption or similar event, in a manner determined to be reasonable by RLI

3.3Charges to Accounts.  As of the date any Plan benefit measured by the Account is paid to the Participant or the Participant’s Beneficiary, the Account shall be charged with the amount of such benefit payment.

ARTICLE 4

BENEFITS

4.1Vesting.  The Participant’s Account shall be fully (100%) Vested.

4.2Payment of Plan Benefits on Termination of Employment - General Rule.  If the Participant has an Account balance at Termination of Employment, RLI shall pay that balance to the Participant in five (5) annual Installments, as follows:

(a)Time.  The first installment shall be paid on the January 1 following the Year in which the Participant’s Termination of Employment occurs.  The remaining installments shall be paid on each subsequent January 1.

(b)Amount.  The amount of each installment shall be determined using a “fractional” method - by multiplying the Participant’s Account balance immediately before the installment payment date by a fraction, the numerator of which is one and the denominator of which is the number of installments remaining (including the installment in question).  The result shall be rounded down to the next lower full share of RLI Stock, except for the final installment, which shall be rounded up to the next higher full share of RLI Stock.

4.3Changing Payment Elections

4.3.1General Rule.  A Participant may elect to change the number of annual installments the Participant receives under the Plan to ten (10) or fifteen (15) installments, subject to the rules below.  Any such election must be made in such manner and in accordance with such rules as may be prescribed for this purpose by RLI (including by means of a voice response or other electronic system under circumstances authorized by RLI).  The installments shall commence on the date specified in Sec. 4.2(a), unless otherwise postponed by this Article 4,

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and the amount of each installment shall be determined under the fractional method described in Sec. 4.2(b).

4.3.2.Election upon Initial Plan Enrollment.  An election to extend the number of installments may be made as part of the Participant’s initial enrollment in the Plan.  Such an election will only be effective to defer amounts earned after the election is made, and not before.

4.3.3.Subsequent Election.  If a Participant did not elect to extend the number of installments upon initial enrollment, or if the Participant wants to further change the number of installments after becoming a Participant, such Participant may elect to change the number of installments in accordance with the following rules:

(a)The election must be received by RLI in writing and in proper form and must not take effect for at least 12 months from the date on which it is submitted to RLI;

(b)The election must be submitted to RLI at least 12 months prior to the specified date of distribution; and

(c)The commencement of installments must be delayed at least five (5) years from the date payments would otherwise commence without this subsequent election.

4.4Special Rules.

4.4.1Specified Employee Exception.  If a Participant is a Specified Employee, such Participant’s initial installment (or lump-sum payment, if applicable) shall be delayed to the later of the January 1 following the Year in which the Participant’s Termination of Employment occurs or the first day of the seventh month following the Participant’s Termination of Employment.  This delay shall not apply in the event of the Participant’s death.  Any remaining annual installments shall be paid as described in Sec. 4.2(a) and Sec. 5.1.

4.4.2Cash-Out of Small Amounts.  Any contrary provision or election notwithstanding, if the Participant’s Account balance is less than one hundred thousand dollars ($100,000) as of the date installments are to commence, the Account shall be paid to the Participant in a single lump-sum, as full settlement of all benefits due under the Plan; provided that, for purposes of applying the one hundred thousand dollar ($100,000) cash-out limit, all nonqualified deferred compensation amounts payable to the Participant by RLI and its Affiliates shall be aggregated If and to the extent required under Code § 409A or any regulations or other guidance issued by the Treasury Department thereunder.

4.5Medium of Payments.  All payments to a Participant shall be made in shares of RLI Stock.  Unless the shares have been registered under the Securities Act of 1933 (the “Act”), are otherwise exempt from the registration requirements of the Act, are the subject of a favorable no action letter issued by the Securities and Exchange Commission, or are the subject of an opinion of counsel acceptable to RLI to the effect that such shares are exempt from the registration requirements of the Act, the certificates representing such shares shall contain a legend precluding the transfer of such shares except in accordance with the provisions of Rule 144 of the Act, as the same may be amended from time to time.

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4.6Delay in Distributions.  A payment under the Plan may be delayed by RLI under any of the following circumstances so long as all payments to similarly situated Participants are treated on a reasonably consistent basis

(a)RLI reasonably anticipates that if such payment were made as scheduled, RLI’s deduction with respect to such payment would not be permitted under Section 162(m) of the Code, provided that the payment is made either during the first Plan Year in which RLI reasonably anticipates, or should reasonably anticipate, that if the payment is made during such year, the deduction of such payment will not be barred by application of Section 162(m) or during the period beginning with the date of the Participant’s Termination of Employment and ending on the later of the last day of RLI’s fiscal year in which the Participant has a Termination of Employment or the 15th day of the third month following the Termination of Employment.

(b)RLI reasonably anticipates that the making of the payment will violate Federal securities laws or other applicable law, provided that the payment is made at the earliest date at which RLI reasonably anticipates that the making of the payment will not cause such violation

(c)Upon such other events as determined by RLI and according to such terms as are consistent with Section 409A or are prescribed by the Commissioner of Internal Revenue.

4.7Acceleration of Distributions.  RLI may, in its discretion, distribute all or a portion of a Participant’s Accounts at an earlier time and in a different form than specified as otherwise provided in this Article 4, under the circumstances described below:

(a)As may be necessary to fulfill a Domestic Relations Order.  Distributions pursuant to a Domestic Relations Order shall be made according to administrative procedures established by RLI.

(b)To the extent reasonably necessary to avoid the violation of ethics laws or conflict of interest laws pursuant to Section 1.409A-3(j)(ii) of the Treasury regulations.

(c)To pay FICA on amounts deferred under the Plan and the income tax resulting from such payment.

(d)To pay the amount required to be included in income as a result of the Plan’s failure to comply with Section 409A.

(e)If RLI determines, in its discretion, that it is advisable to liquidate the Plan in connection with a termination of the Plan subject to the requirements of Section 409A.

(f)As satisfaction of a debt of the Participant to an Affiliate, where such debt is incurred in the ordinary course of the service relationship between the Affiliate and the Participant, the entire amount of the reduction in any Plan Year does not

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exceed $5,000, and the reduction is made at the same time and in the same amount as the debt otherwise would have been due and collected from the Participant.

(g)To pay state, local or foreign tax obligations that may arise with respect to amounts deferred under the Plan and the income tax resulting from such payment.

(h)If the Participant has an unforeseeable emergency.  For these purposes an “unforeseeable emergency” is a severe financial hardship to the Participant, resulting from an illness or accident of the Participant, the Participant’s spouse, the Beneficiary, or the Participant’s dependent (as defined in Section 152, without regard to Section 152(b)(1), (b)(2), and (d)(1)(B) of the Code); loss of the Participant’s property due to casualty (including the need to rebuild a home following damage to a home not otherwise covered by insurance); or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant.  For example, the imminent foreclosure of or eviction from the Participant’s primary residence may constitute an unforeseeable emergency.  In addition, the need to pay for medical expenses, including non-refundable deductibles, as well as for the cost of prescription drug medication, may constitute an unforeseeable emergency.  Finally, the need to pay for funeral expenses of a spouse, Beneficiary, or a dependent (as defined in Section 152, without regard to 152(b)(1), (b)(2), and (d)(1)(B) of the Code) may also constitute an unforeseeable emergency.  Except as otherwise provided in this paragraph (h), the purchase of a home and the payment of college tuition are not unforeseeable emergencies.  Whether a Participant is faced with an unforeseeable emergency permitting a distribution under this paragraph (h) is to be determined based on the relevant facts and circumstances of each case, but, in any case a distribution on account of an unforeseeable emergency may not be made to the extent that such emergency is or may be relieved through reimbursement or compensation from insurance or otherwise, by liquidation of the Participant’s assets, to the extent the liquidation of such assets would not cause severe financial hardship, or by cessation of Elective Deferrals.

Distributions because of an unforeseeable emergency must be limited to the amount reasonably necessary to satisfy the emergency need (which may include amounts necessary to pay any Federal, state, local, or foreign income taxes or penalties reasonably anticipated to result from the distribution).  A determination of the amounts reasonably necessary to satisfy the emergency need must take into account any additional compensation that is available due to cancellation of the Participant’s election as a result of this paragraph (h).

Notwithstanding anything in this Section 4.7 to the contrary, except for a Participant’s election to request a distribution due to an unforeseeable emergency under paragraph (h), above (which the Participant, in the Participant’s discretion, may elect to make or not make), RLI shall not provide the Participant with discretion or a direct or indirect election regarding whether a payment is accelerated pursuant to this Section 4.7.

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4.8When a Payment is Deemed to be Made..  Any payment that is due to be distributed as of a particular date pursuant to the provisions of the Plan, will be deemed to be distributed as of that date if it is distributed on such date or a later date within the same calendar year, or, if later, by the 15th day of the third calendar month following the date, and the Participant is not permitted, directly or indirectly, to designate the calendar year of payment.  Further, a payment will be treated as made on a date if it is made no earlier than 30 days before the date, and the Participant is not permitted, directly or indirectly, to designate the calendar year of payment.  For purposes of the foregoing, if the payment is required to be made during a period of time, the specified date is treated as the first day of the period of time.

ARTICLE 5

DEATH BENEFITS

5.1Death Benefits.

5.1.1Benefits When Participant Dies Before Commencement of Payments.  If the Participant dies before installments commence, the Participant’s Account balance shall be paid to the Participant’s Beneficiary as follows:

(a)If the Participant has made a valid election under Sec. 4.4, payments shall be made in ten (10) or fifteen (15) annual installments, as elected by the Participant.

(b)Otherwise, payments shall be made in five (5) annual installments.

The first installment shall be paid on the January 1 following the Year in which the Participant’s death occurs.  The remaining installments shall be paid on each subsequent January 1.  The amount of each installment shall be determined using the “fractional” method described in Sec. 4.3(b).

5.1.2Benefits When Participant Dies After Commencement of Payments.  If the Participant dies after installments commence and the Participant has an Account balance at death, the remaining Account balance shall be paid to the Participant’s Beneficiary in the same manner as if the Participant were still living.

5.1.3Medium of Payments.  All payments to a Beneficiary shall be made in shares of RLI Stock, subject to any legend precluding transfer that is required under Sec. 4.6.

5.1.4Cash-Out of Small Amounts.  Any contrary provision or election notwithstanding, if the amount payable to the Beneficiary is less than one hundred thousand dollars ($100,000) as of the date installments are to commence, the benefit shall be paid to the Beneficiary in a single lump-sum, as full settlement of all benefits due under the Plan, subject, however, to any limitation on such cash-out under Code § 409A or any regulations or other guidance issued by the Treasury Department thereunder.

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5.2Designation of Beneficiary.

5.2.1Persons Eligible to Designate.  Any Participant may designate a Beneficiary to receive any amount payable under the Plan as a result of the Participant’s death, provided that the Beneficiary survives the Participant.  The Beneficiary may be one or more persons, natural or otherwise.  By way of illustration, but not by way of limitation, the Beneficiary may be an individual, trustee, executor, or administrator.  A Participant may also change or revoke a designation previously made, without the consent of any Beneficiary named therein.

5.2.2Form and Method of Designation.  Any designation or a revocation of a prior designation of Beneficiary shall be in writing on a form acceptable to RLI and shall be filed with RLI.  RLI and all other parties involved in making payment to a Beneficiary may rely on the latest Beneficiary designation on file with RLI at the time of payment or may make payment pursuant to Sec. 5.2.3 if an effective designation is not on file, shall be fully protected in doing so, and shall have no liability whatsoever to any person making claim for such payment under a subsequently filed designation of Beneficiary or for any other reason.

Notwithstanding any provision of this Sec. 5.2 to the contrary, any Beneficiary designation made under the Prior Agreements will continue in effect under this Plan until modified by the Participant pursuant to this Sec. 5.2.

5.2.3No Effective Designation.  If there is not on file with RLI an effective designation of Beneficiary by a deceased Participant, the Beneficiary shall be the person or persons surviving the Participant in the first of the following classes in which there is a survivor, share and share alike:

(a)The Participant’s spouse.  (A “spouse” is a person of the opposite sex to whom the Participant is legally married, including a common-law spouse if the marriage was entered into in a state that recognizes common-law marriages and RLI has received acceptable proof and/or certification of common-law married status.)

(b)The Participant’s then living descendants, per stirpes.

(c)The Participant’s estate.

Determination of the identity of the Beneficiary in each case shall be made by RLI.

5.2.4Successor Beneficiary.  If a Beneficiary who survives the Participant subsequently dies before receiving the complete payment to which the Beneficiary was entitled, the successor Beneficiary, determined in accordance with the provisions of this section, shall be entitled to the payments remaining.  The successor Beneficiary shall be the person or persons surviving the Beneficiary m the first of the following classes in which there is a survivor, share and share alike:

(a)The Participant’s spouse.  (A “spouse” is a person of the opposite sex to whom the Participant is legally married, including a common-law spouse if the marriage was entered into in a state that recognizes common-law marriages and RLI has received acceptable proof and/or certification of common-law married status.)

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(b)The Participant’s then living descendants, per stirpes.

(c)The Participant’s estate.

ARTICLE 6

CLAIMS AND REVIEW PROCEDURES

6.1Application for Benefits.  Benefits shall be paid to Participants automatically (without a written request) at the time and in the manner specified in the Plan.  Benefits shall be paid to a Beneficiary upon RLI’s receipt of a written request for the benefits, including appropriate proof of the Participant’s death and the Beneficiary’s identity and right to payment.  This written request shall be considered a claim for the purposes of this article.

6.2Claims and Review Procedures.  The claims and review procedures set forth in this article shall be the mandatory claims and review procedures for the resolution of disputes and disposition of claims filed under the Plan.

6.2.1Initial Claim.  An individual may, subject to any applicable deadline, file with the Committee a written claim for benefits under the Plan in a form and manner prescribed by RLI.

(a)If the claim is denied in whole or in part, the Committee shall notify the claimant of the adverse benefit determination within ninety (90) days after receipt of the claim.

(b)The ninety (90) day period for making the claim determination may be extended for ninety (90) days if the Committee determines that special circumstances require an extension of time for determination of the claim, provided that the Committee notifies the claimant, prior to the expiration of the initial ninety (90) day period, of the special circumstances requiring an extension and the date by which a claim determination is expected to be made.

6.2.2Notice of Initial Adverse Determination.  A notice of an adverse determination shall set forth in a manner calculated to be understood by the claimant:

(a)The specific reasons for the adverse determination;

(b)References to the specific provisions of the Plan (or other applicable document) on which the adverse determination is based;

(c)A description of any additional material or information necessary to perfect the claim and an explanation of why such material or information is necessary; and

(d)A description of the claims review procedures, including the time limits applicable to such procedures.

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6.2.3Request for Review.  Within ninety (90) days after receipt of an initial adverse benefit determination notice, the claimant may file with the Board a written request for a review of the adverse determination and may, in connection therewith submit written comments, documents, records and other information relating to the claim benefits.  Any request for review of the initial adverse determination not filed within ninety (90) days after receipt of the initial adverse determination notice shall be untimely.

6.2.4Claim on Review.  If the claim, upon review, is denied in whole or in part, the Board shall notify the claimant of the adverse benefit determination within sixty (60) days after receipt of such a request for review.

(a)The sixty (60) day period for deciding the claim on review may be extended for sixty (60) days if the Board determines that special circumstances require an extension of time for determination of the claim, provided that the Board notifies the claimant, prior to the expiration of the initial sixty (60) day period, of the special circumstances requiring an extension and the date by which a claim determination is expected to be made.

(b)In the event that the time period is extended due to a claimant’s failure to submit information necessary to decide a claim on review, the claimant shall have sixty (60) days within which to provide the necessary information and the period for making the claim determination on review shall be tolled from the date on which the notification of the extension is sent to the claimant until the date on which the claimant responds to the request for additional information or, if earlier, the.  expiration of sixty (60) days.

(c)The Board’s review of a denied claim shall take into account all comments, documents, records, and other information submitted by the claimant relating to the claim, without regard to whether such information was submitted or considered in the initial benefit determination.

6.2.5Notice of Adverse Determination for Claim on Review.   A notice of an adverse determination for a claim on review shall set forth in a manner calculated to be understood by the claimant.

(a)The specific reasons for the denial;

(b)References to the specific provisions of the Plan (or other applicable document) on which the adverse determination is based; and

(c)A statement that the claimant is entitled to receive, upon request and free of charge, reasonable access to, and copies of, all documents, records, and other information relevant to the claimant’s claim for benefits.

6.3Claims Rules.

(a)No inquiry or question shall be deemed to be a claim or a request for a review of a denied claim unless made in accordance with the established claims and review

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procedures.  RLI may require that any claim for benefits and any request for a review of a denied claim be filed on forms to be furnished by RLI upon request.

(b)All decisions on claims and on requests for a review of denied claims shall be made by RLI.

(c)Claimants may be represented by a lawyer or other representative at their own expense, but RLI reserves the right to (i) require the claimant to furnish written authorization and (ii) establish reasonable procedures for determining whether an individual has been authorized to act on behalf of a claimant.  A claimant’s representative shall be entitled to copies of all notices given to the claimant.

(d)The decision of RLI on a claim and on a request for a review of a denied claim may be provided to the claimant in electronic form instead or in writing at the discretion of RLI.

(e)In connection with the review of a denied claim, the claimant or the claimant’s representative shall be provided, upon request and free of charge, reasonable access to, and copies of, all documents, records, and other information relevant to the claimant’s claim for benefits.

(f)The time period within which a benefit determination will be made shall begin to run at the time a claim or request for review is filed in accordance with the claims and review procedures, without regard to whether all the information necessary to make a benefit determination accompanies the filing.

(g)The claims and review procedures shall be administered with appropriate safeguards so that benefit claim determinations are made in accordance with governing Plan documents and, where appropriate, the Plan provisions have been applied consistently with respect to similarly situated claimants.

(h)For the purpose of this article, a document, record, or other information shall be considered “relevant” if such document, record, or other information:  (i) was relied upon in making the benefit determination; (ii) was submitted, considered, or generated in the course of making the benefit determination, without regard to whether such document, record, or other information was relied upon in making the benefit determination; or (iii) demonstrates compliance with the administration processes and safeguards designed to ensure that the benefit claim determination was made in accordance with governing Plan documents and that, where appropriate, the Plan provisions have been applied consistently with respect to similarly situated claimants.

(i)RLI may, in its discretion, rely on any applicable statute of limitation or deadline as a basis for denial of any claim.

6.4Deadline to File Claim.  To be considered timely under the Plan’s claims and review procedures, a claim must be filed with the Committee within one (1) year after the claimant knew or reasonably should have known of the principal facts upon which the claim is based.

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6.5Exhaustion of Administrative Remedies.  The exhaustion of the claims and review procedures is mandatory for resolving every claim and dispute arising under the Plan.  As to such claims and disputes no claimant shall be permitted to commence an arbitration action to recover Plan benefits or to enforce or clarify rights under the Plan or under any provision of the law, whether or not statutory, until the claims and review procedures set forth herein have been exhausted in their entirety.

6.6Arbitration.  Any claim, dispute or other matter in question of any kind relating to the Plan which is not resolved by the claims and review procedures shall be settled by arbitration in accordance with the Federal Arbitration Act 9 U.S.C. § 1, et seq.  Notice of demand for arbitration must be made in writing to the opposing party within the time period specified in Sec. 6.7.  In no event will a demand for arbitration be made after the date when the applicable statute of limitations would bar the institution of a legal or equitable proceeding based on such claim, dispute or other matter in question.  The decision of the arbitrator(s) will be final and may be enforced in any court of competent jurisdiction, The arbitrator(s) may award reasonable fees and expenses to the prevailing party in any dispute hereunder and will award reasonable fees and expenses in the event that the arbitrator(s) find that the losing party acted in bad faith or with intent to harass, hinder or delay the prevailing party in the exercise of its rights in connection with the matter under dispute.  The arbitration will take place in Peoria, Illinois, unless otherwise agreed by the parties.

6.7Deadline to File an Arbitration Action.  No arbitration action to recover Plan benefits or to enforce or clarify rights under the Plan under or under any provision of the law, whether or not statutory, may be brought by any claimant on any matter pertaining to the Plan unless the action is commenced before the earlier of:

(a)Thirty (30) months after the claimant knew or reasonably should have known of the principal facts on which the claim is based, or

(b)SIX (6) months after the claimant has exhausted the claims and review procedures.

6.8Knowledge of Fact by Participant Imputed to Beneficiary.  Knowledge of all ‘facts that a Participant knew or reasonably should have known shall be imputed to every claimant who is or claims to be a Beneficiary of the Participant or otherwise claims to derive an entitlement by reference to the Participant for the purpose of applying the previously specified periods.

6.9Deferral of Payment.  If there is a dispute regarding a Plan benefit, RLI, in its sole discretion, may defer payment of the benefit until the dispute has been resolved.

ARTICLE 7

ADMINISTRATION

7.1Administrator.  RLI shall be the administrator of the Plan.  RLI shall control and manage the administration and operation of the Plan and shall make all decisions and determinations incident thereto.  Except with respect to the ordinary day-to-day administration of the Plan, action on behalf of RLI must be taken by one of the following:

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(a)The Board; or

(b)The Committee.

7.1.1Delegation.  The ordinary day-to-day administration of the Plan may be delegated by the Chief Executive Officer to an individual or a committee.  Such individual or committee shall have the authority to delegate or redelegate to one or more persons, jointly or severally, such functions assigned to such individual or committee as such individual or committee may from time to time deem advisable.

7.1.2Automatic Removal.  If any individual or committee member to whom responsibility under the Plan is allocated is a director, officer or employee of RLI when responsibility is so allocated, then such individual shall be automatically removed as a member of a committee at the earliest time such individual ceases to be a director, officer or employee of RLI.  This removal shall occur automatically and without any requirement for action by RLI or any notice to the individual so removed.

7.1.3Conflict of Interest. If any individual or committee member to whom responsibility under the Plan is allocated is also a Participant or Beneficiary, such individual shall have no authority as such member with respect to any matter specifically affecting such individual’s interest hereunder (as distinguished from the interests of all Participants and Beneficiaries or a broad class of Participants and Beneficiaries), all such authority being reserved exclusively to the other members to the exclusion of such Participant or Beneficiary, and such Participant or Beneficiary shall act only in an individual capacity in connection with any such matter.

7.1.4Binding Effect.  The determination of the Board, the Committee or the Chief Executive Officer in any matter within its authority shall be binding and conclusive upon RLI and all persons having any right or benefit under the Plan.

7.1.5Third Party Service Providers.  RLI may from time to time appoint or contract with an administrator, record keeper or other third-party service provider for the Plan.  Any such administrator, record keeper or other third-party service provider will serve in a nondiscretionary capacity and will act in accordance with directions given and procedures established by RLI.

7.2Benefits Not Transferable.  No Participant or Beneficiary shall have the power to transmit, alienate, dispose of, pledge or encumber any benefit payable under the Plan before its actual payment to the Participant or Beneficiary.  Any such effort by a Participant or Beneficiary to convey any interest in the Plan shall not be given effect under the Plan.  No benefit payable under the Plan shall be subject to attachment, garnishment, execution following judgment or other legal process before its actual payment to the Participant or Beneficiary.

7.3Benefits Not Secured.  The rights of each Participant and Beneficiary shall be solely those of an unsecured, general creditor of RLI.  No Participant or Beneficiary shall have any lien, prior claim or other security interest in any property of RLI.

7.4RLI’s Obligations.  RLI shall provide the benefits under the Plan.  RLI’s obligation may be satisfied by distributions from a trust fund created and maintained by RLI, in its sole

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discretion, for such purpose.  However, the assets of any such trust fund shall be subject to claims by the general creditors of RLI in the event RLI is (i) unable to pay its debts as they become due, or (ii) is subject to a pending proceeding as a debtor under the United States Bankruptcy Code.

7.5Withholding Taxes.  RLI shall have the right to withhold (and transmit to the proper taxing authority) such federal, state or local taxes, including (but not limited to) FICA and FUTA taxes, as it may be required to withhold by applicable laws.  Such taxes may be withheld from any benefits due under the Plan or from any other compensation to which the Participant is entitled from RLI and its Affiliates.

7.6Service of Process.  The Chief Executive Officer is designated as the appropriate and exclusive agent for the receipt of service of process directed to the Plan in any legal proceeding, including arbitration, involving the Plan.

7.7Limitation on Liability.  Neither RLI’s officers nor any member of its Board nor any individual or committee to whom RLI delegates responsibility under the ‘Plan in any way secures or guarantees the payment of any benefit or amount which may become due and payable hereunder to or with respect to any Participant.  Each Participant and other person entitled at any time to payments hereunder shall look solely to the assets of RLI for such payments as an unsecured, general creditor.  After benefits have been paid to or with respect to a Participant and such payment purports to cover in full the benefit hereunder, such former Participant or other person(s), as the case may be, shall have no further right or interest in the other assets of RLI in connection with the Plan.  Neither RLI nor any of its officers nor any member of its Board nor any individual or committee to whom RLI delegates responsibility under the Plan shall be under any liability or responsibility for failure to effect any of the objectives or purposes of the Plan by reason of the insolvency of RLI.

ARTICLE 8

AMENDMENT AND TERMINATION

8.1Amendment.  RLI reserves the power to amend the Plan either prospectively or retroactively or both, in any respect, by action of its Board; provided that, no amendment shall be effective to reduce or divest benefits payable with respect to the Account of any Participant or Beneficiary without consent.  No amendment of the Plan shall be effective unless it is in writing and signed on behalf of RLI by a person authorized to execute such writing.  No oral representation concerning the interpretation or effect of the Plan shall be effective to amend the Plan.

8.2Termination.  RLI reserves the right to terminate the Plan at any time by action of its Board; provided that, the termination of the Plan shall not reduce or divest benefits payable with respect to the Account of any Participant or Beneficiary or negate the Participant’s or Beneficiary’s rights with respect to such benefits.  Any such termination will be done in accordance with the requirements of Section 409A.

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ARTICLE 9

MISCELLANEOUS

9.1Effect on Other Plans.  This Plan shall not alter, enlarge or diminish any person’s rights or obligations under any other benefit plan maintained by RLI or any Affiliate.

9.2Effect on Employment.  Neither the terms of this Plan nor the benefits hereunder nor the continuance thereof shall be a term of the employment of any Employee.  RLI shall not be obliged to continue the Plan.  The terms of this Plan shall not give any Employee the right to be retained in the service of RLI or any Affiliate.

9.3Disqualification.  Notwithstanding any other provision of the Plan or any designation made under the Plan, any individual who feloniously and intentionally kills a Participant shall be deemed for all purposes of the Plan and all elections and designations made under the Plan to have died before such Participant.  A final judgment of conviction of felonious and intentional killing is conclusive for this purpose.  In the absence of a conviction of felonious and intentional killing, RLI shall determine whether the killing was felonious and intentional for this purpose.

9.4Rules of Document Construction.  Whenever appropriate, words used herein in the singular may be read in the plural, or words used herein in the plural may be read in the singular; and the words “hereof,” “herein” or “hereunder” or other similar compounds of the word “here” shall mean and refer to the entire Plan and not to any particular article, section or paragraph of the Plan unless the context clearly indicates to the contrary.  The titles given to the various articles and sections of the Plan are inserted for convenience of reference only and are not part of the Plan, and they shall not be considered in determining the purpose, meaning or intent of any provision hereof.  Written notification under the Plan shall include such other methods (for example, facsimile or e-mail) as RLI, in its sole discretion, may authorize from time to time.

9.5References to Laws.  Any reference in the Plan to a statute shall be considered also to mean and refer to the applicable regulations for that statute.  Any reference in the Plan to a statute or regulation shall be considered also to mean and refer to any subsequent amendment or replacement of that statute or regulation.

9.6Choice of Law.  The Plan has been executed in the State of Illinois and has been drawn in conformity to the laws of that state and shall, except to the extent that federal law is controlling, be construed and enforced in accordance with the laws of the State of Illinois (without regard to its conflict of law principles).

9.7Binding Effect.  The Plan shall be binding upon and inure to the benefit of the successors and assigns of RLI, and the Beneficiaries, personal representatives and heirs of the Participant.

IN WITNESS WHEREOF, RLI has caused the Plan to be executed by its duly authorized officers as of the                      day of                         .

RLI CORP
By:
	Its VP, Corporate Secretary
And
By:
	Its Asst. Corporate Secretary

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EX-10.9

Exhibit 10.9

RLI INCENTIVE COMPENSATION PLAN

EFFECTIVE JANUARY 1, 2009

I.              ESTABLISHMENT AND PURPOSE

RLI Corp. (the “Company”) established the RLI Incentive Compensation Plan (the “Plan”), effective January 1, 2006 , for the benefit of its employees and employees of its Affiliates.  The Plan was intended to amend, consolidate and restate certain prior incentive compensation plans established by the Company.  The terms of the Plan, as set forth herein, shall apply to Awards granted under the Plan on and after the Effective Date.  Awards granted under the Company’s incentive compensation plans in effect prior to the Effective Date shall be governed by the terms of such plans.  The Company hereby restates the Plan effective January 1, 2009 (the “Effective Date”)  to comply with the requirements of the final regulations issued under Section 409A of the Code (“Section 409A”) on April 10, 2007.

The Plan is intended to align incentive compensation with achieving the financial performance factors on which the Company’s market value is driven.  The Plan is also designed to promote the accomplishment of management’s primary annual objectives as reflected in the Company’s annual operating plan and in the objectives established by management for employees, and to recognize the achievement of management’s objectives through the payment of incentive compensation.

The Plan provides for incentive payments to employees based upon the achievement of pre-established performance goals.  The performance goals may be annual or multi-year goals.  Incentive compensation payable under the Plan is intended to be deductible by the Company in accordance with Section 162(m) of the Internal Revenue Code of 1986, as amended (the “Code”).  The Company may adopt a variety of bonus and incentive programs under the Plan provided such programs are based on the performance goals described herein.

II.            DEFINITIONS

For purposes of the Plan, unless the context otherwise requires, the following terms shall have the meanings set forth below.

2.1           “Affiliate” means any corporation that is part of a controlled group within the meaning of Code Section 414(b) or (c).

2.2           “Award” means an award of incentive compensation under the Plan to a Participant in accordance with the terms set forth herein.

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2.3           “Board” means the Board of Directors of the Company as constituted at the relevant time.

2.4           “Board Approval Limit” means a predetermined Award level at which the independent directors of the Board approve Awards in accordance with Section 5.3(c).

2.5           “Bonus Bank” means a deferred payment arrangement established under Section 6.2.

2.6           “Bonus Payment Date” means February 1st.  Any payment that is due to be distributed as of the Bonus Payment Date will be deemed to be distributed as of that date if it is distributed on such date or, if later, by the 15th day of March following the date and the Participant is not permitted, directly or indirectly, to designate the calendar year of payment.  Further, a payment will be treated as made on the Bonus Payment Date if it is made no earlier than 30 days before the date, and the Participant is not permitted, directly or indirectly, to designate the calendar year of payment.

2.7           “Bonus Pool” means an amount available for distribution to Participant’s who have been assigned an interest in the Bonus Pool (e.g. Market Value Potential bonus pool arrangement in effect as of the Effective Date.). The amount of the Bonus Pool will be determined by the Committee based on the Performance Goals.

2.8           “Cause” means termination for reasons described in Section 6.3.

2.9           “Code” means the Internal Revenue Code of 1986, as amended.

2.10         “Committee” means the Executive Resources Committee of the Board, as constituted at the relevant time, which shall consist of two or more “outside directors” within the meaning of Section 162(m) of the Code who are not eligible for participation in the Plan.

2.11         “Company” means RLI Corp., an Illinois corporation.

2.12         “Disability or Disabled,” with respect to a Participant, means that the Participant satisfies the requirements to receive long-term disability benefits under the Company-sponsored group long-term disability plan in which the Participant participates without regard to any waiting periods, or that the Participant has been determined by the Social Security Administration to be eligible to receive Social Security disability benefits.  A Participant shall not be considered to be “Disabled” unless the Participant furnishes proof of the Disability to the Company in such form and manner as the Company may require.

2.13         “Eligible Employee,” for any Performance Period, means a 162(m) Employee and such other employees of the Company and its Affiliates as may be designated to participate in the Plan for such Performance Period.  An employee who is

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designated as eligible to participate in the Plan for a particular Performance Period is not necessarily eligible to participate in the Plan for any other Performance Period.

2.14         “Effective Date” means January 1, 2009.

2.15         “Fiscal Year” means the calendar year.

2.16         “Normal Retirement Date,” of a Participant, means the date on which the Participant has attained both (i) combined age and years of service with the Company of seventy-five and (ii)  and at least 10 years of service.  For this purpose, Company service will be based only on Participant’s actual service with the Company (and not any other employer that may be acquired by the Company with respect to service prior to the acquisition) and shall be calculated based on the number of whole employment years the Participant has completed from the date of Participant’s initial employment with the Company.  No credit shall be given for fractional years of service.

2.17         “162(m) Employee,” for any Fiscal Year, means any employee described in Code Section 162(m)(3).

2.18         “Participant,” for any Performance Period, means an Eligible Employee and who has commenced participating in the Plan for such Performance Period.

2.19         “Performance Goals,” of a Participant for a Performance Period, are the goals established for the Performance Period, the achievement of which is a condition for receiving an Award under the Plan.

In the case of a Participant who is a 162(m) Employee, all Performance Goals must be pre-established by the Committee, must be objective, and must state, in terms of an objective formula or standard, the method for computing the amount of compensation payable if the goal is attained.  A Performance Goal is considered “pre-established” for purposes of this paragraph if it is established in writing by the Committee no later than 90 days after the commencement of a Performance Period, provided that the outcome is substantially uncertain at the time the Committee actually establishes the goal.  However, in no event will a Performance Goal be considered to be pre-established if it is established after 25% of a Performance Period has elapsed.  A Performance Goal is considered “objective” if a third party having knowledge of the relevant facts could determine whether the goal is met.  A formula or standard is considered “objective” if a third party having knowledge of the relevant performance results could calculate the amount to be paid to the Participant.  A Performance Goal may be adjusted in accordance with Code Section 162(m) during a Performance Period to prevent dilution or enlargement of an Award as a result of extraordinary events or circumstances as determined by the Committee or to exclude the effects of extraordinary, unusual or nonrecurring events, changes in accounting principles, discontinued operations, acquisitions, divestitures and material restructuring charges.

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Performance Goals may be based on one or more of the following criteria and may be based on attainment of a particular level of, or on a positive change in, a factor:  revenue, revenue per employee, earnings before income tax (profit before taxes), earnings before interest and income tax, net earnings (profit after taxes), earnings per employee, earnings per share, operating income, total shareholder return, market share, return on equity, before-tax return on net assets, after-tax return on net assets, economic value added (economic profit), market value potential, and underwriting profit.  Such criteria may relate to one or any combination of two or more of Company, Affiliate, division or individual performance.

2.20         “Performance Period” means, generally, the Fiscal Year.  However, the Committee may, its discretion, designate a shorter or longer Performance Period.

2.21         “Plan Administrative Committee” means the Chief Executive Officer, Chief Financial Officer, Chief Operating Officer, and Chief Human Resources Officer of the Company or such other officers as the Committee may designate from time to time.

2.22         “Retirement,” of a Participant, means the Participant’s Termination of Employment with the Company and all Affiliates on or after his Normal Retirement Date.

2.23         “Salary,” of a Participant for a Performance Period means the annualized base compensation payable to a Participant determined by the salary rate in effect on the last day of the Performance Period.  The salary rate shall be determined without regard to reductions or deferrals of compensation under qualified and nonqualified plan or welfare benefit plan.  The salary rate shall be determined without regard to fringe benefits, bonuses or other payments in addition to Participant’s base compensation.

2.24         “Target Performance Award” means a dollar amount (which may be expressed as a percentage of Salary) established for a Participant if the Performance Goal for the Participant is achieved.  The Target Performance Award may also state the maximum amount that may actually be paid to the Participant under Section 5.3 (which may be expressed as a percentage of Salary.)

2.25         “Termination of Employment” with respect to a Participant, means the Participant’s separation from service with all Affiliates, within the meaning of Section 409A(a)(2)(A)(i) of the Code and the regulations under such section.  Solely for this purpose, a Participant who is an eligible Employee will be considered to have a Termination of Employment when the Participant dies, retires, or otherwise has a termination of employment with all Affiliates.  The employment relationship is treated as continuing intact while the Participant is on military leave, sick leave, or other bona fide leave of absence if the period of such leave does not exceed six months, or if longer, so long as the individual retains a right to reemployment with an Affiliate under an applicable statute or by contract.  For purposes hereof, a leave of absence constitutes a bona fide leave of absence only if there is a reasonable expectation that the Participant will return to perform services for an Affiliate.  If the period of leave exceeds six months and the individual does not retain a right to reemployment under an applicable statute or

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by contract, the employment relationship is deemed to terminate on the first date immediately following such six-month period.  Notwithstanding the foregoing, where a leave of absence is due to any medically determinable physical or mental impairment that can be expected to last for a continuous period of not less than six months, where such impairment causes the employee to be unable to perform the duties of such employee’s position of employment or any substantially similar position of employment, RLI may substitute a 29-month period of absence for such six-month period.

Whether a termination of employment has occurred is determined based on whether the facts and circumstances indicate that the Affiliate and the Participant reasonably anticipated that no further services will be performed after a certain date or that the level of bona fide services the Participant will perform after such date will permanently decrease to no more than 49 percent of the average level of bona fide services performed over the immediately preceding 36-month period (or the full period of services if the Participant has been providing services for less than 36 months).

Notwithstanding anything in Section 2.1.2 to the contrary, in determining whether a Participant has had a Termination of Employment with an Affiliate, an entity’s status as an “Affiliate” shall be determined substituting “50 percent” for “80 percent” each place it appears in Section 1563(a)(1),(2), and (3) and in Treasury Regulation Section 1.414(c)-2.

RLI shall have discretion to determine whether a Participant has experienced a Termination of Employment in connection with an asset sale transaction entered into by RLI or an Affiliate, provided that such determination conforms to the requirements of Section 409A and the regulations and other guidance issued under such section, in which case RLI’s determination shall be binding on the Participant.

III.           ADMINISTRATION

3.1           Duties of Committee.  The Committee will administer the Plan.  Any actions taken by the Committee shall be by a majority vote of all Committee members.  The Committee may establish such rules and regulations as it deems necessary for the Plan and its interpretation.  In addition, the Committee may make such determinations and take such actions in connection with the Plan as it deems necessary.  Each determination made by the Committee in accordance with the provisions of the Plan will be final, binding and conclusive. The Committee may rely on the financial statements certified by the Company’s independent public accountants.

3.2           Duties of Plan Administrative Committee.  Except as provided in Section 3.3, the Committee may delegate some or all of its administrative powers and responsibilities under the Plan to the Plan Administrative Committee. Unless the Committee determines otherwise, the Committee shall be treated as delegating its authority to the Plan Administrative Committee to the full extent permitted hereunder.  The Plan Administrative Committee may make such determinations and take such actions within the scope of such delegation and as otherwise provided in the Plan, as it deems necessary.  The Plan Administrative Committee may further delegate any duties delegated to it pursuant to this

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Section 3.2 to other officers or employees of the Company and any such delegation may allow for further delegation to other officers or employees.   Each determination made by the Plan Administrative Committee, or its delegate, will be final, binding and conclusive. The Plan Administrative Committee and its delegates may rely on the financial statements certified by the Company’s independent public accountants.  Notwithstanding any such delegation, the Committee may review and change any decision made by the Plan Administrative Committee or its delegate.

3.3           Committee’s Duties with Respect to 162(m) Employees and to Amend or Terminate Plan.  Notwithstanding anything in the Plan to the contrary:  (a) the Committee shall have sole and exclusive authority to (i) establish the Performance Goals for all 162(m) Employees, (ii) determine and certify the achievement of the Performance Goals for all 162(m) Employees, (iii) decrease the amount of Awards payable to all 162(m) Employees pursuant to Section 5.2 and 5.3, and (iv) to modify, suspend, terminate or reinstate the Plan.

IV.           ELIGIBILITY TO PARTICIPATE

Participation in the Plan is limited to Eligible Employees.  An employee who is a 162(m) Employee for a Performance Period shall be eligible to participate in the Plan for the Performance Period.  Prior to, or within an administratively reasonable period of time following, the beginning of a Performance Period, the Plan Administrative Committee, or its delegate, shall determine which other employees are Eligible Employees for the Performance Period.  The Committee has final authority to approve or disapprove the selection of any Eligible Employee.  An Eligible Employee (other than a 162(m) Employee) shall become a Participant only upon approval by the Plan Administrative Committee or it’s delegate and compliance with such terms and conditions as the Committee or Plan Administrative Committee may from time to time establish for the implementation of the Plan.

V.            CALCULATION OF AWARDS

A Participant’s Award for a Performance Period is determined as follows:

5.1           Establishing Performance Goals and Target Performance Awards and Board Approval Limits.  Prior to the beginning of a Performance Period or as soon thereafter as administratively reasonable, but no later than the time permitted under Code Section 162(m), the Committee (in the case of Participants who are 162(m) Employees) and the Plan Administrative Committee, or its delegate, (in the case of all other Participants), shall establish the Performance Goal or Goals and each Participant’s Target Performance Award.  Alternatively the Committee (in the case of Participants who are 162(m) Employees) and the Plan Administrative Committee, or its delegate (in the case of all other Participants), may establish a Bonus Pool for one or more Participants and assign Participants an interest in the Bonus Pool.  In addition, the Committee shall establish a Board Approval Limit for each Award made to a 162(m) Employee.

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5.2           Calculation of Awards. Following the close of a Performance Period, the Committee (in the case of the 162(m) Employees) and the Plan Administrative Committee (in the case of all other Participants) shall determine the actual Award payable to a Participant by (i) multiplying the percentage achievement of the Performance Goal against the Target Performance Award to determine the Participant’s Award for the Performance period or (ii) multiplying the Participant’s interest in any Bonus Pool by the final amount of the Bonus Pool. No Award will be paid to a Participant if the percentage achievement of a Performance Goal is below any minimum level of performance established for such Performance Goal.  In no event shall the aggregate of all Award payments (including the amount of any Award credited to a Bonus Bank) with respect to a Participant in any Fiscal Year exceed $7,500,000.

5.3           Adjustments and Certifications of Awards.  Once the determination in section 5.2 is made, the Committee, in the case of a Participant who is a 162(m) Employee, and the Plan Administrative Committee or its delegate in all other cases, shall:

(a)           Review the amount of each Award and make any adjustments it, in its sole discretion, deems appropriate to the amount of the Award.  In general, each Participant’s Award will be the amount pre-established (when the Performance Goals were established) for achievement of the Performance Goals at the achievement levels described in Section 5.1.  However, at the discretion of the Plan Administrative Committee, this amount may be increased (except in the case of a Participant who is a 162(m) Employee) or decreased based upon such objective or subjective criteria, as it deems appropriate.  The Committee, in its discretion, may decrease (but not increase) the amount in the case of a 162(m) Employee based upon such objective or subjective criteria as it deems appropriate; and

(b)           In the case of a Participant who is a 162(m) Employee, the Committee shall certify the extent to which the Participant has satisfied each of the Performance Goals and all other material terms of an Award.

(c)           In the case of any Award subject to a Board Approval Limit, the independent directors serving on the Board may reduce the actual Award, but not below the Board Approval Limit established by the Committee.

VI.           PAYMENT OF AWARDS

6.1           Timing of Award Payment.  Except as provided in Section 6.2, a Participant’s Award for a Performance Period shall be paid in a cash lump sum to him or her no later March 15 following the end of the Fiscal Year in which the Performance Period ends.  A Participant who is also eligible to Participate in the RLI Corp. Executive Deferred Compensation Plan may elect to defer some or all of any amount otherwise payable to him or her under this Section 6.2 to the extent permitted by such plan.

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6.2           Bonus Bank.  The Committee may specify that a portion of an Award will be credited to a Bonus Bank immediately prior to the beginning of a Performance Period. Any such Award will be in writing and shall specify a fixed schedule of payments and such other terms and conditions as the Committee or Plan Administrative Committee may choose.  The terms of the Award may provide that amounts credited to the Bonus Bank may be reduced if Performance Goals in a subsequent Performance Period are not met.  Amounts deposited to the Bonus Bank will be credited with interest equivalent to the interest rate on three year U.S. Government Treasury Bills in effect at the beginning of the fiscal year.

6.3           Change in Employment Status During Performance Period.  In general, in order to receive a payment a Participant must be employed by the Company or Affiliate on (i) the date of actual payment with respect to an Award that is not held under a Bonus Bank and (ii) the date of actual payouts from a Bonus Bank arrangement.  If the Participant’s employment is terminated during a Performance Period due to death, Retirement, or Disability, the Participant (or the Participant’s beneficiary in the case of the Participant’s death) will be entitled to receive a pro rata portion of the Award only if the Award expressly provides for such payment.  If the Participant’s employment is terminated at a time when a Participant has a balance in a Bonus Bank due to death or Disability, the Participant (or the Participant’s beneficiary in the case of the Participant’s death) will be entitled to receive a payment equal to the balance of the Bonus Bank adjusted for interest through the end of the preceding quarter within 30 days of termination.  Notwithstanding anything in this Section 6.3 to the contrary, a Participant shall not be entitled to any Award for a Performance period if the Participant’s employment is terminated by the Company or Affiliate for “Cause” during the Performance Period.  For these purposes “Cause” shall mean the Participant’s:  (a) failure to comply with any material policies and procedures of the Company or Affiliate; (b) conduct reflecting dishonesty or disloyalty to the Company or Affiliate, or which may have a negative impact on the reputation of the Company or Affiliate; (c) commission of a felony, theft or fraud, or violations of law involving moral turpitude; (d) failure to perform the material duties of his or her employment; (e) excessive absenteeism; (f) unethical behavior; or (g) violation of a material policy of the Company.  If a Participant’s employment is terminated for “Cause,” the date on which the Participant’s employment is considered to be terminated, for purposes of this Section 6.3, shall be the time at which such Participant is instructed or notified to cease performing job responsibilities for the Company or any Affiliate, whether or not for other reasons, such as payroll, benefits or compliance with legal procedures or requirements, he or she may still have other attributes of an employee.

6.4           Beneficiary.  In the event that any amount becomes payable under the Plan by reason of the Participant’s death, such amount shall be paid to the same beneficiary or  beneficiaries (and in the same proportions) as last designated by the Participant to receive benefits under the Company basic life insurance plan upon the Participant’s death.  Such amount shall be paid to the beneficiary or beneficiaries at the same time such amount would have been paid to the Participant had he or she survived.  In order for such designation to be valid for purposes of the Plan, it must be completed and filed with the

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Company according to the rules established by the Company for the Company basic life insurance plan.  If the Participant has not completed a beneficiary designation for the Company basic life insurance plan, or all such beneficiaries have predeceased the Participant, then any amount that becomes payable under the Plan by reason of the Participant’s death shall be paid to the personal representative of the Participant’s estate.  If there is any question as to the legal right of any person to receive a distribution under the Plan by reason of the Participant’s death, the amount in question may, at the discretion of the Committee, be paid to the personal representative of the Participant’s estate, in which event the Company shall have no further liability to anyone with respect to such amount.

6.5           Forfeiture.  All Awards paid to the Chief Executive Officer and Chief Financial Officer of the Company under this Plan are subject to forfeiture as provided in Section 304 of the Sarbanes-Oxley Act of 2002, and the implementing rules and regulations.

VII.          MISCELLANEOUS

7.1           No Guaranty of Employment.  Neither the adoption nor maintenance of the Plan, the designation of an employee as an Eligible Employee, the setting of Performance Goals, nor the provision of any Award under the Plan shall be deemed to be a contract of employment between the Company or an Affiliate and any employee.  Nothing contained in the Plan shall give any employee the right to be retained in the employ of the Company or an Affiliate or to interfere with the right of the Company or an Affiliate to discharge any employee at any time, nor shall it give the Company or an Affiliate the right to require any employee to remain in its employ or to interfere with the employee’s right to terminate employment at any time.

7.2           Release.  Any payment of an Award to or for the benefit of a Participant or beneficiary that is made in good faith by the Company in accordance with the Company’s interpretation of its obligations hereunder shall be in full satisfaction of all claims against the Company for payments under the Plan to the extent of such payment.

7.3           Notices.  Any notice provided by the Company under the Plan may be posted to a Company-designated web-site.

7.4           Nonalienation.  No benefit payable at any time under the Plan shall be subject in any manner to alienation, sale, transfer, assignment, pledge, levy, attachment, or encumbrance of any kind by any Participant or beneficiary.

7.5           Plan is Unfunded.  All Awards under the Plan shall be paid from the general assets of the Company.  No Participant shall be deemed to have, by virtue of being a Participant in the Plan, any claim on any specific assets of the Company such that the Participant would be subject to income taxation on any Award prior to distribution to him or her, and the rights of a Participant or beneficiary to any payment to which he or

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she is otherwise entitled under the Plan shall be those of an unsecured general creditor of the Company.

7.6           Tax Liability.  The Company may withhold from any payment of Awards or other compensation payable to or on behalf of a Participant or beneficiary such amounts as the Company determines are reasonably necessary to pay any taxes required to be withheld under applicable law.

7.7           Captions.  Article and section headings and captions are provided for purposes of reference and convenience only and shall not be relied upon in any way to construe, define, modify, limit, or extend the scope of any provision of the Plan.

7.8           Invalidity of Certain Plan Provisions.  If any provision of the Plan is held invalid or unenforceable, such invalidity or unenforceability shall not affect any other provision of the Plan and the Plan shall be construed and enforced as if such provision had not been included.

7.9           Venue.  As a substantial portion of the duties and obligations of the parties created by the Plan will be performed in Peoria, Illinois, it shall be the sole and exclusive venue for any arbitration, litigation, special proceedings, or other proceedings between the parties in connection with the Plan.

7.10         Hold Harmless.  A Participant shall hold the Company harmless from and pay any cost, expense or fee (not to exceed the bank balance) incurred by the Company with respect to any claim, due or demand asserted by any person, except the Company against any amounts due Participant under the Plan.

7.11         No Other Agreements.  The terms and conditions set forth herein constitute the entire understanding of the Company and the Participants with respect to the matters addressed herein.

7.12         Incapacity.  In the event that any Participant is unable to care for the Participant’s affairs because of illness or accident, any payment due may be paid to the Participant’s duly qualified guardian or other appointed legal representative.

7.13         Applicable Law.  The Plan and all rights under it shall be governed by and construed according to the laws of the State of Illinois.

Date:                           , 2006	RLI CORP.
	By
		Chief Executive Officer

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EX-13

Exhibit 13

THE ROAD TO DIFFERENT

2008 RLI CORP. FINANCIAL ANNUAL REPORT

TABLE OF CONTENTS

01 / Management’s Discussion and Analysis

28 / Consolidated Balance Sheets

29 / Consolidated Statements of Earnings and Comprehensive Earnings

30 / Consolidated Statements of Cash Flows

32 / Consolidated Statements Shareholders’ Equity

33 / Notes to Consolidated Financial Statements

57 / Letters of Responsibility

61 / Glossary

62 / Selected Financial Data

64 / Investor Information

MANAGEMENT’S DISCUSSION AND ANALYSIS

OVERVIEW

RLI Corp. underwrites selected property and casualty insurance through major subsidiaries collectively known as RLI Insurance Group. As a “niche” company, we offer specialty insurance coverages designed to meet specific insurance needs of targeted insured groups and underwrite particular types of coverage for certain markets that are underserved by the insurance industry, such as our difference in conditions coverages or oil and gas surety bonds. We also provide types of coverages not generally offered by other companies, such as our stand-alone personal umbrella policy. The excess and surplus market, which unlike the standard admitted market, is less regulated and more flexible in terms of policy forms and premium rates, provides an alternative for customers with hard-to-place risks. When we underwrite within the surplus lines market, we are selective in the line of business and type of risks we choose to write. Using our non-admitted status in this market allows us to tailor terms and conditions to manage these exposures more effectively than our admitted counterparts. Often the development of these specialty insurance coverages is generated through proposals brought to us by an agent or broker seeking coverage for a specific group of clients. Once a proposal is submitted, underwriters determine whether it would be a viable product in keeping with our business objectives.

The foundation of our overall business strategy is to underwrite for profit in all marketplaces, and we have achieved this for 13 consecutive years, averaging an 88.5 combined ratio over that period of time. This foundation drives our ability to provide shareholder returns in three different ways: the underwriting income itself, net investment income from our investment portfolio, and long-term appreciation in our equity portfolio. Our investment strategy is based on preservation of capital as the first priority, with a secondary focus on generating total return. The fixed income portfolio consists primarily of highly rated, investment grade securities to protect invested assets. Regular underwriting income allows a portion of our shareholders’ equity to be invested in equity securities. Our equity portfolio consists of a core stock portfolio weighted toward dividend-paying stocks, as well as preferred stock, exchange traded funds (ETFs), and mutual funds. Private equity investments, primarily our minority ownership in Maui Jim, Inc. (Maui Jim), have also enhanced overall returns. We have a diversified investment portfolio and balance our investment credit risk and related underwriting risks to minimize total potential exposure to any one security. Despite fluctuations of realized and unrealized gains and losses in the equity portfolio, our investment in equity securities as part of a long-term asset allocation strategy has contributed significantly to our historic growth in book value.

We measure the results of our insurance operations by monitoring certain measures of growth and profitability across three distinct business segments: casualty, property, and surety. Growth is measured in terms of gross premiums written and profitability is analyzed through combined ratios, which are further subdivided into their respective loss and expense components. The combined ratios represent the income generated from our underwriting segments.

The casualty portion of our business consists largely of general liability, personal umbrella, transportation, executive products, commercial umbrella, multi-peril program business, and other specialty coverages. In addition, we provide employers’ indemnity and in-home business owners coverage. The casualty business is subject to the risk of estimating losses and related loss reserves because the ultimate settlement of a casualty claim may take several years to fully develop. The casualty segment may also be affected by evolving legislation and court decisions that define the extent of coverage and the amount of compensation due for injuries or losses.

Our property segment primarily underwrites commercial fire, earthquake, difference in conditions, marine, facultative reinsurance, and in the state of Hawaii, select personal lines policies. Property insurance results are subject to the variability introduced by perils such as earthquakes, fires, and hurricanes. Our major catastrophe exposure is to losses caused by earthquakes, primarily on the West Coast. Our second largest catastrophe exposure is to losses caused by hurricanes to commercial properties throughout the Gulf and East Coasts, as well as to homes we insure in Hawaii. We limit our net aggregate exposure to a catastrophic event by limiting the total policy limits written in a particular region, by purchasing reinsurance, and through extensive use of computer-assisted modeling techniques. These techniques provide estimates of the concentration of risks exposed to catastrophic events.

The surety segment specializes in writing small-to-large commercial and small contract surety coverages, as well as those for the energy (plugging and abandonment of oil wells), petrochemical, and refining industries. We offer miscellaneous bonds, including license and permit, notary, and court bonds. We also offer fidelity and crime coverage for commercial insureds and select financial institutions. Often, our surety coverages involve a statutory requirement for bonds. While these bonds have maintained a relatively low loss ratio, losses may fluctuate due to adverse economic conditions that may affect the financial viability of an insured. The contract surety marketplace guarantees the construction work of a commercial contractor for a specific

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project. Generally, losses occur due to adverse economic conditions or the deterioration of a contractor’s financial condition. As such, this line has historically produced marginally higher loss ratios than other surety lines.

The insurance marketplace softened over the last several years, meaning that the marketplace became more competitive and prices were falling even as coverage terms became less restrictive. Nevertheless, we believe that our business model is geared to create underwriting income by focusing on sound underwriting discipline. Our primary focus will continue to be on underwriting profitability as opposed to premium growth or market share measurements.

GAAP AND NON-GAAP FINANCIAL PERFORMANCE METRICS

Throughout this annual report, we present our operations in the way we believe will be most meaningful, useful, and transparent to anyone using this financial information to evaluate our performance. In addition to the GAAP (generally accepted accounting principles in the United states of America) presentation of net income and certain statutory reporting information, we show certain non-GAAP financial measures that we believe are valuable in managing our business and drawing comparisons to our peers. These measures are underwriting income, gross premiums written, net premiums written, combined ratios, and net unpaid loss and settlement expenses.

Following is a list of non-GAAP measures found throughout this report with their definitions, relationships to GAAP measures, and explanations of their importance to our operations.

Underwriting Income

Underwriting income or profit represents one measure of the pretax profitability of our insurance operations and is derived by subtracting losses and settlement expenses, policy acquisition costs, and insurance operating expenses from net premium earned. Each of these captions is presented in the statements of earnings but not subtotaled. However, this information is available in total and by segment in note 11 to the financial statements, regarding operating segment information. The nearest comparable GAAP measure is earnings before income taxes which, in addition to underwriting income, includes net investment income, net realized gains/losses on investments, general corporate expenses, debt costs, and unconsolidated investee earnings.

Gross premiums written

While net premiums earned is the related GAAP measure used in the statements of earnings, gross premiums written is the component of net premiums earned that measures insurance business produced before the impact of ceding reinsurance premiums, but without respect to when those premiums will be recognized as actual revenue. We use this measure as an overall gauge of gross business volume in our insurance underwriting operations with some indication of profit potential subject to the levels of our retentions, expenses, and loss costs.

Net premiums written

While net premiums earned is the related GAAP measure used in the statements of earnings, net premiums written is the component of net premiums earned that measures the difference between gross premiums written and the impact of ceding reinsurance premiums, but without respect to when those premiums will be recognized as actual revenue. We use this measure as an indication of retained or net business volume in our insurance underwriting operations. It is an indicator of future earnings potential subject to our expenses and loss costs.

Combined ratios

This ratio is a common industry measure of profitability for any underwriting operation, and is calculated in two components. First, the loss ratio is losses and settlement expenses divided by net premiums earned. The second component, the expense ratio, reflects the sum of policy acquisition costs and insurance operating expenses, divided by net premiums earned. The sum of the loss and expense ratios is the combined ratio. The difference between the combined ratio and 100 reflects the per-dollar rate of underwriting income or loss. For example, a combined ratio of 85 implies that for every $100 of premium we earn, we record $15 of underwriting income.

Net unpaid loss and settlement expenses

Unpaid losses and settlement expenses, as shown in the liabilities section of our balance sheet, represents the total obligations to claimants for both estimates of known claims and estimates for incurred but not reported (IBNR) claims. The related asset item, reinsurance balances recoverable on unpaid losses and settlement expense, is the estimate of known claims and estimates of IBNR that we expect to recover from reinsurers. The net of these two items is generally referred to as net unpaid loss and settlement expenses and is commonly referred to in our disclosures regarding the process of establishing these various estimated amounts.

In preparing the consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses for the reporting period. Actual results could differ significantly from those estimates.

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The most critical accounting policies involve significant estimates and include those used in determining the liability for unpaid losses and settlement expenses, investment valuation and other-than-temporary impairment, recoverability of reinsurance balances, deferred policy acquisition costs and deferred taxes.

CRITICAL ACCOUNTING POLICIES

LOSSES AND SETTLEMENT EXPENSES

Overview

Loss and loss adjustment expense (LAE) reserves represent our best estimate of ultimate amounts for losses and related settlement expenses from claims that have been reported but not paid, and those losses that have occurred but have not yet been reported to us. Loss reserves do not represent an exact calculation of liability, but instead represent our estimates, generally utilizing individual claim estimates and actuarial expertise and estimation techniques at a given accounting date. The loss reserve estimates are expectations of what ultimate settlement and administration of claims will cost upon final resolution. These estimates are based on facts and circumstances then known to us, review of historical settlement patterns, estimates of trends in claims frequency and severity, projections of loss costs, expected interpretations of legal theories of liability, and many other factors. In establishing reserves, we also take into account estimated recoveries, reinsurance, salvage, and subrogation. The reserves are reviewed regularly by a team of actuaries we employ.

The process of estimating loss reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both internal and external events, such as changes in claims handling procedures, claim personnel, economic inflation, legal trends, and legislative changes, among others. The impact of many of these items on ultimate costs for loss and LAE is difficult to estimate. Loss reserve estimations also differ significantly by coverage due to differences in claim complexity, the volume of claims, the policy limits written, the terms and conditions of the underlying policies, the potential severity of individual claims, the determination of occurrence date for a claim, and reporting lags (the time between the occurrence of the policyholder event and when it is actually reported to the insurer). Informed judgment is applied throughout the process. We continually refine our loss reserve estimates as historical loss experience develops and additional claims are reported and settled. We rigorously attempt to consider all significant facts and circumstances known at the time loss reserves are established.

Due to inherent uncertainty underlying loss reserve estimates, including but not limited to the future settlement environment, final resolution of the estimated liability may be different from that anticipated at the reporting date. Therefore, actual paid losses in the future may yield a materially different amount than currently reserved — favorable and unfavorable.

The amount by which estimated losses differ from those originally reported for a period is known as “development.” Development is unfavorable when the losses ultimately settle for more than the levels at which they were reserved or subsequent estimates indicate a basis for reserve increases on unresolved claims. Development is favorable when losses ultimately settle for less than the amount reserved or subsequent estimates indicate a basis for reducing loss reserves on unresolved claims. We reflect favorable or unfavorable developments of loss reserves in the results of operations in the period the estimates are changed.

We record two categories of loss and LAE reserves — case-specific reserves and IBNR reserves.

Within a reasonable period of time after a claim is reported, our claim department completes an initial investigation and establishes a case reserve. This case-specific reserve is an estimate of the ultimate amount we will have to pay for the claim, including related legal expenses and other costs associated with resolving and settling a particular claim. The estimate reflects all of the current information available regarding the claim, the informed judgment of our professional claim personnel, our reserving practices and experience, and the knowledge of such personnel regarding the nature and value of the specific type of claim. During the life cycle of a particular claim, more information may materialize that causes us to revise the estimate of the ultimate value of the claim either upward or downward. We may determine that it is appropriate to pay portions of the reserve to the claimant or related settlement expenses before final resolution of the claim. The amount of the individual claim reserve will be adjusted accordingly and is based on the most recent information available.

We establish IBNR reserves to estimate the amount we will have to pay for claims that have occurred, but have not yet been reported to us; claims that have been reported to us that may ultimately be paid out differently than expected by our case-specific reserves; and claims that have been paid and closed, but may reopen and require future payment.

Our IBNR reserving process involves three steps including an initial IBNR generation process that is prospective in nature; a loss and LAE reserve estimation process that occurs retrospectively; and a subsequent discussion and reconciliation between our prospective and retrospective IBNR estimates which includes changes in our provisions for IBNR where deemed appropriate. These three processes are discussed in more detail in the following sections.

LAE represents the cost involved in adjusting and administering losses from policies we issued. The LAE reserves are frequently separated into two components: allocated and unallocated. Allocated loss adjustment expense (ALAE) reserves represent an estimate of claims

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settlement expenses that can be identified with a specific claim or case. Examples of ALAE would be the hiring of an outside adjuster to investigate a claim or an outside attorney to defend our insured. The claims professional typically estimates this cost separately from the loss component in the case reserve. Unallocated loss adjustment expense (ULAE) reserves represent an estimate of claims settlement expenses that cannot be identified with a specific claim. An example of ULAE would be the cost of an internal claims examiner to manage or investigate a reported claim.

All decisions regarding our best estimate of ultimate loss and LAE reserves are made by our Loss Reserve Committee (LRC). The LRC is made up of various members of the management team including the chief executive officer, chief operating officer, chief financial officer, chief actuary, general counsel and other selected executives. We do not use discounting (recognition of the time value of money) in reporting our estimated reserves for losses and settlement expenses. Based on current assumptions used in calculating reserves, we believe that our overall reserve levels at December 31, 2008, make a reasonable provision to meet our future obligations.

Initial IBNR Generation Process

Initial carried IBNR reserves are determined through a reserve generation process. The intent of this process is to establish an initial total reserve that will provide a reasonable provision for the ultimate value of all unpaid loss and ALAE liabilities. For most casualty and surety products, this process involves the use of an initial loss and ALAE ratio that is applied to the earned premium for a given period. The result is our best initial estimate of the expected amount of ultimate loss and ALAE for the period by product. Paid and case reserves are subtracted from this initial estimate of ultimate loss and ALAE to determine a carried IBNR reserve.

For most property products, we use an alternative method of determining an appropriate provision for initial IBNR. since this segment is characterized by a shorter period of time between claim occurrence and claim settlement, the IBNR reserve is determined by an initial loss percentage applied to the rolling 12 month’s premium earned. No deductions for paid or case reserves are made. This alternative method of determining initial IBNR reacts more quickly to the actual loss emergence and is more appropriate for our property products where final claim resolution occurs quickly.

We do not reserve for natural or man-made catastrophes until an event has occurred. shortly after such occurrence, we review insured locations exposed to the event, model loss estimates of the event based on our own exposures, and industry loss estimates of the event, and we consider our knowledge of frequency and severity from early claim reports to determine an appropriate reserve for the catastrophe. These reserves are reviewed frequently based on loss reports and appropriate changes to our estimates are made to reflect any new information as it arises.

The initial loss and ALAE ratios that are applied to earned premium are reviewed at least semi-annually. Prospective estimates are made based on historical loss experience adjusted for mix and price change and loss cost inflation. The initial loss and ALAE ratios also reflect some provision for estimation risk. We consider estimation risk by segment and product line. A segment with greater overall volatility and uncertainty has greater estimation risk. Characteristics of segments and products with higher estimation risk, include those exhibiting, but not limited to, the following characteristics:

·significant changes in underlying policy terms and conditions,

·a new business or one experiencing significant growth and/or high turnover,

·small volume or lacking internal data requiring significant reliance on external data,

·longer emergence patterns with exposures to latent unforeseen mass tort,

·high severity and/or low frequency,

·operational processes undergoing significant change, and/or

·high sensitivity to significant swings in loss trends or economic change.

The historical and prospective loss and ALAE estimates along with the risks listed are the basis for determining our initial and subsequent carried reserves. Adjustments in the initial loss ratio by product and segment are made where necessary and reflect updated assumptions regarding loss experience, loss trends, price changes, and prevailing risk factors. The LRC makes all final decisions regarding changes in the initial loss and ALAE ratios.

Loss and LAE Reserve Estimation Process

A full analysis of our loss reserves takes place at least semi-annually. The purpose of these analyses is to provide validation of our carried loss reserves. Estimates of the expected value of the unpaid loss and LAE are derived using actuarial methodologies. These estimates are then compared to the carried loss reserves to determine the appropriateness of the current reserve balance.

The process of estimating ultimate payment for claims and claims expenses begins with the collection and analysis of current and historical claim data. Data on individual reported claims including paid amounts and individual claim adjuster estimates are grouped by common characteristics. There is judgment involved in this grouping. Considerations when grouping data include the volume of the data available, the credibility of the data available, the homogeneity of the risks in each cohort, and both settlement and payment pattern consistency. We use this data to determine historical

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claim reporting and payment patterns which are used in the analysis of ultimate claim liabilities. For portions of the business without sufficiently large numbers of policies or that have not accumulated sufficient historical statistics, our own data is supplemented with external or industry average data as available and when appropriate. For our executive products and marine business, we utilize external data extensively.

In addition to the review of historical claim reporting and payment patterns, we also incorporate an estimate of expected losses relative to premium by year into the analysis. The expected losses are based on a review of historical loss performance, trends in frequency and severity, and price level changes. The estimation of expected losses is subject to judgment including consideration given to internal and industry data available, growth and policy turnover, changes in policy limits, changes in underlying policy provisions, changes in legal and regulatory interpretations of policy provisions, and changes in reinsurance structure.

We use historical development patterns, estimations of the expected loss ratios, and standard actuarial methods to derive an estimate of the ultimate level of loss and LAE payments necessary to settle all the claims occurring as of the end of the evaluation period. Once an estimate of the ultimate level of claim payments has been derived, the amount of paid loss and LAE and case reserve through the evaluation date is subtracted to reveal the resulting level of IBNR.

Our reserve processes include multiple standard actuarial methods for determining estimates of IBNR reserves. Other supplementary methodologies are incorporated as deemed necessary. Mass tort and latent liabilities are examples of exposures where supplementary methodologies are used. Each method produces an estimate of ultimate loss by accident year. We review all of these various estimates and the actuaries assign weight to each based on the characteristics of the product being reviewed. The result is a single actuarial point estimate by product, by accident year.

Our estimates of ultimate loss and LAE reserves are subject to change as additional data emerges. This could occur as a result of change in loss development patterns, a revision in expected loss ratios, the emergence of exceptional loss activity, a change in weightings between actuarial methods, the addition of new actuarial methodologies or new information that merits inclusion, or the emergence of internal variables or external factors that would alter our view.

There is uncertainty in the estimates of ultimate losses. significant risk factors to the reserve estimate include, but are not limited to, unforeseen or unquantifiable changes in:

·loss payment patterns,

·loss reporting patterns,

·frequency and severity trends,

·underlying policy terms and conditions,

·business or exposure mix,

·operational or internal process changes affecting timing of recording transactions,

·regulatory and legal environment, and/or

·economic environment.

Our actuaries engage in discussions with senior management, underwriting, and the claims department on a regular basis to attempt to ascertain any substantial changes in operations or other assumptions that are necessary to consider in the reserving analysis.

A considerable degree of judgment in the evaluation of all these factors is involved in the analysis of reserves. The human element in the application of judgment is unavoidable when faced with material uncertainty. Different experts will choose different assumptions when faced with such uncertainty, based on their individual backgrounds, professional experiences, and areas of focus. Hence, the estimate selected by various qualified experts may differ materially from each other. We consider this uncertainty by examining our historic reserve accuracy and through an internal peer review process.

Given the substantial impact of the reserve estimates on our financial statements, we subject the reserving process to significant diagnostic testing and reasonability checks. We have incorporated data validity checks and balances into our front-end processes. Data anomalies are researched and explained to reach a comfort level with the data and results. Leading indicators such as actual versus expected emergence and other diagnostics are also incorporated into the reserving processes.

Determination of Our Best Estimate

Upon completion of our full loss and LAE estimation analysis, the results are discussed with the LRC. As part of this discussion, the analysis supporting an indicated point estimate of the IBNR loss reserve by product is reviewed. The actuaries also present explanations supporting any changes to the underlying assumptions used to calculate the indicated point estimate. Quarterly, we also consider the actual loss emergence as compared to the expected loss emergence derived from the last full loss and LAE analyses. A review of the resulting variance between the indicated reserves and the carried reserves determined from the initial IBNR generation process takes place. After discussion of these analyses and all relevant risk factors, the LRC determines whether the reserve balances require adjustment.

As a predominantly excess and surplus lines and specialty insurer servicing niche markets, we believe there are several reasons to carry — on an overall basis — reserves above the actuarial point estimate. We believe we are subject to above-average variation in estimates and that this variation is not symmetrical around the actuarial point estimate.

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One reason for the variation is the above-average policyholder turnover and changes in the underlying mix of exposures typical of an excess and surplus lines business. This constant change can cause estimates based on prior experience to be less reliable than estimates for more stable, admitted books of business. Also, as a niche market writer, there is little industry-level information for direct comparisons of current and prior experience and other reserving parameters. These unknowns create greater-than-average variation in the actuarial point estimates.

Actuarial methods attempt to quantify future events. Insurance companies are subject to unique exposures that are difficult to foresee at the point coverage is initiated and, often, many years subsequent. Judicial and regulatory bodies involved in interpretation of insurance contracts have increasingly found opportunities to expand coverage beyond that which was intended or contemplated at the time the policy was issued. Many of these policies are issued on an “all risk” and occurrence basis. Aggressive plaintiff attorneys have often sought coverage beyond the insurer’s original intent. some examples would be the industry’s ongoing asbestos and environmental litigation, court interpretations of exclusionary language on mold and construction defect, and debates over wind versus flood as the cause of loss from major hurricane events.

We believe that because of the inherent variation and the likelihood that there are unforeseen and under-quantified liabilities absent from the actuarial estimate, it is prudent to carry loss reserves above the actuarial point estimate. Most of our variance between the carried reserve and the actuarial point estimate is in the most recent accident years for our casualty segment where the most significant estimation risks reside. These estimation risks are considered when setting the initial loss ratio for the product and segment. In the cases where these risks fail to materialize, favorable loss development will likely occur over subsequent accounting periods. It is also possible that the risks materialize above the amount we considered when booking our initial loss reserves. In this case, unfavorable loss development is likely to occur over subsequent accounting periods.

Our best estimate of our loss and LAE reserves may change depending on a revision in the actuarial point estimate, the actuary’s certainty in the estimates and processes, and our overall view of the underlying risks. From time to time, we benchmark our reserving policies and procedures and refine them by adopting industry best practices where appropriate. A detailed, ground-up analysis of the actuarial estimation risks associated with each of our products and segments, including an assessment of industry information, is performed annually.

Loss reserve estimates are subject to a high degree of variability due to the inherent uncertainty of ultimate settlement values. Periodic adjustments to these estimates will likely occur as the actual loss emergence reveals itself over time. We believe our loss reserving processes reflect industry best practices and our methodologies result in a reasonable provision for reserves as of December 31, 2008.

INVESTMENT VALUATION AND OTHER-THAN-TEMPORARY IMPAIRMENT

Throughout each year, we and our investment managers buy and sell securities to achieve investment objectives in accordance with investment policies established and monitored by our board of directors and executive officers.

We classify our 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 with unrealized gains/losses recorded as a component of comprehensive earnings and shareholders’ equity, net of deferred income taxes. Trading securities are carried at fair value with unrealized gains/losses included in earnings.

We regularly evaluate our fixed income and equity securities using both quantitative and qualitative criteria to determine impairment losses for other-than-temporary declines in the fair value of the investments. The following are the factors for determining if a security is other-than-temporarily impaired:

·The length of time and the extent to which the fair value has been less than cost;

·The probability of significant adverse changes to the cash flows on a fixed income investment;

·The occurrence of a discrete credit event resulting in the issuer defaulting on a material obligation or the issuer is seeking protection from creditors under the bankruptcy laws, or the issuer is proposing a voluntary reorganization which creditors are asked to exchange their claims for cash or securities having a fair value substantially lower than par value of their claims; or

·The probability that we will not receive all contractual or estimated cash flows in the form of principal and interest.

Quantitative criteria considered during this process include, but are not limited to: the degree and duration of current fair value as compared to the cost (amortized, in certain cases) of the security, degree and duration of the security’s fair value being below cost and, for fixed maturities, whether the issuer is in compliance with terms and covenants of the security. Qualitative criteria include the credit quality, current economic conditions, the anticipated speed of cost recovery, the financial health of and specific prospects for the issuer, as well as our intent and ability to hold the security to maturity or until forecasted recovery. In addition, we consider price declines of securities in our other-than-temporary impairment analysis where such price declines provide evidence of

6

declining credit quality, and we distinguish between price changes caused by credit deterioration, as opposed to rising interest rates.

Factors that we consider in the evaluation of credit quality include:

·changes in technology that may impair the earnings potential of the investment,

·the discontinuance of a segment of the business that may affect the future earnings potential,

·reduction or elimination of dividends,

·specific concerns related to the issuer’s industry or geographic area of operation,

·significant or recurring operating losses, poor cash flows, and/or deteriorating liquidity ratios, and

·downgrade in credit quality by a major rating agency.

Part of our evaluation of whether particular securities are other-than-temporarily impaired involves assessing whether we have both the intent and ability to continue to hold securities in an unrealized loss position. significant changes in these factors could result in a charge to net earnings for impairment losses. Impairment losses result in a reduction of the underlying investment’s cost basis.

RECOVERABILITY OF REINSURANCE BALANCES

Ceded unearned premiums and reinsurance balances recoverable on paid and unpaid losses and settlement expenses are reported separately as assets, rather than being netted with the related liabilities, since reinsurance does not relieve us of our liability to 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. We continually monitor the financial condition of our reinsurers. As part of our monitoring efforts, we review their annual financial statements, securities and Exchange Commission filings, A.M. Best and s&P rating developments, and insurance industry developments that may impact the financial condition of our reinsurers. In addition, we subject our reinsurance recoverables to detailed recoverable tests, including one based on average default by s&P rating. Based upon our review and testing, our policy is to charge to earnings, in the form of an allowance, an estimate of unrecoverable amounts from reinsurers. This allowance is reviewed on an ongoing basis to ensure that the amount makes a reasonable provision for reinsurance balances that we may be unable to recover.

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. Acquisition-related costs may be deemed ineligible for deferral when they are based on contingent or performance criteria beyond the basic acquisition of the insurance contract. All eligible 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. This would also give effect to the premiums to be earned and anticipated losses and settlement expenses, as well as certain other costs expected to be incurred as the premiums are earned. Judgments as to the ultimate recoverability of such deferred costs are highly dependent upon estimated future loss costs associated with the premiums written. This deferral methodology applies to both gross and ceded premiums and acquisition costs.

DEFERRED TAXES

We record net deferred tax assets to the extent temporary differences representing future deductible items exceed future taxable items. A significant amount of our deferred tax assets relate to expected future tax deductions arising from claim reserves and future tax deductions related to changes in our investments’ unrealized gain or loss positions.

Since there is no absolute assurance that these assets will be ultimately realized, management reviews our deferred tax positions to determine if it is more likely than not that the assets will be realized. Periodic reviews include, among other things, the nature and amount of the taxable income and expense items, the expected timing of when assets will be used or liabilities will be required to be reported and the reliability of historical profitability of businesses expected to provide future earnings. Furthermore, management considers tax-planning strategies it can use to increase the likelihood that the tax assets will be realized. If after conducting the periodic review, management determines that the realization of the tax asset does not meet the “more-likely-than-not” criteria, an offsetting valuation allowance is recorded, thereby reducing net earnings and the deferred tax asset in that period. In addition, management must make estimates of the tax rates expected to apply in the periods in which future taxable items are realized. such estimates include determinations and judgments as to the expected manner in which certain temporary differences, including deferred amounts related to our equity method investment, will be recovered and thereby the applicable tax rates. These estimates are subject to change based on the circumstances.

On January 1, 2007, we adopted the provisions of FIN 48, “Accounting for Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with FAsB statement No. 109, “Accounting for Income Taxes.” As it relates to uncertainties in income taxes, our unrecognized tax benefits, including interest and penalty accruals, are not

7

considered material to the consolidated financial statements and have not changed significantly upon the adoption of FIN 48. Also, no tax uncertainties are expected to result in significant increases or decreases to unrecognized tax benefits within the next 12-month period. Penalties and interest related to income tax uncertainties, should they occur, would be included in tax expense.

Additional discussion of other significant accounting policies may be found in note 1 to the financial statements.

RESULTS OF OPERATIONS

Consolidated revenue, as displayed in the table that follows, totaled $561.0 million for 2008, compared to $652.3 million in 2007 and $632.7 million in 2006.

CONSOLIDATED REVENUE

	Year ended December 31,
(in thousands)	2008			2007		2006
Net premiums earned	$	528,764		$	544,478	$	530,338
Net investment income	78,986			78,901		71,325
Net realized investment gains (losses)	(46,738		)	28,966		31,045
Total consolidated revenue	$	561,012		$	652,345	$	632,708

Revenue declined in 2008 as premiums earned from insurance operations were down and the financial market turmoil resulted in realized losses on investment securities. Net premiums earned declined 3 percent in 2008, returning to a level similar to 2006. Casualty premium continued to decline due to overall rate softening and served to more than offset the increased premium writings our property and surety segments posted in the last three years and the subsequent earning of this premium as revenue. Despite a declining interest rate environment, investment income was flat compared to 2007, after posting a 10 percent increase in 2007. The result for 2007 was influenced by higher investment yields and an increased asset base over 2006. During 2008, we recorded $46.7 million in net realized investment losses, primarily from other-than-temporarily impaired securities. Impairment charges were recorded on a high-yield municipal bond fund and securities in the financial sector, as the credit crisis and financial turmoil negatively impacted fixed income and equity values in the latter half of 2008. In 2007 and 2006, net realized gains contributed significantly to revenue. Results in 2007 included gains associated with the sale of certain equity securities deemed to have reached their full potential. Funds received were used to further diversify the investment portfolio. Realized gains in 2006 were largely due to the sale of the equity in one of our investee holdings.

NET EARNINGS (in thousands)	2008			2007			2006
Underwriting income	$	83,063		$	155,765		$	84,056
Net investment income	78,986			78,901			71,325
Net realized investment gains (losses)	(46,738		)	28,966			31,045
Debt interest	(6,704		)	(6,997		)	(6,581		)
Corporate expenses	(6,853		)	(9,474		)	(8,069		)
Investee earnings	4,844			7,315			15,117
Pretax earnings	$	106,598		$	254,476		$	186,893
Income tax	(27,922		)	(78,609		)	(52,254		)
Net earnings	$	78,676		$	175,867		$	134,639

Net earnings declined in 2008 after two consecutive years of record earnings. The result for 2008 included $24.0 million in hurricane losses and was negatively impacted by net realized investment losses. As discussed previously, in 2008, we recorded $46.7 million in net realized investment losses, primarily from other-than-temporarily impaired securities.

Underwriting income remained positive at $83.1 million, compared to $155.8 million in 2007 and $84.1 million in 2006. For each of these periods, the results were the product of disciplined underwriting in the current accident year, coupled with favorable development on prior accident years’ reserves. In a soft market, as we have seen in the past several years, disciplined underwriting can result in a reduction in premium revenue. This discipline, however, can differentiate us from the broader market by ensuring more adequate pricing of both new and renewal business and serves to slow the pace of deterioration in underwriting results. Included in underwriting income for each of the last three years were the effects of favorable development on prior years’ loss reserves. The more significant of these developments occurred in our casualty and surety segments, where loss trends have remained favorable. In 2008, we experienced $55.7 million in favorable development on prior accident years’ casualty and surety reserves, compared to favorable development for these segments of $98.5 million in 2007 and $41.6 million in 2006. Further discussion of reserve development can be found in note 6 to the financial statements.

Bonuses earned by executives, managers and associates are predominately influenced by corporate performance (operating earnings and return on capital). Bonus and profit sharing-related expenses attributable to the aforementioned favorable reserve developments totaled $6.0 million, $9.9 million, and $3.5 million, respectively, for 2008, 2007 and 2006. These performance-related expenses affected policy acquisition, insurance operating and general corporate expenses. Partially offsetting the 2008 increase were reductions in bonus and profit-sharing earned due to hurricane losses and lower returns on capital. Hurricane losses resulted in a $2.8 million reduction in bonus-related expenses. Realized and unrealized losses on investment

8

securities reduced our return on capital and resulted in reductions to and/or elimination of other bonus and profit-sharing expenses in 2008. In addition, we focused efforts on reducing non-acquisition/non-production expenses in 2008, which served to further reduce other insurance expenses.

Over the past several years, we have invested in our capacity to produce premium. We have expanded our geographic footprint of existing products by adding underwriters and entering new markets, and we have hired teams of underwriters to start new products. As a result, our policy acquisition costs, which include the expenses associated with this expansion, increased in 2008 and 2007. We believe this investment has positioned us well to capitalize on future market opportunities.

Investee earnings declined in 2008 and 2007. Investee results for 2008 were impacted by foreign exchange losses and the economic slowdown experienced during the last half of the year. The decline in 2007 was due in large part to the fourth quarter 2006 sale of the equity in one of our investee holdings.

Comprehensive loss for 2008 was $1.9 million compared to comprehensive earnings of $166.4 million in 2007 and $157.0 million in 2006. Results for 2008 were negatively impacted by unrealized losses on equity and fixed income securities.

RLI INSURANCE GROUP

In general, we have experienced continued softening in the marketplace over the last several years. As reflected in the table below, premium writings were down in 2008 and 2007. Increased competition and capacity in the marketplace have resulted in rate declines in our casualty and property segments. Our largest growth contributor in 2006, general liability, experienced a rate decline of 12 percent in 2008, following a similar rate decline in 2007. While rates have declined, this product continued to produce underwriting income. On the property side, in addition to a decline in rates, targeted reductions in our catastrophe exposure resulted in reduced writings in 2008 and 2007, as we continued to manage our exposure to catastrophic events. In 2008 and 2007, we posted moderate growth in our surety segment as we added underwriters and expanded geographically.

Our underwriting income and combined ratios are displayed in the tables below. solid underwriting results for the casualty and surety segments were magnified by favorable development on prior accident years’ loss reserves in each of the last three years. The property segment was impacted by hurricane losses in 2008, while 2007 and 2006 benefited from light hurricane seasons. Excluding hurricanes, loss frequency and severity declined in 2008 and 2007, particularly with respect to the discontinued construction program and reduction in habitational fire exposures, both of which negatively impacted results for 2006. The following table and narrative provide a more detailed look at individual segment performance over the last three years.

GROSS PREMIUMS WRITTEN

(in thousands)	2008		2007		2006
Casualty	$	403,337	$	462,591	$	506,887
Property	200,794		206,041		225,610
Surety	77,038		70,702		66,516
Total	$	681,169	$	739,334	$	799,013

UNDERWRITING INCOME

(in thousands)	2008		2007		2006
Casualty	$	46,507	$	101,863	$	68,393
Property	15,813		30,569		4,988
Surety	20,743		23,333		10,675
Total	$	83,063	$	155,765	$	84,056

COMBINED RATIO

	2008	2007	2006
Casualty	85.2	70.3	80.4
Property	89.3	77.9	95.9
Surety	69.7	62.8	82.1
Total	84.2	71.4	84.1

The following table further summarizes revenues (net premiums earned) by major coverage type within each segment:

(in thousands)	2008		2007		2006
CASUALTY
General liability	$	140,891	$	167,876	$	180,037
Commercial and personal umbrella	65,091		66,281		64,730
Commercial transportation	46,710		49,119		48,285
Specialty program business	31,425		29,362		25,507
Executive products	13,846		12,029		13,040
Other	15,518		18,735		16,618
Total	$	313,481	$	343,402	$	348,217
PROPERTY
Commercial property	$	85,271	$	92,634	$	91,507
Marine	48,166		32,868		16,785
Other property	13,426		12,865		14,289
Total	$	146,863	$	138,367	$	122,581
SURETY	$	68,420	$	62,709	$	59,540
Grand total	$	528,764	$	544,478	$	530,338

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Casualty

Casualty gross premiums written of $403.3 million were down 13 percent in 2008 following a decline of 9 percent in 2007 and 2 percent decline in 2006. Personal umbrella, executive products, and specialty program business experienced modest premium growth, while all other lines were down by varying degrees as marketplace conditions for this segment continued to soften. General liability, our largest product in this segment, experienced a rate decline of 12 percent in 2008, following rate declines of 12 percent in 2007 and 8 percent in 2006. General liability posted gross premiums written of $140.0 million, down 21 percent from 2007 and 28 percent from 2006. While rates have deteriorated, this coverage continued to sustain a good margin and profitable results. Transportation and commercial umbrella also sustained declines in gross premiums written in 2008, down 15 percent each, due to continued rate and exposure declines. Our personal umbrella coverage posted a 3 percent increase in gross premiums written in 2008, after posting a 5 percent increase in 2007. Executive products posted a 4 percent increase in gross premiums written in 2008, as the marketplace for this product improved during the last quarter of the year. Increased submission activity and opportunities to write new business resulted in increased production in the last quarter of the year. specialty program business posted a 1 percent increase in gross premiums as new production sources and product offerings served to offset declines in existing programs that were scaled back. Despite competitive pressures in the casualty segment, we remained disciplined in writing only those accounts which we believe will provide adequate returns. The soft marketplace is likely to continue to challenge our ability to grow premium in this segment in 2009.

Underwriting income for the casualty segment was $46.5 million in 2008, compared to $101.9 million in 2007 and $68.4 million in 2006. These results translated into combined ratios of 85.2, 70.3 and 80.4, respectively for 2008, 2007, and 2006. Favorable development on prior accident years’ loss reserves totaled $50.6 million, $87.4 million, and $40.0 million, respectively, for 2008, 2007, and 2006. This favorable emergence was concentrated in accident years 2002-2006, with the more recent years representing a larger portion of the release. In each of these years, actuarial studies indicated that cumulative experience attributable to some casualty coverages for mature accident years was considerably lower than the reserves booked, resulting in the release of reserves. The 2007 result was further impacted by a detailed analysis of recent favorable loss trends and reserve risk factors. This review resulted in certain refinements to our reserving methodologies. This and the increased stability in our business in more recent years diminished the needed level of carried reserves above the actuarial point estimate. Over half of the favorable prior years’ loss development recorded in 2007 was the result of this detailed assessment and resulting reductions to our booked reserves.

From an insurance standpoint, the casualty segment has exposure to the financial crisis and subprime market issues through our executive products’ (directors and officers) coverages. As financial institutions have not been a segment of focus for our executive products’ coverages, we believe our exposure to the financial crisis is limited. In addition, we believe our exposure to subprime is also minimal.

Property

Gross premiums written in the property segment declined 3 percent in 2008 after posting a decline of 9 percent in 2007 and an increase of 28 percent in 2006. The decline in 2008 and 2007 was reflective of the softening marketplace for commercial property, impacted by two years (2006 and 2007) of benign hurricane activity. While the market experienced hurricane losses in 2008, we have not seen a significant increase in rates as capacity remains available. softening rates for coastal wind-exposed risks, combined with increased competition for non-catastrophe exposed accounts, resulted in a reduction in premium writings in 2008 and 2007. In addition, targeted reductions in our catastrophe exposure to earthquake reduced property writings. Earthquake coverage premiums have dropped in each of the last three years as we focused on reducing our exposure. While still providing an adequate return, wind rates softened toward the end of 2006 and have remained soft through 2008. On a positive note, our marine division that was launched in 2005 posted gross writings of $61.4 million in 2008, compared to $45.3 million in 2007 and $28.7 million in 2006. In addition, facultative reinsurance added $4.8 million during 2008 in gross premiums written in its first full year of production.

Net premiums earned for the property segment advanced for each of the last three years. Net premiums earned for 2008 benefited from decreased catastrophe reinsurance costs and a reduction in facultative reinsurance purchased. We have increased our retention in select areas. The marine division, a growth product over the last three years, represented a larger percentage of segment premiums and has increased retentions. Increased retention results in a higher level of risk of loss. Net premiums earned in 2007 and 2006 advanced as the significant growth in premium writings in commercial fire and marine during each of the preceding years was earned as revenue.

Underwriting income was $15.8 million in 2008, compared to income of $30.6 million in 2007 and $5.0 million in 2006. Results for 2008 include $22.8 million in losses associated with Hurricanes Gustav and Ike, which more than offset the improved loss performance of non-wind

10

commercial fire accounts. Results for 2007 benefited from a benign hurricane season, a decline in losses from tornadoes and hail storms, as well as lower frequency and severity of commercial fire losses. Additionally, unlike 2006, the segment’s results for 2008 and 2007 were not adversely affected by losses on discontinued construction coverages. In fact, results for 2008 include favorable development on prior years’ construction reserves as losses developed better than anticipated. For 2006, although we experienced a light hurricane season, other catastrophe losses such as tornadoes and hailstorms, along with increased severity of commercial fire losses, served to hamper the segment’s income. Favorable loss reserve development from prior years’ hurricane reserves contributed $4.2 million to income in 2006. However, additional charges were incurred from the run-off of the previously exited construction coverage, which amounted to $13.7 million in 2006.

Surety

Surety gross premiums written increased in each of the last three years, as all coverages in this segment produced increases in 2008. Net premiums earned followed suit, improving by 9 percent in 2008, 6 percent in 2007 and 15 percent in 2006. Investment in capacity, through underwriter additions and geographic expansion, fueled premium growth in mature coverages. In addition, we established a new fidelity division in late 2008 focusing on fidelity and crime coverage for commercial insureds and select financial institutions. While these investments resulted in increased acquisition costs, loss ratios remained low resulting in positive underwriting income.

Underwriting income totaled $20.7 million in 2008, compared to $23.3 million in 2007 and $10.7 million in 2006. After doubling for two consecutive years, underwriting income declined modestly in 2008, but represented excellent results for this segment. Premium growth was achieved while maintaining underwriting discipline. Positive results on the current accident year were amplified by favorable development on prior accident years. In 2008, favorable development on prior accident years’ loss reserves totaled $5.1 million, compared to $11.1 million in 2007 and $1.6 million in 2006. The majority of development in 2008 was from the 2007 accident year, as loss trends continued to be favorable. For 2007, the majority of the favorable development was the result of our actuary’s risk reassessment and reflection of significantly lower reserve risk, following continued favorable loss trends and further progress on the Commercial Money Center litigation.

As discussed more fully in note 10, we have been in litigation regarding certain commercial surety bond claims arising out of a specific bond program (the Commercial Money Center or “CMC” litigation). During 2008, we reached confidential settlements with the two remaining banks. With these two settlements, we have now reached settlements with each of the five investor banks that had claimed entitlement under the surety bonds issued. We were adequately reserved for these settlements. See note 10 for further discussion.

The surety segment is another area that can have exposure to the financial crisis and subprime market issues. The financial turmoil resulted in a slight increase in claim frequency on miscellaneous and energy bonds during the last quarter of the year. As for subprime market issues, we write only a few mortgage broker bonds and believe this exposure to be minimal. In addition, we do not have significant exposure from a surety standpoint to the home building industry.

NET INVESTMENT INCOME AND REALIZED INVESTMENT GAINS

During 2008, net investment income was flat. The average annual yields on our investments were as follows for 2008, 2007, and 2006:

	2008		2007		2006
PRETAX YIELD
Taxable (on book value)	5.58	%	5.46	%	5.22	%
Tax-exempt (on book value)	3.99	%	4.07	%	4.02	%
Equities (on fair value)	3.81	%	3.03	%	2.78	%
AFTER-TAX YIELD
Taxable (on book value)	3.63	%	3.55	%	3.40	%
Tax-exempt (on book value)	3.78	%	3.85	%	3.81	%
Equities (on fair value)	3.27	%	2.60	%	2.39	%

The after-tax yield reflects the different tax rates applicable to each category of investment. Our taxable fixed income securities are subject to our corporate tax rate of 35 percent, our tax-exempt municipal securities are subject to a tax rate of 5.3 percent and our dividend income is generally subject to a tax rate of 14.2 percent. During 2008, the average after-tax yield on the fixed income portfolio remained at 3.7 percent, the same yield as 2007. During the year, we focused on purchasing high-quality fixed income investments, primarily in the 5-15 year range of the yield curve.

The fixed income portfolio decreased by $98.3 million during the year. This portfolio had net realized losses of $8.2 million and a tax-adjusted total return on a mark-to-market basis of 2.5 percent. Our equity portfolio decreased by $106.9 million during 2008, to $286.8 million. As of December 31, 2008, our equity portfolio had net unrealized gains of $35.5 million. The total return for the year on the equity portfolio was -31.1 percent.

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Our investment results for the last five years are shown in the following table:

(in thousands)	AverageInvestedAssets(1)		Net InvestmentIncome(2)(3)		NetRealizedGains(Losses)(3)			Change inUnrealizedAppreciation(3)(4)			Annualizedreturnon Avg.InvestedAssets		TaxEquivalentAnnualizedReturnon Avg.InvestedAssets
2004	1,451,539		54,087		13,365			13,200			5.6	%	6.3	%
2005	1,633,755		61,641		16,354			(35,788		)	2.6	%	3.3	%
2006	1,763,016		71,325		31,045			34,395			7.8	%	8.6	%
2007	1,834,009		78,901		28,966			(14,650		)	5.1	%	5.9	%
2008	1,749,303		78,986		(46,738		)	(123,607		)	-5.2	%	-4.5	%
5-yr Avg.	$	1,686,324	$	68,988	$	8,598		$	(25,290	)	3.2	%	3.9	%

(1) Average amounts at beginning and end of year.

(2) Investment income, net of investment expenses.

(3) Before income taxes.

(4) Relates to available-for-sale fixed income and equity securities.

We realized $46.7 million in net investment losses in 2008. Included in this number is $38.7 million in net realized losses in the equity portfolio, $8.2 million in net realized losses in the fixed income portfolio, and other realized gains of $0.2 million. In 2007, we realized $29.0 million in net investment gains. We realized $29.9 million in net realized gains in the equity portfolio, $1.0 million in net realized losses in the fixed income portfolio, and other realized gains of $0.1 million. In 2006, we realized net investment gains of $31.0 million. Included in this number are net realized gains of $22.4 million in the equity portfolio, net realized losses of $7.3 million in the fixed income portfolio, and other realized gains of $16.0 million. Included in other gains for 2006 was a $16.2 million gain from the sale of our equity in Taylor, Bean, & Whitaker Mortgage Corp. (TBW) as discussed in note 1 to the financial statements.

We regularly evaluate the quality of our investment portfolio. When we believe that a specific security has suffered an other-than-temporary decline in value, the investment’s value is adjusted by reclassifying the decline from unrealized to realized losses. This has no impact on shareholders’ equity. During 2008, we recognized other-than-temporary impairment losses of $76.2 million. This total includes $64.2 million in equity and $12.0 million in fixed income securities. The majority of the losses came during the third and fourth quarters as the markets were impacted by the slowing economy and global financial crisis. The majority of our other-than-temporary impairment losses were related to securities in the financial sector and a high-yield municipal bond mutual fund. The impaired securities were negatively impacted by the overall financial crisis and lack of liquidity in the credit markets. There were no losses associated with the other-than-temporary impairment of securities in 2007 or 2006.

The following table is used as part of our impairment analysis and illustrates the total value of securities that were in an unrealized loss position as of December 31, 2008. This table segregates the securities based on type, noting the fair value, cost (or amortized cost), and unrealized loss on each category of investment as well as in total. The table further classifies the securities based on the length of time they have been in an unrealized loss position.

(in thousands)	0-12 Mos.			>12 Mos.			Total
U.S. Government
fair value	$	—		$	—		$	—
Cost or amortized cost	—			—			—
Unrealized loss	—			—			—
U.S. Agency
fair value	$	34,955		$	—		$	34,955
Cost or amortized cost	35,379			—			35,379
Unrealized loss	(424		)	—			(424		)
Mtge/ABS/CMO*
fair value	$	38,551		$	16,721		$	55,272
Cost or amortized cost	41,769			19,495			61,264
Unrealized loss	(3,218		)	(2,774		)	(5,992		)
Corporate
fair value	$	135,865		$	32,737		$	168,602
Cost or amortized cost	149,935			38,707			188,642
Unrealized loss	(14,070		)	(5,970		)	(20,040		)
States, political subdivisions and revenues
fair value	$	133,515		$	13,250		$	146,765
Cost or amortized cost	137,660			13,970			151,630
Unrealized loss	(4,145		)	(720		)	(4,865		)
Subtotal, debt securities
fair value	$	342,886		$	62,708		$	405,594
Cost or amortized cost	364,743			72,172			436,915
Unrealized loss	(21,857		)	(9,464		)	(31,321		)
Common stock
fair value	$	83,406		$	11,912		$	95,318
Cost or amortized cost	106,540			16,076			122,616
Unrealized loss	(23,134		)	(4,164		)	(27,298		)
Preferred stock
fair value	$	2,613		$	—		$	2,613
Cost or amortized cost	2,871			—			2,871
Unrealized loss	(258		)	—			(258		)
Total
fair value	$	428,905		$	74,620		$	503,525
Cost or amortized cost	474,154			88,248			562,402
Unrealized loss	(45,249		)	(13,628		)	(58,877		)

*Mortgage-backed, asset-backed & collateralized mortgage obligations

12

The following table is also used as part of our impairment analysis and illustrates certain industry-level measurements relative to our equity portfolio as of December 31, 2008, including fair value, cost basis, and unrealized gains and losses.

	Cost		12/31/08		Net Unrealized								Unrealized Gain/
(in thousands)	Basis		Fair Value		Gains		Losses			Net			Loss%(1)
Common stock:
Consumer discretionary	$	18,265	$	14,700	$	102	$	(3,667	)	$	(3,565	)	-19.5	%
Consumer staples	11,492		22,113		10,621		—			10,621			92.4	%
Energy	11,171		22,181		11,792		(782		)	11,010			98.6	%
Financials	17,549		20,406		4,134		(1,277		)	2,857			16.3	%
Healthcare	10,395		18,439		9,073		(1,029		)	8,044			77.4	%
Industrials	15,560		19,249		5,121		(1,432		)	3,689			23.7	%
Information technology	13,005		14,807		4,333		(2,531		)	1,802			13.9	%
Materials	4,329		3,284		—		(1,045		)	(1,045		)	-24.1	%
REITs	4,771		4,833		86		(24		)	62			1.3	%
Telecommunications	4,408		8,950		4,542		—			4,542			103.0	%
Utilities	41,980		52,495		12,581		(2,066		)	10,515			25.0	%
ETFs	53,556		40,111		—		(13,445		)	(13,445		)	-25.1	%
High-yield muni fund	33,341		33,341		—		—			—			—
Preferred stock	11,461		11,881		678		(258		)	420			3.7	%
Total	$	251,283	$	286,790	$	63,063	$	(27,556	)	$	35,507		14.1	%

(1) Calculated as the percentage of net unrealized gain (loss) to cost basis

As of December 31, 2008, we held 37 securities in our equity portfolio that were in unrealized loss positions. The total unrealized loss on these securities was $27.6 million. In considering both the significance and duration of the unrealized loss positions, we have no equity securities in an unrealized loss of greater than 20 percent for more than six months.

The fixed income portfolio contained 229 positions at an unrealized loss as of December 31, 2008. Of these 229 securities, 33 have been in an unrealized loss position for more than 12 consecutive months and these collectively represent $9.5 million in unrealized losses. The fixed income unrealized losses can be primarily attributed to spreads widening in the corporate, municipal and mortgage backed security markets. We have the ability and intent to hold these securities to maturity. In addition, we continually monitor the credit quality of our fixed income investments to assess if it is probable that we will receive our contractual or estimated cash flows in the form of principal and interest. We consider price declines of securities in our other-than-temporary impairment analysis where such price declines provide evidence of declining credit quality, and we distinguish between price changes caused by credit deterioration, as opposed to rising interest rates.

Factors that we consider in the evaluation of credit quality include:

·changes in technology that may impair the earnings potential of the investment,

·the discontinuance of a segment of the business that may affect the future earnings potential,

·reduction or elimination of dividends,

·specific concerns related to the issuer’s industry or geographic area of operation,

·significant or recurring operating losses, poor cash flows, and/or deteriorating liquidity ratios, and

·downgrade in credit quality by a major rating agency.

Based on our analysis, we’ve concluded that the remaining securities are not other-than-temporarily impaired.

INVESTMENTS

We maintain a diversified investment portfolio which has had an 80 percent fixed income and 20 percent equity target over the last five years. As of December 31, 2008, the portfolio had a fair value of $1.7 billion, down from $1.8 billion at the end of 2007. The decline in the value of the investment portfolio was the result of the severe downturn in the global financial markets and economy. Our continuing focus is to manage our risks and to position the portfolio to take advantage of market opportunities while minimizing declines in the portfolio.

As of December 31, 2008, our investment portfolio had the following asset allocation breakdown:

PORTFOLIO ALLOCATION

(in thousands) Asset Class	Cost or Amortized Cost		Fair Value		Unrealized Gain/(Loss)			% of Total Fair Value		Quality
Agencies	$	294,897	$	298,093	$	3,196		18.0	%	AAA
Corporates	290,492		272,886		(17,606		)	16.4	%	A
Mortgage-backed	217,778		216,196		(1,582		)	13.0	%	AAA
Asset-backed	21,594		21,206		(388		)	1.3	%	AAA
Treasuries	12,662		13,396		734			0.8	%	AAA
Munis	449,356		453,879		4,523			27.3	%	AA
Total fixed income	$	1,286,779	$	1,275,656	$	(11,123	)	76.8	%	AA
Equities	$	206,481	$	241,568	$	35,087		14.6	%
High-yield muni fund	33,341		33,341		—			2.0	%
Total equity	$	239,822	$	274,909	$	35,087		16.6	%
Preferred stock	$	11,461	$	11,881	$	420		0.7	%
Short-term investments	$	97,982	$	97,982	—			5.9	%
Total portfolio	$	1,636,044	$	1,660,428	$	24,384		100.0	%

Quality in the above table and in all subsequent tables is an average of each bond’s credit rating, adjusted for its relative weighting in the portfolio.

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Our fixed income portfolio comprised 77 percent of our total 2008 portfolio, versus 75 percent of the total at December 31, 2007, and 74 percent of the total as of December 31, 2006. As of December 31, 2008, the carrying value of our fixed income portfolio consisted of 48 percent AAA-rated securities, 23 percent AA-rated securities, 22 percent A-rated securities, and 7 percent BBB-rated or lower securities.

In selecting the maturity of securities in which we invest, we consider the relationship between the duration of our fixed income investments and the duration of our liabilities, including the expected ultimate payout patterns of our reserves. We believe that both liquidity and interest rate risk can be minimized by such asset/liability management. As of December 31, 2008, our fixed income portfolio’s duration was 4.4 years and remained diversified. During 2008, the total return on our bond portfolio on a tax-equivalent, mark-to-market basis was 2.5 percent.

In addition, at December 31, 2008, our equity portfolio had a value of $286.8 million, all of which is classified as available-for-sale and is also a source of liquidity. We maintain a diversified group of equity securities. The securities within the equity portfolio remain primarily invested in large-cap issues with strong dividend performance. In addition, we have investments in real estate investment trusts, exchange traded funds, preferred stocks, and a high-yield municipal bond fund. The strategy remains one of value investing, with security selection taking precedence over market timing. A buy-and-hold strategy is used, minimizing both transactional costs and taxes. During 2008, the total return on our equity portfolio on a mark-to-market basis was -31.1 percent, compared to the s&P return of -37.0 percent.

Our investment portfolio does not have any direct exposure to credit default swaps or derivatives. As of December 31, 2008, $15.4 million of our bond portfolio was part of a securities lending program. We have suspended the securities lending program and expect to be out of the program by the end of next year.

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FIXED INCOME PORTFOLIO

As of December 31, 2008, our fixed income portfolio had the following rating distributions:

FAIR VALUE

(in thousands)	AAA		AA		A		BBB		BB or Below		Fair Value
Bonds:
Corporate - financial	$	1,542	$	5,118	$	58,927	$	12,803	$	6	$	78,396
All other corporate	1,595		1,755		120,795		48,755		2,959		175,859
Financials - private placements	—		—		1,619		7,894		—		9,513
All other corporates - private placements	—		—		7,578		1,540		—		9,118
U.S. govt. agency (GSE)	311,224		265		—		—		—		311,489
Tax-Exempt municipal securities	57,026		290,284		85,429		21,140		—		453,879
Structured:
GSE - RMBS	$	170,537	$	2,024	—		—		—		$	172,561
Non-GSE RMBS - prime	—		—		—		—		—		—
Non-GSE RMBS - Alt A	—		—		—		—		—		—
Non-GSE RMBS - subprime	—		—		—		—		—		—
ABS - home equity	2,529		—		—		—		—		2,529
ABS - credit cards	339		—		—		—		—		339
ABS - auto loans	3,646		—		—		153		—		3,799
All other ABS	14,539		—		—		—		—		14,539
CMBS	43,635		—		—		—		—		43,635
CDOs/CLOs	—		—		—		—		—		—
	$	606,612	$	299,446	$	274,348	$	92,285	$	2,965	$	1,275,656

Our fixed income portfolio remained diversified with investments in treasury, government sponsored agency, corporate, municipal, mortgage backed, and asset backed securities. All fixed income securities in the investment portfolio continue to pay the expected coupon payments under the contractual terms of the securities and we believe it is probable that we will receive all contractual or estimated cash flows based on our analysis of previously disclosed factors.

We have two securities that are rated BB or below. The first security, a Lehman Bros. corporate bond, has a fair value of $5,700 and is held in our trading portfolio. We are currently not receiving any interest payments for this security. The second security, a Wrigley Co. corporate bond, has a fair value of $3.0 million and is currently not rated. The Wrigley Co. was purchased by a private company, Mars, Inc., in 2008. We believe it is probable that we will receive all contractual payments from this security.

Mortgage-Backed, Commercial Mortgage-Backed, and Asset-Backed Securities

Our mortgage-backed securities (MBs) portfolio is comprised of residential MBs investments. As of December 31, 2008, MBs investments totaled $172.6 million (14 percent) of the fixed income portfolio compared to $205.7 million (15 percent) as of December 31, 2007.

We believe MBs investments add diversification, liquidity, credit quality and additional yield to our portfolio. Our objective for the MBs portfolio is to provide reasonable cash flow stability and increased yield. This sector experienced unusually high volatility given the concerns over housing prices and general economic conditions. The MBs portfolio includes collateralized mortgage obligations (CMOs) and mortgage-backed pass-through securities. A mortgage pass-through is a security consisting of a pool of residential mortgage loans. All payments of principal and interest are passed through to investors each month. A CMO is a mortgage-backed security with a fixed maturity. This can eliminate the risks associated with prepayment because each security is divided into maturity classes that are paid off in order. Our MBs portfolio does not include interest-only securities, principal-only securities or other MBs investments which may exhibit extreme market volatility.

Prepayment/extension risk is an inherent risk of holding MBss. However, the degree of prepayment/extension risk varies by the type of MBs held. We reduce our portfolio’s exposure to prepayment/extension by including less volatile types of MBss. As of December 31, 2008, $0.6 million of the MBs portfolio was invested in planned amortization class CMOs (PACs) compared to $32.2 million (16 percent) as of December 31, 2007. PACs are securities whose cash flows are designed to remain constant in a variety of mortgage prepayment environments. Most of the portfolio’s non-PAC MBss possess varying degrees of cash flow structure and prepayment/extension risk. The MBs portfolio contained 78 percent of pure pass-throughs as of December 31, 2008, compared to 81 percent as of December 31, 2007. As of December 31, 2008, virtually all of the securities in our MBs portfolio were rated AAA. In addition, these securities were mortgage-backed securities issued by

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the Governmental National Mortgage Association (GNMA), Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC). Government sponsored Enterprises (GsEs), such as GNMA, FNMA and FHLMC, facilitate liquidity in the mortgage market by purchasing conforming mortgages from lenders, securitizing them and selling them into the secondary market. This market was further strengthened in the fourth quarter as a result of several federal Treasury policies including buying mortgages in the open market.

The following table summarizes the distribution by investment type of our MBs portfolio as of the dates indicated:

MBS

(in thousands)	Rating	Amortized Cost		Fair Value		% of Total
2008
Planned amortization class	AAA	$	62	$	62	0	%
Sequential	AAA	37,846		38,538		22	%
Pass-throughs	AAA	130,343		133,962		78	%
Total		$	168,251	$	172,562	100	%
2007
Planned amortization class	AAA	$	32,481	$	32,180	16	%
Sequential	AAA	5,964		5,987		3	%
Pass-throughs	AAA	166,463		167,520		81	%
Total		$	204,908	$	205,687	100	%

An asset-backed security (ABs) is a type of debt security that is based on pools of assets or collateralized by the cash flows from a specific pool of underlying assets. These asset pools can include items such as credit card payments, auto loans and mortgages. The majority of our ABs portfolio is comprised of rate reduction utility bonds. As of December 31, 2008, ABs/CMBs (commercial mortgage-backed securities) investments were $64.8 million (5 percent) of the fixed income portfolio, compared to $97.7 million (7 percent) as of December 31, 2007. CMBs made up $43.6 million (67 percent) of the ABs/CMBs portfolio compared to $61.5 million (63 percent) at December 31, 2007. The entire CMBs portfolio was rated AAA as of December 31, 2008.

We believe that ABs/CMBs investments add diversification and additional yield to our portfolio. Like the MBs portfolio, the objective for the ABs/CMBs portfolio is to provide reasonable cash flow stability and attractive yield. Our ABs/CMBs portfolio does not include interest- only securities, principal-only securities or other ABs/CMBs investments which may exhibit extreme market volatility.

The following table summarizes the distribution by investment type of our ABs/CMBs portfolio as of the dates indicated:

ABS/CMBS

(in thousands)	Rating	Amortized Cost		Fair Value		% of Total
2008
CMBS	AAA	$	49,527	$	43,635	67	%
Home equity	AAA	2,702		2,529		4	%
Auto	AAA	3,903		3,799		6	%
Equipment	AAA	1,768		1,774		3	%
Franchise	AAA	—		—		—
Utility	AAA	12,860		12,765		19	%
Credit card	AAA	361		339		1	%
Total		$	71,121	$	64,841	100	%
2007
CMBS	AAA	$	61,333	$	61,493	63	%
Home equity	AAA	9,716		9,629		10	%
Auto	AAA	5,000		5,024		5	%
Equipment	AAA	3,460		3,486		4	%
Franchise	AAA	3,000		2,960		3	%
Utility	AAA	14,350		14,664		15	%
Credit card	AAA	409		408		0	%
Total	AAA	$	97,268	$	97,664	100	%

When making investments in MBs/ABs/CMBs, we evaluate the quality of the underlying collateral, the structure of the transaction (which dictates how losses in the underlying collateral will be distributed) and prepayment risks.

Recent market activity has put pressure on many collateralized securities. In general, as credit becomes more difficult to obtain, interest rate spreads on collateralized securities widen. As stated previously, the vast majority of our MBs/ABs/CMBs portfolio is rated AAA.

The following table summarizes the distribution by collateral classification and rating of our subprime securities as of December 31, 2008 and 2007:

SUBPRIME

(in thousands)	Rating	Amortized Cost		Fair Value		% of Total
2008
Home equity	AAA	$	2,702	$	2,529	100	%
Total		$	2,702	$	2,529	100	%
2007
Home equity	AAA	$	9,716	$	9,629	100	%
Total		$	9,716	$	9,629	100	%

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We define subprime mortgages as loans which include one or more of the following: a weak credit score (FICO score of less than 640), high debt-to-income ratio, high loan-to-value ratio or undocumented income. We have reviewed our subprime investment exposure and believe our risk is minimal. We review our portfolio in three main areas to assess our subprime investment exposure — fixed income securities, common stocks and preferred stocks. Our exposure to subprime is through direct investments in subprime backed mortgage products and is less than $3 million. Of this amount, all securities are rated AAA and have been paying as agreed. All of these are fixed rate, exclude interest rate resets, were issued prior to 2005, and are not currently on watch from any major rating agency.

Municipal Fixed Income Securities

We have a significant allocation to municipal fixed income securities. As of December 31, 2008, municipal bonds totaled $453.9 million (36 percent) of our fixed income portfolio as compared to $473.7 million (34 percent) as of December 31, 2007.

We believe municipal fixed income securities provide diversification, high credit quality and additional yield to our portfolio. Our objective for the municipal fixed income portfolio is to provide reasonable cash flow stability and increased after tax yield.

Our municipal fixed income portfolio is comprised of general obligation (GO) and revenue securities. The revenue sources include sectors such as sewer and water, public improvement, school, transportation, colleges and universities, water and sewer.

As of December 31, 2008, approximately 55 percent of the municipal fixed income securities in the investment portfolio were GO and the remaining 45 percent were revenue fixed income. seventy-six percent of our municipal fixed income securities were rated AA or better, while 95 percent were rated A or better. Our municipal fixed income portfolio has very high credit quality.

The amortized cost and fair value of fixed income securities at December 31, 2008, by contractual maturity, are shown as follows:

(in thousands)	amortized Cost		fair Value
Total fixed income
Due in one year or less	$	28,430	$	28,725
Due after one year through five years	280,630		284,994
Due after five years through 10 years	447,920		439,101
Due after 10 years	529,799		522,836
Total	$	1,286,779	$	1,275,656

Corporate Debt Securities

As of December 31, 2008, our corporate debt portfolio totaled $272.9 million (21 percent) of the fixed income portfolio compared to $232.1 million (17 percent) as of December 31, 2007. The corporate debt portfolio has an overall quality rating of single A, diversified amongst 102 issuers across 18 industries.

The following table illustrates our corporate debt exposure to the financial and non-financial sectors as of December 31, 2008, including fair value, cost basis, and unrealized gains and losses:

(in thousands)	amortized Cost		fair Value		Gross Unrealized Gains		Gross Unrealized losses
Bonds:
Corporate – financial	$	84,267	$	78,396	$	110	$	(5,981	)
all other corporate	183,509		175,859		2,600		(10,250		)
financials – private placements	12,026		9,513		—		(2,513		)
all other corporate – private placements	10,690		9,118		—		(1,572		)
	$	290,492	$	272,886	$	2,710	$	(20,316	)

Corporate debt securities experienced large interest rate spread widening in 2008 as this market was directly impacted by the declining housing market, credit crisis and slowing economy. We believe corporate debt investments add diversification and additional yield to our portfolio. With our high quality, diversified portfolio, the corporate debt investments will continue to be a significant part of our investment program and we believe it is probable that the securities in our portfolio will continue to receive contractual payments in the form of principal and interest.

EQUITY SECURITIES

As of December 31, 2008, our equity portfolio totaled $286.8 million (17 percent) of the investment portfolio compared to $393.7 million (21 percent) as of December 31, 2007. The securities within the equity portfolio remain primarily invested in large-cap issues with a focus on dividend income. In addition, we have investments in real estate investment trusts, exchange traded funds, preferred stocks, and a high-yield municipal bond fund. In 2008, we recorded impairment losses of $64.2 million on our equity securities. The impairments were the result of our belief that the securities were not likely to recover in a reasonable period of time.

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The following table illustrates the distribution by sector of our equity portfolio as of December 31, 2008, including fair value, cost basis, and unrealized gains and losses:

(in thousands)	Cost Basis		12/31/2008 Fair Value		% of Total Fair Value		Net Unrealized Gain/Loss
Common stock:
Consumer discretionary	$	18,265	$	14,700	5.1	%	$	(3,565	)
Consumer staples	11,492		22,113		7.7	%	10,621
Energy	11,171		22,181		7.7	%	11,010
Financials	17,549		20,406		7.1	%	2,857
Healthcare	10,395		18,439		6.4	%	8,044
Industrials	15,560		19,249		6.7	%	3,689
Information technology	13,005		14,807		5.2	%	1,802
Materials	4,329		3,284		1.2	%	(1,045		)
REITs	4,771		4,833		1.7	%	62
Telecommunications	4,408		8,950		3.1	%	4,542
Utilities	41,980		52,495		18.3	%	10,515
ETFs	53,556		40,111		14.0	%	(13,445		)
High-yield muni fund	33,341		33,341		11.6	%	—
Preferred stock	11,461		11,881		4.2	%	420
Total	$	251,283	$	286,790	100.0	%	$	35,507

Common Stocks

As of December 31, 2008, our common stock portfolio totaled $201.5 million (70 percent) of the equity portfolio compared to $322.7 million (82 percent) as of December 31, 2007. The decline in value of our common stock portfolio in 2008 was primarily due to an investment decision to reduce our common stock exposure as well as a negative return in the asset class.

Our common stock portfolio consists largely of large cap, value oriented, dividend paying securities. We employ a long-term, buy-and-hold strategy that has provided superior returns over the last 10 years. While we anticipate continued volatility, we believe an equity allocation provides certain diversification and return benefits over the long term. The strategy provides above-market dividend yields with less volatility than the market. The beta of our equity portfolio is 0.7.

Exchange Traded Fund Securities (ETFs)

ETFs are portfolios of stocks, bonds or, in some cases, other investments that trade on a stock exchange much the same as a regular stock.

All of our ETF holdings are stock portfolios that track to major indices. We believe this ETF strategy is a low cost, efficient vehicle enabling us to effectively participate in certain sectors of the market.

In 2008, we added two exchange traded funds to our equity portfolio. As of December 31, 2008, our ETF investment totaled $40.1 million (14 percent) of the equity portfolio compared to $2.6 million (1 percent) as of December 31, 2007. The ETF investments add diversification, liquidity and increased return potential to our portfolio. In 2008, our ETFs outperformed the overall market but still contributed to the negative performance of the equity portfolio. We believe that ETF securities will be an important part of our investment program going forward. Our current ETFs contain large-cap securities that match our overall equity investment philosophy of providing superior dividend yields with less volatility than the market. These ETFs track various indices and have returns for 2008 consistent with the benchmark indices they follow.

High-Yield Municipal Bond Fund

As of December 31, 2008, our investment in the high-yield municipal bond fund totaled $33.3 million (12 percent) of the equity portfolio compared to $34.3 million (9 percent) as of December 31, 2007. While this mutual fund is comprised of fixed income securities, as a mutual fund we treat it as an equity. In 2008, we recorded impairment losses of $18.6 million on the high-yield municipal bond fund due to our belief that the fund is unlikely to completely recover in value in a reasonable period of time and related changes in our intent to hold this security until recovery.

The holdings are comprised of lower quality investment grade and below investment grade tax-exempt securities. sectors include healthcare, airports, tobacco, and infrastructure securities among others. The fund continues to make dividend payments and default rates of the bonds held in the fund remain below 1%. This market has been hurt by the flight to quality and overall liquidity in the municipal bond markets.

Preferred Stocks

As of December 31, 2008, our investment in preferred stock securities totaled $11.9 million (4 percent) of the equity portfolio compared to $34.2 million (9 percent) as of December 31, 2007. Preferred stocks are primarily issued by companies in the financial sector and were negatively affected by this year’s credit crisis.

In 2008, we recorded other-than-temporary impairment losses of $26.4 million in our preferred stock portfolio based on our analysis of factors previously disclosed. In addition, we had related changes in our intent to hold these securities until recovery.

INTEREsT AND GENERAL CORPORATE EXPENsE

Interest on debt declined in 2008 as we paid off our short-term debt. We incur short-term debt primarily through the use of reverse repurchase transactions. The use and repayment of such agreements remains an investment decision, based on whether the allocation of available cash flow to purchase debt securities generates a greater amount of investment income than would be paid in interest

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expense. In 2007, we had expanded our use of this debt as yield spreads had widened. We paid off the reverse repurchase debt in 2008 as the credit markets experienced increased volatility. Decisions regarding future short-term debt management will be based on available cash flow and the interest rate environment.

In 2008, 2007, and 2006, we incurred $6.0 million in interest on our long-term debt each year. Our long-term debt consists of $100.0 million in senior notes that mature on January 15, 2014, and pay interest semi-annually at the rate of 5.95 percent.

General corporate expenses tend to fluctuate relative to our executive compensation plan. Our compensation model measures comprehensive earnings against a minimum required return on our capital. Bonuses are earned as we generate earnings in excess of this required return. In 2008, the actual return was below the required return resulting in no bonus earned on the current year and reductions to bonuses accrued but unpaid on prior years. In 2007 and 2006, we had generated earnings significantly above the required return, resulting in increased bonuses accrued.

INVESTEE EARNINGS

We maintain a 40 percent equity interest in Maui Jim, Inc. (Maui Jim), a manufacturer of high-quality polarized sunglasses. Maui Jim’s chief executive officer owns a controlling majority of the outstanding shares of Maui Jim. In 2008, we recorded $4.8 million in earnings from this investment compared to $7.3 million in 2007 and $8.8 million in 2006. While sunglass sales advanced 7 percent in 2008 and 15 percent in 2007, costs associated with expansion efforts, foreign exchange losses, and the global economy affected earnings. In 2008, Maui Jim recorded over $5 million in foreign exchange loss and was negatively affected by the global economic slowdown. In 2007 and 2006, Maui Jim had recorded foreign exchange gains of $0.5 million and $1.9 million, respectively. In 2007, Maui Jim invested heavily in new sales and distribution offices (nationally and internationally), a new state-of-the-art Rx lab for prescription sunglasses, as well as new display programs and duty free and corporate gift channels across the world. In addition, the company recorded higher-than-normal expense associated with the discontinuance of some slow-moving styles and the replacement of temples on a specific product line.

In 2006, investee earnings included $6.3 million from our investment in TBW. In the fourth quarter of 2006, we sold our equity in TBW for $32.5 million, resulting in a pretax realized gain of $16.2 million.

INCOME TAXES

Our effective tax rates were 26.2 percent, 30.9 percent, and 28.0 percent for 2008, 2007, and 2006, respectively. Effective rates are dependent upon components of pretax earnings and the related tax effects. The effective rate for 2008 was lower than 2007 and 2006 due to the decrease in underwriting income and the recognition of realized investment losses, which were taxed at 35.0 percent.

Our net earnings also include equity in earnings of an unconsolidated investee, Maui Jim. This investee does not have a pattern of paying dividends. As a result, we record a deferred tax liability on these earnings at the corporate capital gains rate of 35%. In recent periods, a tax benefit was realized associated with a dividend declared and subsequently received from Maui Jim. As required under statement of Financial Accounting Standards (SFAS) 109, “Accounting for Income Taxes,” the tax benefit results from applying the lower tax rate applicable to affiliated dividends (7 percent) as compared to the corporate capital gains tax rate (35 percent) on which previous tax estimates were based.

In addition, our pretax earnings in 2008 included $30.3 million of investment income that is partially exempt from federal income tax, compared to $29.8 million and $28.7 million in 2007 and 2006, respectively. Partially offsetting tax expense in 2007 was a $2.4 million tax benefit recorded in the third quarter to reflect the benefit expected to be realized upon the future payment of certain accrued compensation. Results for 2006 include the favorable resolution of a tax examination. During 2006, the Internal Revenue Service concluded an examination of our tax years 2000 through 2004. As a result of this exam, we recorded a $3.2 million tax benefit, resulting from a change in tax estimate related to the sale of assets.

NET UNPAID LOSSES AND SETTLEMENT EXPENSES

The primary liability on our balance sheet relates to unpaid losses and settlement expenses, which represents our estimated liability for losses and related settlement expenses before considering offsetting reinsurance balances recoverable. The largest asset on our balance sheet, outside of investments, is the reinsurance balances recoverable on unpaid losses and settlement expenses, which serves to offset this liability.

The liability can be further deconstructed into two parts: (1) case reserves representing estimates of losses and settlement expenses on known claims and (2) IBNR — incurred but not reported — reserves representing estimates of losses and settlement expenses on claims that have occurred but have not yet been reported to us. Our gross liability for both case and IBNR reserves is reduced by reinsurance balances recoverable on unpaid losses and settlement expenses to calculate our net reserve balance. This net reserve balance increased to $809.0 million at December 31, 2008, from $774.9 million as of December 31, 2007. This reflects incurred losses of $247.2 million in

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2008 offset by paid losses of $213.1 million, compared to incurred losses of $190.9 million offset by $209.0 million paid in 2007. The overall increase in our net loss and loss adjustment expense reserves between 2008 and 2007 was due to higher loss and loss adjustment expense ratios for the current accident year reflecting soft market conditions and a net loss from 2008 hurricanes of $24.0 million which is still largely unpaid. In 2008, favorable loss development of $62.3 million from prior years offset a portion of these increases.

Both the gross reserves (liability) and the reinsurance balances recoverable (asset) were reduced by the favorable reserve development. Total gross and ceded loss and loss adjustment expense reserves dropped to $1,159.3 million and $350.3 million, respectively, at December 31, 2008, from $1,192.2 million and $417.3 million, respectively, at December 31, 2007.

MARKET RISK DISCLOSURE

Market risk is a general term describing the potential economic loss associated with adverse changes in the fair value of financial instruments. Management of market risk is a critical component of our investment decisions and objectives. We manage our exposure to market risk by using the following tools:

·monitoring the fair value of all financial assets on a constant basis,

·changing the character of future investment purchases as needed, and

·maintaining a balance between existing asset and liability portfolios.

INTEREST RATE RISK

Our primary exposure to interest rate risk is with our fixed income investment portfolio. Modified duration analysis is used to measure the sensitivity of the fixed income portfolio to changes in interest rates, providing a measure of price percentage volatility. We attempt to minimize interest rate risk by matching the duration of assets to that of liabilities.

Interest rate risk will also affect our income statement due to its impact on interest expense. As of December 31, 2008, we had no short-term debt obligations. At the end of 2007, our short-term debt was $28.0 million. We also maintain a debt obligation that is long-term in nature. Our long-term debt carries a fixed interest rate. As such, our interest expense on this obligation is not subject to changes in interest rates. As this debt is not due until 2014, we will not assume risk in our ability to refinance this debt for many years.

EQUITY PRICE RISK

Equity price risk is the potential that we will incur economic loss due to the decline of common stock prices. Beta analysis is used to measure the sensitivity of our equity portfolio to changes in the value of the S&P 500 Index (an index representative of the broad equity market). Our current equity portfolio has a beta of 0.7 in comparison to the S&P 500. Our equity investment returns have been superior to the S&P 500 with less volatility. This low beta statistic reflects our long-term emphasis on maintaining a value oriented, dividend-driven investment philosophy for our equity portfolio.

SENSITIVITY ANALYSIS

The tables that follow detail information on the market risk exposure for our financial investments as of December 31, 2008. Listed on each table is the December 31, 2008, fair value for our assets and the expected pretax reduction in fair value given the stated hypothetical events. This sensitivity analysis assumes the composition of our assets remains constant over the period being measured and also assumes interest rate changes are reflected uniformly across the yield curve. For example, our ability to hold non-trading securities to maturity mitigates price fluctuation risks. For purposes of this disclosure, market-risk-sensitive instruments are divided into two categories: instruments held for trading purposes and those held for non-trading purposes. The examples given are not predictions of future market events, but rather illustrations of the effect such events may have on the fair value of our investment portfolio.

As of December 31, 2008, our fixed income portfolio had a fair value of $1.3 billion. The sensitivity analysis uses scenarios of interest rates increasing 100 and 200 basis points from their December 31, 2008, levels with all other variables held constant. Such scenarios would result in decreases in the fair value of the fixed income portfolio of $41.1 million and $88.4 million, respectively. Due to our use of the held-to-maturity designation for a portion of the fixed income portfolio, the balance sheet impact of these scenarios would be lower.

As of December 31, 2008, our equity portfolio had a fair value of $286.8 million. The base sensitivity analysis uses market scenarios of the S&P 500 Index declining both 10 percent and 20 percent. These scenarios would result in approximate decreases in the equity fair value of $22.7 million and $45.4 million, respectively. As we designate all equities as available-for-sale, these fair value declines would impact our balance sheet.

Counter to the base scenarios shown in Tables 1 and 2, Tables 3 and 4 quantify the opposite impact. Under the assumptions of falling interest rates and an increasing S&P 500 Index, the fair value of our assets will increase from their present levels by the indicated amounts.

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TABLE 1

Effect of a 100-basis-point increase in interest rates and a 10% decline in the S&P 500:

(in thousands)	12/31/08 Fair Value		Interest Rate Risk			Equity Risk
Held for trading purposes
Fixed income securities	$	10,020	$	(282	)	$	—
Total trading	10,020		(282		)	—
Held for nontrading purposes
Fixed income securities	1,265,636		(40,836		)	—
Equity securities	286,790		—			(22,715		)
Total nontrading	1,552,426		(40,836		)	(22,715		)
Total trading & nontrading	$	1,562,446	$	(41,118	)	$	(22,715	)

TABLE 2

Effect of a 200-basis-point increase in interest rates and a 20% decline in the S&P 500:

(in thousands)	12/31/08 Fair Value		Interest Rate Risk			Equity Risk
Held for trading purposes
Fixed income securities	$	10,020	$	(648	)	$	—
Total trading	10,020		(648		)	—
Held for nontrading purposes
Fixed income securities	1,265,636		(87,747		)	—
Equity securities	286,790		—			(45,429		)
Total nontrading	1,552,426		(87,747		)	(45,429		)
Total trading & nontrading	$	1,562,446	$	(88,395	)	$	(45,429	)

TABLE 3

Effect of a 100-basis-point decrease in interest rates and a 10% increase in the S&P 500:

(in thousands)	12/31/08 Fair Value		Interest Rate Risk		Equity Risk
Held for trading purposes
Fixed income securities	$	10,020	$	340	$	—
Total trading	10,020		340		—
Held for nontrading purposes
Fixed income securities	1,265,636		37,591		—
Equity securities	286,790		—		22,715
Total nontrading	1,552,426		37,591		22,715
Total trading & nontrading	$	1,562,446	$	37,931	$	22,715

TABLE 4

Effect of a 200-basis-point decrease in interest rates and a 20% increase in the S&P 500:

(in thousands)	12/31/08 Fair Value		Interest Rate Risk		Equity Risk
Held for trading purposes
Fixed income securities	$	10,020	$	763	$	—
Total trading	10,020		763		—
Held for nontrading purposes
Fixed income securities	1,265,636		78,206		—
Equity securities	286,790		—		45,429
Total nontrading	1,552,426		78,206		45,429
Total trading & nontrading	$	1,562,446	$	78,969	$	45,429

LIQUIDITY AND CAPITAL RESOURCES

OVERVIEW

We have three primary types of cash flows: (1) operating cash flows, which consist mainly of cash generated by our underwriting operations and income earned on our investment portfolio, (2) investing cash flows related to the purchase, sale, and maturity of investments, and (3) financing cash flows that impact our capital structure, such as changes in debt and shares outstanding. The following table summarizes these three cash flows over the last three years.

(in thousands)	2008			2007			2006
Operating cash flows	$	161,334		$	127,023		$	171,775
Investing cash flows (uses)	(69,474		)	(6,718		)	(63,325		)
Financing cash flows (uses)	(91,860		)	(120,305		)	(108,450		)

We have posted strong operating cash flow in each of the last three years. Over the last ten years, our operating cash flow has averaged $138.9 million per year. variations in operating cash flow between periods are largely driven by premium volume, claim payments, reinsurance and taxes. In addition, fluctuations in insurance operating expenses impact operating cash flow. The reduction in premium volume experienced in 2008 and 2007 was partially offset by a decline in paid losses, relative to the level experienced in 2006. Loss payments were higher in 2006 as prior year hurricane claims were settled. In 2007, a higher level of pre-tax earnings resulted in significantly higher tax payments than were experienced in either 2008 or 2006. In each of the last three years, the majority of the operating cash flow generated was used in financing activities, funding the share repurchase program. During the last half of 2008, the share repurchase program was suspended and operating cash flow was allocated to investing activities.

Our balance sheet does not reflect any cash balance because all of our funds are invested in short-term investments, primarily highly rated money market instruments.

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We have entered into certain contractual obligations that require us to make recurring payments. The following table summarizes our contractual obligations as of December 31, 2008.

CONTRACTUAL OBLIGATIONS

			Payments due by period
			Less than						More than
(in thousands)	Total		1 yr.		1-3 yrs.		3-5 yrs		5 yrs.
Loss and settlement expense	$	1,159,311	$	329,581	$	443,185	$	186,972	$	199,573
Long-term debt	132,725		5,950		11,900		11,900		102,975
Operating leases	12,948		3,676		5,901		3,275		96
Total	$	1,304,984	$	339,207	$	460,986	$	202,147	$	302,644

Loss and settlement expense reserves represent management’s best estimate of the ultimate cost of settling reported and unreported claims and related expenses. As discussed previously, the estimation of loss and loss expense reserves is based on various complex and subjective judgments. Actual losses and settlement expenses paid may deviate, perhaps substantially, from the reserve estimates reflected in our financial statements. Similarly, the timing for payment of our estimated losses is not fixed and is not determinable on an individual or aggregate basis. The assumptions used in estimating the payments due by periods are based on our historical claims payment experience. Due to the uncertainty inherent in the process of estimating the timing of such payments, there is a risk that the amounts paid in any period can be significantly different than the amounts disclosed above. Amounts disclosed above are gross of anticipated amounts recoverable from reinsurers. Reinsurance balances recoverable on unpaid loss and settlement reserves are reported separately as assets, instead of being netted with the related liabilities, since reinsurance does not discharge us of our liability to policyholders. Amounts recoverable from reinsurers on unpaid loss and settlement reserves totaled $350.3 million at December 31, 2008.

The next largest contractual obligation relates to long-term debt outstanding. On December 12, 2003, we completed a public debt offering of $100 million in senior notes maturing January 15, 2014 (a 10-year maturity) and paying interest semi-annually at the rate of 5.95 percent. The notes were issued at a discount resulting in proceeds, net of discount and commission, of $98.9 million. These notes are rated Baa2 by Moody’s and BBB+ by S&P. We are not party to any off-balance sheet arrangements.

Our primary objective in managing our capital is to preserve and grow shareholders’ equity and statutory surplus to improve our competitive position and allow for expansion of our insurance operations. Our insurance subsidiaries must maintain certain minimum capital levels in order to meet the requirements of the states in which we are regulated. Our insurance companies are also evaluated by rating agencies that assign financial strength ratings that measure our ability to meet our obligations to policyholders over an extended period of time.

We have historically grown our shareholders’ equity and/ or policyholders’ surplus as a result of three sources of funds: (1) earnings on underwriting and investing activities, (2) appreciation in the value of our invested assets, and (3) the issuance of common stock and debt.

At December 31, 2008, we had short-term investments and other investments maturing within one year of approximately $126.2 million and investments of $409.8 million maturing within five years. We maintain a revolving line of credit with JP Morgan, which permits us to borrow up to an aggregate principal amount of $25.0 million. Under certain conditions, the line may be increased up to an aggregate principal amount of $50.0 million. The facility has a three- year term that expires on May 31, 2011. As of December 31, 2008, no amounts were outstanding on the revolving line of credit. We believe that cash generated by operations, cash generated by investments and cash available from financing activities will provide sufficient sources of liquidity to meet our anticipated needs over the next 12 to 24 months. We have generated positive operating cash flow for more than 20 consecutive years. In the most recent three years ended December 31, 2008, 2007, and 2006, our operating cash flow was $161.3 million, $127.0 million, and $171.8 million, respectively. The primary factor in our ability to generate positive operating cash flow is underwriting profitability.

OPERATING ACTIVITIES

The following table highlights some of the major sources and uses of cash flow from operating activities:

Sources	Uses
Premiums received	Claims
Loss payments from reinsurers	Ceded premium to reinsurers
Investment income (interest & dividends)	Commissions paid
	Operating expenses
	Interest expense
	Income taxes

Our largest source of cash is from premiums received from our customers, which we receive at the beginning of the coverage period, for most policies. Our largest cash outflow is for claims that arise when a policyholder incurs an insured loss. Because the payment of claims occurs after the receipt of the premium, often years later, we invest the cash in various investment securities that earn interest and dividends — another source of cash. We use cash to pay commissions to brokers and agents, as well as to pay for ongoing operating expenses such as salaries, rent, taxes, and interest expense. We also utilize reinsurance to manage the risk that we take on our policies. We cede, or pay out, part of the premiums we receive to our reinsurers, and collect cash back when losses subject to our reinsurance coverage are paid.

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The timing of our cash flows from operating activities can vary among periods due to the timing by which payments are made or received. Some of our payments and receipts, including loss settlements and subsequent reinsurance receipts, can be significant, so their timing can influence cash flows from operating activities in any given period. We are subject to the risk of incurring significant losses on catastrophes, both natural (such as earthquakes and hurricanes) and man-made (such as terrorism). If we were to incur such losses, we would have to make significant claims payments in a relatively concentrated period of time.

INVESTING ACTIVITIES

The following table highlights some of the major sources and uses of cash flow from investing activities:

Sources	Uses
Proceeds from bonds sold, called or matured	Purchase of bonds
	Purchase of stocks
Proceeds from stocks sold
Proceeds from sale of unconsolidated investee

We maintain a diversified investment portfolio representing policyholder funds that have not yet been paid out as claims, as well as the capital we hold for our shareholders. As of December 31, 2008, our portfolio had a carrying value of $1.7 billion. Invested assets at December 31, 2008, decreased by $180.9 million, or 10 percent, from December 31, 2007.

Our overall investment philosophy is designed to first protect policyholders by maintaining sufficient funds to meet corporate and policyholder obligations, then generate longterm growth in shareholders’ equity. Because our existing and projected liabilities are sufficiently funded by the fixed income portfolio, we can improve returns by investing a portion of the surplus (within limits) in an equity portfolio. As of December 31, 2008, 41 percent of our shareholders’ equity was invested in equities, as compared to 51 percent at December 31, 2007, and 49 percent at December 31, 2006.

We currently classify 3 percent of the securities in our fixed income portfolio as held-to-maturity, meaning they are carried at amortized cost and are intended to be held until their contractual maturity. Other portions of the fixed income portfolio are classified as available-for-sale (96 percent) or trading (1 percent) and are carried at fair value. As of December 31, 2008, we maintained $1.2 billion in fixed income securities within the available-for-sale and trading classifications. The available-for-sale portfolio provides an additional source of liquidity and can be used to address potential future changes in our asset/liability structure.

The fixed income portfolio is structured to meet policyholder obligations and optimize the generation of after-tax investment income and total return objectives.

FINANCING ACTIVITIES

In addition to the previously discussed operating and investing activities, we also engage in financing activities to manage our capital structure. The following table highlights some of the major sources and uses of cash flow from financing activities:

Sources	Uses
Proceeds from stock offerings	Shareholder dividends
Proceeds from debt offerings	Debt repayment
Short-term borrowing	Share buy-backs
Shares issued under stock option plans

Our capital structure is comprised of equity and debt obligations. As of December 31, 2008, our capital structure consisted of $100.0 million in 10-year maturity senior notes (long-term debt) and $708.2 million of shareholders’ equity. Debt outstanding comprised 12 percent of total capital as of December 31, 2008.

Our 131st consecutive dividend payment was declared in the first quarter of 2009 and will be paid on April 15, 2009, in the amount of $0.26 per share. Since the inception of cash dividends in 1976, we have increased our annual dividend every year.

Dividend payments to us from our principal insurance subsidiary are restricted by state insurance laws as to the amount that may be paid without prior approval of the regulatory authorities of Illinois. The maximum dividend distribution in a rolling 12-month period is limited by Illinois law to the greater of 10 percent of RLI Insurance Company (RLI Ins.) policyholder surplus as of December 31 of the preceding year or the net income of RLI Ins. For the 12-month period ending December 31 of the preceding year. Therefore, the maximum dividend distribution that can be paid by RLI Ins. during 2009 without prior approval is $67.8 million which represents 10 percent of policyholder surplus at December 31, 2008. The 12-month rolling dividend limitation in 2008, based on the above criteria, was $126.2 million. In 2008, total cash dividends of $70.0 million were paid by RLI Ins. These dividends were paid to provide additional capital to RLI Corp. and used for the share repurchase plan, shareholder dividends, interest on senior notes, and general corporate expenses.

For the year, we repurchased 917,200 shares at an average cost of $52.23 per share ($47.9 million). We have $37.8 million of remaining capacity from the $200 million stock repurchase program approved in 2007. In light of market volatility in the second half of 2008, the repurchase program was suspended in the third quarter of 2008 and will remain suspended until conditions warrant its reactivation.

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OUTLOOK FOR 2009

The insurance marketplace, and in particular the excess and surplus lines segment, is subject to cycles involving alternating periods of price increases (“hard markets”) and price decreases (“soft markets”). It is expected that deteriorating industry results, the “financial meltdown” of 2008 and the economic recession that intensified in late 2008 will begin to have a moderating impact on the soft market that has been in existence for the past several years.

We expect to see premium growth in selected products in 2009 and underwriting income overall, absent any major catastrophe. Specific details regarding events in our insurance segments follow.

CASUALTY

We will maintain our profit-focused strategy and look to broaden our production sources and product offerings as a means to holding our market position in this segment. We do expect to see soft market pricing beginning to moderate as the year unfolds.

Continued rate declines will make it increasingly difficult to post underwriting profits. However, we look to our ability to continue to exercise underwriting discipline, and select quality risks to outperform the marketplace in 2009.

PROPERTY

We believe property pricing will start to flatten in the year ahead. We expect our marine business to grow moderately due to new product offerings and an increased focus on writing inland marine coverages. In addition, the recently launched facultative reinsurance product will be additive to premium in 2009. We expect the segment to produce underwriting income in 2009 absent any major catastrophes.

SURETY

The surety segment, like our other segments, is expected to feel the pressure of the stressed economic situation. In 2008, we expanded our geographic footprint and added fidelity coverages. We expect premium growth to continue in 2009. Our experienced underwriting staff coupled with our effective use of technology point to continued profitability in 2009.

INVESTMENTS

We anticipate further volatility in the capital markets in 2009. The underlying factors that drove equity prices higher including earnings growth, ease of credit, leverage, etc., are under pressure going into 2009. Because of this, we have allowed our equity allocations to drift below our 20 percent target. We would expect our allocation to remain below our target unless market conditions improve.

The low interest rate environment will put pressure on our investment income as cash flow is invested at lower yields.

Given the economic conditions of a recession, we believe maintaining a high quality, liquid portfolio in this environment is prudent.

PROSPECTIVE ACCOUNTING STANDARDS

There are several prospective accounting standards that we have not implemented either because the standard has not been finalized or the implementation date has not yet occurred. For a discussion of these prospective standards, see note 1 to the financial statements.

STATE AND FEDERAL LEGISLATION

As an insurance holding company, we, as well as our insurance company subsidiaries, are subject to regulation by the states and territories in which the insurance subsidiaries are domiciled or transact business. Holding company registration in each insurer’s state of domicile requires periodic reporting to the state regulatory authority of the financial, operational and management data of the insurers within the holding company system. All transactions within a holding company system affecting insurers must have fair and reasonable terms, and the insurer’s policyholder surplus following any transaction must be both reasonable in relation to its outstanding liabilities and adequate for its needs. Notice to regulators is required prior to the consummation of certain transactions affecting insurance company subsidiaries of the holding company system.

The insurance holding company laws also require that ordinary dividends be reported to the insurer’s domiciliary regulator prior to payment of the dividend and that extraordinary dividends may not be paid without such regulator’s prior approval. An extraordinary dividend is generally defined under Illinois law as a dividend that, together with all other dividends made within the past 12 months, exceeds the greater of 100 percent of the insurer’s statutory net income for the most recent calendar year, or 10 percent of its statutory policyholders’ surplus as of the preceding year end. Insurance regulators have broad powers to prevent the reduction of statutory surplus to inadequate levels, and there is no assurance that extraordinary dividend payments would be permitted.

Other regulations impose restrictions on the amount and type of investments our insurance company subsidiaries may have. Regulations designed to ensure financial solvency of insurers and to require fair and adequate treatment and service for policyholders are enforced by filing, reporting and examination requirements. Marketplace oversight is conducted by monitoring and periodically examining trade practices, approving policy forms, licensing of agents and brokers, and requiring the filing and in some cases, approval, of premiums and commission rates to ensure they are fair and equitable. Such restrictions may limit the ability of our insurance company subsidiaries to introduce new

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coverages or implement desired changes to current premium rates or policy forms. Financial solvency is monitored by minimum reserve and capital requirements (including risk-based capital requirements), periodic reporting procedures (annually, quarterly, or more frequently if necessary), and periodic examinations.

The quarterly and annual financial reports to the states utilize statutory accounting principles that are different from GAAP, which show the business as a going concern. The statutory accounting principles used by regulators, in keeping with the intent to assure policyholder protection, are generally based on a solvency concept.

Many jurisdictions have laws and regulations that limit an insurer’s ability to withdraw from a particular market. For example, states may limit an insurer’s ability to cancel or not renew policies. Furthermore, certain states prohibit an insurer from withdrawing one or more lines of business from the state, except pursuant to a plan that is approved by the state insurance department. The state insurance department may disapprove a plan that may lead to marketplace disruption. Laws and regulations that limit cancellation and non-renewal and that subject program withdrawals to prior approval requirements may restrict our ability to exit unprofitable marketplaces in a timely manner.

In addition, state-level changes to the insurance regulatory environment are frequent, including changes caused by legislation, regulations by the state insurance regulators, and court rulings. For example, the Florida supreme Court issued a case ruling in 2008 with the effect that surplus lines insurance in Florida is subject to the same regulation as admitted insurance in Florida, excluding rate regulation and certain other areas. Although not stated expressly in the ruling, it implies that surplus lines policy forms must be filed and approved by the Florida Office of Insurance Regulation (FOIR). In response, the FOIR has publicly stated that it disagrees with the ruling and its foundations and that the FOIR does not now nor has it ever required surplus lines insurers to comply with such form filing requirements. In early 2009, a bill was introduced in the Florida legislature to clarify the regulatory status of surplus lines insurance in Florida and provide that policy forms need not be filed and approved by the FOIR. Although the status of this situation is uncertain and at this stage we cannot predict if such legislation will become law or how this matter ultimately will be resolved, we believe it will not result in material negative consequences for us.

Virtually all states require licensed insurers to participate in various forms of guaranty associations in order to bear a portion of the loss suffered by the policyholders of insurance companies that become insolvent. Depending upon state law, licensed insurers can be assessed an amount that is generally equal to a small percentage of the annual premiums written for the relevant lines of insurance in that state to pay the claims of an insolvent insurer. These assessments may increase or decrease in the future, depending upon the rate of insolvencies of insurance companies. In some states, these assessments may be wholly or partially recovered through policy fees paid by insureds.

In addition, the insurance holding company laws require advance approval by state insurance commissioners of any change in control of an insurance company that is domiciled (or, in some cases, having such substantial business that it is deemed to be commercially domiciled) in that state. “Control” is generally presumed to exist through the ownership of 10 percent or more of the voting securities of a domestic insurance company or of any company that controls a domestic insurance company. In addition, insurance laws in many states contain provisions that require prenotification to the insurance commissioners of a change in control of a non-domestic insurance company licensed in those states. Any future transactions that would constitute a change in control of our insurance company subsidiaries, including a change of control of us, would generally require the party acquiring control to obtain the prior approval by the insurance departments of the insurance company subsidiaries’ states of domicile or commercial domicile, if any, and may require pre-acquisition notification in applicable states that have adopted pre-acquisition notification provisions. Obtaining these approvals could result in a material delay of, or deter, any such transaction.

In addition to monitoring our existing regulatory obligations, we are also monitoring developments in the following areas to determine the potential effect on our business and to comply with our legal obligations.

TROUBLED ASSET RELIEF PROGRAM

In 2008, in response to market and banking turmoil, the federal government implemented the Troubled Asset Relief Program (TARP), which is a federal program of the Department of Treasury designed to strengthen U.S. financial institutions through purchasing or insuring troubled assets and equity. The TARP program contains restrictions and controls on participating entities, and may be amended in the future to contain additional restrictions in areas such as executive compensation. To the extent an insurance company participates in TARP, it will be subject to all applicable restrictive and control provision. We do not currently participate in TARP and do not anticipate electing to participate in the future.

TERRORISM INSURANCE

After the events of september 11, 2001, the National Association of Insurance Commissioners (NAIC) urged states to grant conditional approval to commercial lines endorsements that excluded coverage for acts of terrorism consistent with language developed by the Insurance

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Services Office, Inc. (ISO). The ISO endorsement included certain coverage limitations. Many states allowed the endorsements for commercial lines, but rejected such exclusions for personal exposures.

On November 26, 2002, the federal Terrorism Risk Insurance Act of 2002 (TRIA) became law. TRIA was extended through December 31, 2007 and reauthorized through December 31, 2014. The act, as extended and amended, provides for a federal backstop for terrorism losses as defined by the act and certified by the Secretary of the Treasury in concurrence with the Secretary of State and the U.S. Attorney General. Under TRIA, coverage provided for losses caused by acts of foreign or domestic terrorism is partially reimbursed by the United States under a formula whereby the government pays 85 percent of covered terrorism losses exceeding a prescribed deductible to the insurance company providing the coverage. The deductible is 20 percent of gross earned premium net of a few excludable lines and the federal coverage is limited to $100 billion. Coverage under the act must be made available to policyholders, with certain specified exceptions, in commercial property and casualty policies. The immediate effect, as regards state regulation, was to nullify terrorism exclusions to the extent they exclude losses that would otherwise be covered under the act. We are in compliance with the requirements of TRIA and have made terrorism coverage available to applicable policyholders. Given the challenges associated with attempting to assess the possibility of future acts of terror exposures and assign an appropriate price to the risk, we have taken a conservative underwriting position on most of our affected coverages.

SARBANES-OXLEY ACT OF 2002

The Sarbanes-Oxley Act of 2002 presents a significant expansion of securities law regulation of corporate governance and compliance, accounting practices, reporting, and disclosure that affects publicly traded companies. The act, in part, sets forth requirements for certification by CEOs and CFOs of certain reports filed with the securities and Exchange Commission (SEC), disclosures pertaining to the adoption of a code of ethics applicable to certain management personnel, and safeguards against actions to fraudulently influence, manipulate or mislead independent public or certified accountants of the issuer’s financial statements. It also provides stronger requirements for development and evaluation of internal control procedures, as well as provisions pertaining to a company’s audit committee of the board of directors. As required by the act and under the supervision from and participation of management, we annually complete an evaluation of our internal control system including all design, assessment, documentation, and testing phases. This evaluation is intended to identify any deficiencies, measure their materiality, and implement procedures, where necessary, to remediate them.

The annual certification of our CEO with respect to compliance with the New York Stock Exchange corporate governance listing standards has been submitted to the New York Stock Exchange and the annual certifications of our CEO and CFO required by the Sarbanes-Oxley Act of 2002 with respect to our 2008 fiscal year have been filed with the SEC as an exhibit to our annual report on Form 10-K for 2008.

FEDERAL REGULATION OF INSURANCE

The U.S. insurance industry is not currently subject to any significant amount of federal regulation, and instead is regulated principally at the state level. However, federal insurance legislation of various types is periodically proposed in Congress, and in 2007 several bills were introduced in Congress that would impact and regulate various aspects of the insurance industry. These proposed laws covered many areas, including amending and extending the current TRIA law, optional federal charter, streamlining state regulation of nonadmitted insurance, expanding the national flood insurance program, creating a national catastrophe insurance program, and ending the antitrust exemption for insurance companies. However, only the extension and amendment of the TRIA law was enacted. In 2008, such proposals were limited, but we expect that the federal government’s reaction to the economic and financial market turmoil will include some type of federal oversight of the insurance industry, including possibly establishing a federal insurance charter and a federal Office of Insurance Information. We cannot predict whether one or more of the other proposed bills will again be proposed or enacted or whether any significant federal involvement in insurance regulation will be implemented in 2009 or later, or the impact of any such laws or regulation on our company. We will continue to monitor all significant federal insurance legislation.

CORPORATE COMPLIANCE

We have a code of conduct, corporate governance guidelines and compliance manual, which provide directors, officers, and employees with guidance and requirements for complying with a variety of federal and state laws and company policies. Electronic versions of these documents, as well as the following documents, are, or will be, available on our web site (www.rlicorp.com): 2008 summary annual report; 2008 financial report; 2009 proxy statement; annual report on Form 10-K for 2008; and charters of the executive resources, audit, finance and investment, strategy, and nominating/corporate governance committees of our board of directors. Printed copies of these documents will be made available upon request without charge to any shareholder.

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FORWARD LOOKING STATEMENTS

Forward looking statements within the meaning of section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 appear throughout this report. These statements relate to our current expectations, beliefs, intentions, goals or strategies regarding the future and are based on certain underlying assumptions by us. These forward looking statements generally include words such as “expect,” “will,” “should,” “anticipate,” and similar expressions. Such assumptions are, in turn, based on information available and internal estimates and analyses of general economic conditions, competitive factors, conditions specific to the property and casualty insurance industry, claims development, and the impact thereof on our loss reserves, the adequacy of our reinsurance programs, developments in the securities market and the impact on our investment portfolio, regulatory changes and conditions, and other factors. Actual results could differ materially from those expressed in, or implied by, these forward looking statements. We assume no obligation to update any such statements. You should review the various risks, uncertainties, and other factors listed from time to time in our Securities and Exchange Commission filings.

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CONSOLIDATED BALANCE SHEETS

	December 31
in thousands, except per share data	2008			2007
Assets
Investments:
Fixed income:
Available-for-sale, at fair value (amortized cost – $1,236,676 in 2008 and $1,274,734 in 2007)	$	1,224,215		$	1,283,305
Held-to-maturity, at amortized cost (fair value – $41,421 in 2008 and $75,673 in 2007)	39,821			73,648
Trading, at fair value (amortized cost – $10,282 in 2008 and $15,350 in 2007)	10,020			15,413
Equity securities available-for-sale, at fair value (cost – $251,283 in 2008 and $255,598 in 2007)	286,790			393,680
Short-term investments, at cost which approximates fair value	97,982			73,731
Total investments	1,658,828			1,839,777
Cash	—			—
Accrued investment income	17,226			18,296
Premiums and reinsurance balances receivable, net of allowances for uncollectible amounts of $14,740 in 2008 and $13,336 in 2007	92,149			105,937
Ceded unearned premiums	65,977			71,021
Reinsurance balances recoverable on unpaid losses and settlement expenses, net of allowances for uncollectible amounts of $15,803 in 2008 and $18,877 in 2007	350,284			417,250
Deferred policy acquisition costs, net	78,520			78,882
Property and equipment, at cost, net of accumulated depreciation of $43,218 in 2008 and $40,509 in 2007	21,565			20,050
Income taxes – deferred	24,141			—
Investment in unconsolidated investees	38,697			38,162
Goodwill	26,214			26,214
Other assets	45,800			10,934
Total assets	$	2,419,401		$	2,626,523
Liabilities and Shareholders’ Equity
Liabilities:
Unpaid losses and settlement expenses	$	1,159,311		$	1,192,178
Unearned premiums	335,170			355,522
Reinsurance balances payable	30,224			38,273
Notes payable, short-term debt	—			27,975
Income taxes – deferred	—			25,042
Bonds payable, long-term debt	100,000			100,000
Accrued expenses	32,894			39,303
Other liabilities	53,648			73,808
Total liabilities	$	1,711,247		$	1,852,101
Shareholders’ equity:
Common stock ($1 par value, authorized 50,000,000 shares, issued 32,106,085 shares in 2008 and 31,869,596 shares in 2007)	32,106			31,870
Paid-in capital	196,989			192,446
Accumulated other comprehensive earnings, net of tax	15,130			95,701
Retained earnings	807,195			749,767
Deferred compensation	8,312			7,980
Treasury stock, at cost (10,631,656 shares in 2008 and 9,714,456 shares in 2007)	(351,578		)	(303,342		)
Total shareholders’ equity	$	708,154		$	774,422
Total liabilities and shareholders’ equity	$	2,419,401		$	2,626,523

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

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CONSOLIDATED STATEMENTS OF EARNINGS AND COMPREHENSIVE EARNINGS

	Years Ended December 31
in thousands, except per share data	2008			2007			2006
Net premiums earned	$	528,764		$	544,478		$	530,338
Net investment income	78,986			78,901			71,325
Net realized investment gains (losses)	(46,738		)	28,966			31,045
Consolidated revenue	561,012			652,345			632,708
Losses and settlement expenses	247,174			190,868			256,889
Policy acquisition costs	163,320			155,610			145,776
Insurance operating expenses	35,207			42,235			43,617
Interest expense on debt	6,704			6,997			6,581
General corporate expenses	6,853			9,474			8,069
Total expenses	459,258			405,184			460,932
Equity in earnings of unconsolidated investees	4,844			7,315			15,117
Earnings before income taxes	106,598			254,476			186,893
Income tax expense (benefit):
Current	33,721			75,551			59,942
Deferred	(5,799		)	3,058			(7,688		)
Income tax expense	27,922			78,609			52,254
Net earnings	$	78,676		$	175,867		$	134,639
Other comprehensive earnings (loss), net of tax
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the period	$	(111,152	)	$	9,339		$	32,011
Less: Reclassification adjustment for losses (gains) included in net earnings	30,581			(18,783		)	(9,651		)
Other comprehensive earnings (loss)	(80,571		)	(9,444		)	22,360
Comprehensive earnings (loss)	$	(1,895	)	$	166,423		$	156,999
Earnings per share:
Basic – Net earnings per share	$	3.65		$	7.46		$	5.40
Comprehensive earnings (loss) per share	$	(0.09	)	$	7.06		$	6.30
Earnings per share:
Diluted – Net earnings per share	$	3.60		$	7.30		$	5.27
Comprehensive earnings (loss) per share	$	(0.09	)	$	6.91		$	6.14
Weighted average number of common shares outstanding:
Basic	21,540			23,574			24,918
Diluted	21,848			24,085			25,571

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

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CONSOLIDATED STATEMENTS OF CASH FLOWS

			Years ended December 31,
(in thousands)			2008			2007			2006
Cash flows from operating activities
Net earnings			$	78,676		$	175,867		$	134,639
Adjustments to reconcile net earnings to net cash provided by operating activities:
Net realized investment losses (gains)			46,738			(28,966		)	(31,045		)
Depreciation			3,596			3,567			3,503
Other items, net			17,287			10,137			5,783
Change in:	Accrued investment income		1,070			332			(1,654		)
	Premiums and reinsurance balances receivable  (net of direct write-offs and commutations)		13,788			20,084			873
	Reinsurance balances payable		(8,049		)	(16,702		)	(12,480		)
	Ceded unearned premium		5,044			26,575			17,072
	Reinsurance balances recoverable on unpaid losses		66,966			108,421			67,538
	Deferred policy acquisition costs		362			(5,065		)	(4,340		)
	Accounts payable and accrued expenses		(6,409		)	4,613			3,005
	Unpaid losses and settlement expenses		(32,867		)	(126,599		)	(13,089		)
	Unearned premiums		(20,352		)	(32,289		)	4,128
Income taxes:	Current		2,163			(12,250		)	6,823
	Deferred		(5,799		)	3,058			(7,688		)
Stock option excess tax benefit			(4,929		)	(2,042		)	(2,930		)
Changes in investment in unconsolidated investees:		Undistributed earnings	(4,844		)	(7,315		)	(15,117		)
		Dividends received	3,960			5,940			16,500
Net (cash used in) proceeds from trading portfolio activity			4,933			(343		)	254
Net cash provided by operating activities			$	161,334		$	127,023		$	171,775

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				Years ended December 31,
(in thousands)				2008			2007			2006
Cash flows from Investing activities
Purchase of:	Fixed income, held-to-maturity			$	—		$	—		$	—
	Fixed income, available-for-sale			(445,778		)	(339,334		)	(412,019		)
	Equity securities, available-for-sale			(123,415		)	(101,332		)	(139,462		)
	Short-term investments, net			(88,838		)	—			(61,548		)
	Property and equipment			(6,002		)	(4,456		)	(4,590		)
	Note receivable			—			—			(5,000		)
Proceeds from sale of:		Fixed income, held-to-maturity		5,230			—			—
		Fixed income, available-for-sale		143,074			99,360			231,385
		Equity securities, available-for-sale		89,032			77,040			146,635
		Short-term investments, net		—			18,926			—
		Property and equipment		891			1,429			1,356
		Investment in unconsolidated investee		—			—			32,499
Proceeds from call or maturity of:			Fixed income, held-to-maturity	28,870			32,722			28,215
			Fixed income, available-for-sale	327,462			199,427			117,204
			Note receivable	—			9,500			2,000
Net cash used in investing activities				$	(69,474	)	$	(6,718	)	$	(63,325	)
Cash flows from financing activities
Proceeds from issuance of short term debt				$	54,017		$	80,619		$	35
Payment on short-term debt				(81,992		)	(52,644		)	(15,576		)
Stock option excess tax benefit				4,929			2,042			2,930
Proceeds from stock option exercises				(150		)	2,952			3,254
Treasury shares purchased				(47,904		)	(133,268		)	(81,069		)
Cash dividends paid				(20,760		)	(20,006		)	(18,024		)
Net cash used in financing activities				$	(91,860	)	$	(120,305	)	$	(108,450	)
Net decrease in cash				—			—			—
Cash at beginning of year				—			—			—
Cash at end of year				$	—		$	—		$	—

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

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CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(in thousands, except per share data)	Common Shares		Total Shareholders’ Equity			Common Stock		Paid-in Capital			Accumulated Other Comprehensive Earnings (loss)			Retained Earnings			Deferred Compensation		Treasury Stock at Cost
Balance, January 1, 2006	25,551,305		$	692,941		$	31,344	$	181,794		$	82,785		$	478,043		$	7,735	$	(88,760	)
Net earnings			$	134,639										134,639
Other comprehensive earnings, net of tax			22,360								22,360
Treasury shares purchased	(1,624,009	)	(81,069		)														(81,069		)
Deferred compensation under Rabbi trust plans			—														9		(9		)
Stock option excess tax benefit			2,930					2,930
Exercise of stock options	345,682		3,254			346		2,908
Dividends declared ($.75 per share)			(18,535		)									(18,535		)
Balance, December 31, 2006	24,272,978		$	756,520		$	31,690	$	187,632		$	105,145		$	594,147		$	7,744	$	(169,838	)
Net earnings			$	175,867										175,867
Other comprehensive loss, net of tax			(9,444		)						(9,444		)
Treasury shares purchased	(2,297,694	)	(133,268		)														(133,268		)
Deferred compensation under Rabbi trust plans			—														236		(236		)
Stock option excess tax benefit			2,042					2,042
Exercise of stock options	179,856		2,952			180		2,772
Dividends declared ($.87 per share)			(20,247		)									(20,247		)
Balance, December 31, 2007	22,155,140		$	774,422		$	31,870	$	192,446		$	95,701		$	749,767		$	7,980	$	(303,342	)
Net earnings			$	78,676										78,676
Other comprehensive loss, net of tax			(80,571		)						(80,571		)
Treasury shares purchased	(917,200	)	(47,904		)														(47,904		)
Deferred compensation under Rabbi trust plans			—														332		(332		)
Stock option excess tax benefit			4,929					4,929
Exercise of stock options	236,489		(150		)	236		(386		)
Dividends declared ($.99 per share)			(21,248		)									(21,248		)
Balance, December 31, 2008	21,474,429		$	708,154		$	32,106	$	196,989		$	15,130		$	807,195		$	8,312	$	(351,578	)

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

A. DESCRIPTION OF BUSINESS: We underwrite selected property and casualty insurance coverages.

We conduct operations principally through three insurance companies. RLI Insurance Company (RLI Ins.), our principal subsidiary, writes multiple lines insurance on an admitted basis in all 50 states, the District of Columbia, and Puerto Rico. Mt. Hawley Insurance Company, a subsidiary of RLI Ins., writes surplus lines insurance in all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands, and Guam. RLI Indemnity Company (RIC), a subsidiary of Mt. Hawley Insurance Company, has authority to write multiple lines insurance on an admitted basis in 49 states and the District of Columbia.

B. PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION: The accompanying consolidated financial statements were prepared in conformity with GAAP (generally accepted accounting principles in the United States of America), which differ in some respects from those followed in reports to insurance regulatory authorities. The consolidated financial statements include the accounts of our holding company and our subsidiaries. All significant intercompany balances and transactions have been eliminated.

C. ADOPTED ACCOUNTING STANDARDS

SFAS NO. 157, Fair Value Measurements (SFAS 157)

On January 1, 2008, we partially adopted statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements.” As allowed under Financial Accounting Standards Board (FASB) Staff Position (FSP) FAS 157-2, we have elected not to fully adopt SFAS 157 at this time and have deferred adoption for certain nonfinancial assets and liabilities. SFAS 157 establishes a single authoritative definition of fair value, sets out a framework for measuring fair value, and provides a hierarchical disclosure framework for assets and liabilities measured at fair value. The pronouncement describes fair value as being based on a hypothetical transaction to sell an asset or transfer a liability at a specific measurement date (an exit price), as considered from the perspective of a market participant who holds the asset or owes the liability. In addition, fair value should be viewed as a market-based measurement, not an entity-specific measurement. Therefore, fair value should be determined based on the assumptions that market participants would use in pricing an asset or liability, including all risks associated with that asset or liability, such as credit or liquidity risk. SFAS 157 became effective for fiscal years beginning after November 15, 2007. The partial adoption of SFAS 157 had no impact on our financial position or results of operations.

FSP FAS 157-2, Effective Date of FASB Statement No. 157

FASB Staff Position (FSP) FAS 157-2 delays the effective date of FAS 157, Fair Value Measurements, to fiscal years beginning after November 15, 2008 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. The delay is intended to allow the Board and constituents additional time to consider the effect of various implementation issues that have arisen, or that may arise, from the application of FAS 157. Partial deferral of FAS 157 would apply to our goodwill.

FSP FAS 157-3, Determining the Fair Value of a Financial Asset when the Market for that Asset is not Active

FSP FAS 157-3 became effective on October 10, 2008 and clarifies the application of FASB Statement No. 157, “Fair Value Measurements,” in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. In situations in which there is little, if any, market activity for an asset at the measurement date, the fair value measurement objective remains the same, that is, the price that would be received by the holder of the financial asset in an orderly transaction that is not a forced liquidation or distressed sale. Determining the fair value of a financial asset in an illiquid market depends on the facts and circumstances and may require the use of significant judgments for certain Level 2 and all Level 3 financial assets where market activity is not readily available. As of December 31, 2008, we did not have any Level 3 financial assets which would require the use of significant judgments in the determination of fair value.

SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159)

On January 1, 2008, we adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” The Statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is expected to expand the use of fair value measurement, which is consistent with the board’s long-term measurement objectives for accounting for financial instruments. SFAS 159 became effective for fiscal years beginning after November 15, 2007. We elected not to

33

implement the fair value option with respect to any existing assets or liabilities; therefore, the adoption of SFAS 159 had no impact on our financial position or results of operations.

D. PROSPECTIVE ACCOUNTING STANDARDS

SFAS No. 141(R), “Business Combinations” (SFAS 141(R))

In December 2007, the FASB issued SFAS 141(R), “Business Combinations,” which replaces SFAS 141, “Business Combinations.” Assets and liabilities that arose from business combinations which occurred prior to the adoption of SFAS 141(R) are not adjusted upon the adoption of SFAS 141(R). Among other things, SFAS 141(R) broadens the scope of SFAS 141 to include all transactions where an acquirer obtains control of one or more other businesses. SFAS 141(R) retains the guidance to recognize intangible assets separately from goodwill and requires, with limited exceptions, that all assets acquired and liabilities assumed, including certain contractual contingencies, be measured at their acquisition date fair values. SFAS 141(R) requires most acquisition and restructuring—related costs to be expensed as incurred. Step acquisitions, once control is acquired, are to be recorded at the full amounts of the fair values of the identifiable assets, liabilities and the non-controlling interest in the acquiree. SFAS 141(R) also replaces the reduction of asset values and recognition of negative goodwill with a requirement to recognize a gain in earnings. The provisions of SFAS 141(R) are effective for fiscal years beginning after December 15, 2008. Early adoption is not permitted. We will apply the provisions of SFAS No. 141(R) as applicable when effective.

FSP No. 142-3, “Determination of the Useful Life of Intangible Assets” (FSP 142-3)

In April 2008, the FASB issued FSP 142-3, “Determination of the Useful Life of Intangible Assets.” FSP 142-3 amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under FASB 142, “Goodwill and Other Intangible Assets.” The intent of FSP 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R) and other generally accepted accounting principles. This new guidance applies prospectively to intangible assets that are acquired individually or with a group of other assets in business combinations and asset acquisitions. FSP 142-3 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. Early adoption is prohibited. We do not expect the implementation of FSP 142-3 to have a significant impact on our financial position or results of operations.

FSP No. 140-4 and FIN 46(R)-8, “Disclosure by public Entities (Enterprises) About Transfers of Financial Assets and interests in Variable Interest Entities” (FSP 140-4 and FIN 46(R)-8)

In December 2008, the FASB issued FSP 140-4 and FIN 46R-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in variable Interest Entities.” FSP 140-4 and FIN 46R-8 require additional disclosures about transfers of financial assets and involvement with variable interest entities. The requirements apply to transferors, sponsors, servicers, primary beneficiaries and holders of significant variable interests in a variable interest entity or qualifying special purpose entity. Disclosures required by FSP 140-4 and FIN 46R-8 are effective in the first quarter of fiscal 2009. Because FSP 140-4 and FIN 46R-8 only require additional disclosures, the adoption will not impact our financial position or results of operations.

E. INVESTMENTS: In compliance with statement of Financial Accounting standards (SFAS) 115, “Accounting for Certain Investments in Debt and Equity securities,” we classify our investments in all debt and equity securities into one of three categories: available-for-sale, held-to-maturity, or trading.

Available-For-Sale Securities

Debt and equity securities not included as held-to-maturity or trading are classified as available-for-sale and reported at fair value. Our equity securities consist of a core stock portfolio weighted toward dividend-paying stocks, as well as preferred stock, real estate investment trusts (REITs), exchange traded funds (ETFs), and mutual funds. Unrealized gains and losses on these securities are excluded from net earnings but are recorded as a separate component of comprehensive earnings and shareholders’ equity, net of deferred income taxes. All of our equity securities and approximately 94 percent of debt securities are classified as available-for-sale.

Held-to-Maturity Securities

Debt securities that we have the positive intent and ability to hold to maturity are classified as held-to-maturity and carried at amortized cost. Except for declines that are other-than-temporary, changes in the fair value of these securities are not reflected in the financial statements. We have classified approximately 3 percent of our debt securities portfolio as held-to-maturity.

Trading Securities

Debt and equity securities purchased for short-term resale are classified as trading securities. These securities are reported at fair value with unrealized gains and losses included in earnings. We have classified approximately 1 percent of our debt securities portfolio as trading. In 2008,

34

we inadvertently sold three fixed income positions ($5.2 million) designated as held-to-maturity. From a custodial perspective, these securities were held with our available-for-sale portfolio. These transactions generated a realized gain of $0.2 million. To mitigate the likelihood of this event reoccurring, we opened new custodial accounts to segregate our held-to-maturity investments from our available-for-sale investments.

For the years ended December 31, 2008, 2007, and 2006, no securities were transferred from held-to-maturity to available-for-sale or trading.

We regularly evaluate our fixed income and equity securities using both quantitative and qualitative criteria to determine impairment losses for other-than-temporary declines in the fair value of the investments. The following are the factors for determining if a security is other-than-temporarily impaired:

·The length of time and the extent to which the fair value has been less than cost;

·The probability of significant adverse changes to the cash flows on a fixed income investment;

·The occurrence of a discrete credit event resulting in the issuer defaulting on a material obligation or the issuer is seeking protection from creditors under the bankruptcy laws, or the issuer is proposing a voluntary reorganization which creditors are asked to exchange their claims for cash or securities having a fair value substantially lower than par value of their claims; or

·The probability that we will not receive all contractual or estimated cash flows in the form of principal and interest.

Quantitative criteria considered during this process include, but are not limited to: the degree and duration of current fair value as compared to the cost (amortized, in certain cases) of the security, degree and duration of the security’s fair value being below cost and, for fixed maturities, whether the issuer is in compliance with terms and covenants of the security. Qualitative criteria include the credit quality, current economic conditions, the anticipated speed of cost recovery, the financial health of and specific prospects for the issuer, as well as our intent and ability to hold the security to maturity or until forecasted recovery. In addition, we consider price declines of securities in our other-than-temporary impairment analysis where such price declines provide evidence of declining credit quality, and we distinguish between price changes caused by credit deterioration, as opposed to rising interest rates. see note 2 for further discussion of other-than-temporary impairment.

Interest on fixed maturities and short-term investments is credited to earnings as it accrues. Premiums and discounts are amortized or accreted over the lives of the related fixed maturities. Dividends on equity securities are credited to earnings on the ex-dividend date. Realized gains and losses on disposition of investments are based on specific identification of the investments sold on the trade date.

F. CASH: Cash consists of cash in banks, generally in operating accounts. On a daily basis, our cash accounts are swept into short-term investments, principally money market instruments. As a result, our balance sheet does not reflect any cash balance.

G. SHORT-TERM INVESTMENTS: We classify money market funds and securities lending collateral as short-term investments. Whereas our strategy is to be fully invested at all times, short-term investments in excess of demand deposit balances are considered a component of investment activities, and thus are classified as investments in our consolidated balance sheets. Short-term investments are carried at cost, which approximates fair value. These funds generally have original maturities of less than 90 days and, therefore, bear minimal risk. We have not experienced losses on these instruments.

H. REINSURANCE: Ceded unearned premiums and reinsurance balances recoverable on paid and unpaid losses and settlement expenses are reported separately as assets, instead of being netted with the related liabilities, since reinsurance does not relieve us of our legal liability to our policyholders.

We continuously monitor the financial condition of our reinsurers. As part of our monitoring efforts, we review their annual financial statements and Securities and Exchange Commission filings. We also review insurance industry developments that may impact the financial condition of our reinsurers. We analyze the credit risk associated with our reinsurance balances recoverable by monitoring the A.M. Best and Standard & Poor’s (S&P) ratings of our reinsurers. In addition, we subject our reinsurance recoverables to detailed recoverable tests, including one based on average default by S&P rating. Based upon our review and testing, our policy is to charge to earnings, in the form of an allowance, an estimate of unrecoverable amounts from reinsurers. This allowance is reviewed on an ongoing basis to ensure that the amount makes a reasonable provision for reinsurance balances that we may be unable to recover.

I. 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. Acquisition-related costs may be deemed ineligible for deferral when they are based on contingent or performance criteria beyond the basic acquisition of the insurance contract. All eligible 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. This

35

would also give effect to the premiums to be earned and anticipated losses and settlement expenses, as well as certain other costs expected to be incurred as the premiums are earned. Judgments as to the ultimate recoverability of such deferred costs are highly dependent upon estimated future loss costs associated with the premiums written. This deferral methodology applies to both gross and ceded premiums and acquisition costs.

J. PROPERTY AND EQUIPMENT: Property and equipment are presented at cost less accumulated depreciation and are depreciated on a straight-line basis for financial statement purposes over periods ranging from three to 10 years for equipment and up to 30 years for buildings and improvements.

K. INVESTMENT IN UNCONSOLIDATED INVESTEES: We maintain a 40 percent interest in the earnings of Maui Jim, Inc. (Maui Jim), a manufacturer of high-quality polarized sunglasses, which is accounted for by the equity method. We also maintain a similar minority representation on their board of directors, held by our chairman, president, and CFO. Maui Jim’s chief executive officer owns a controlling majority of the outstanding shares of Maui Jim, Inc. Our investment in Maui Jim was $38.7 million in 2008 and $38.2 million in 2007. In 2008, we recorded $4.8 million in investee earnings compared to $7.3 million in 2007 and $8.8 million in 2006. Maui Jim recorded net income of $11.6 million in 2008, $18.0 million in 2007 and $22.1 million in 2006. Additional summarized financial information for Maui Jim for 2008 and 2007 is outlined in the following table:

(in millions)	2008		2007
Total assets	$	141.3	$	150.3
Total liabilities	68.4		79.0
Total equity	72.9		71.3

Approximately $26.0 million of undistributed earnings from Maui Jim are included in our retained earnings as of December 31, 2008. In 2008, we received a dividend of $4.0 million from Maui Jim.

Prior to December 2006, we also maintained a 21 percent interest in the earnings of Taylor, Bean & Whitaker Mortgage Corp. (TBW), a private mortgage origination company which was accounted for by the equity method. In December 2006, we sold our interest in the company for $32.5 million to TBW’s chairman, who owned the majority of the outstanding shares prior to the sale. We realized a $16.2 million pretax gain on the sale of equity. Our investment in TBW, prior to the sale, was $16.3 million in 2006. In 2006, we recorded $6.3 million in investee earnings.

In December 2006, we became a 17 percent participant in a loan syndicate which provided TBW’s majority shareholder with short-term financing. Our share of the loan totaled $5.0 million. The loan was collateralized by TBW shares and our portion contained the same market terms and conditions as those of the lead and other syndicate members. We also had a separate note receivable from TBW totaling $4.5 million at December 31, 2006, which originated in 1999 as an operating loan. In 2007, we received payment in full for both the loan and note receivable from TBW.

We perform an impairment review of our investment in our unconsolidated investee which considers current valuation and operating results. Based upon the most recent review, this asset was not impaired.

L. INTANGIBLE ASSETS: In accordance with SFAS 142, “Goodwill and Other Intangible Assets,” the amortization of goodwill and indefinite-lived intangible assets is not permitted. Goodwill and indefinite-lived intangible assets remain on the balance sheet and are tested for impairment on an annual basis, or earlier when there is reason to suspect that their values may have been diminished or impaired. Goodwill, which relates to our surety segment, is listed separately on the balance sheet and totaled $26.2 million at December 31, 2008 and 2007. Goodwill impairment testing was performed during 2008, pursuant to the requirements of SFAS 142. Based upon this review, this asset was not impaired.

Intangible assets with definite lives continue to be amortized over their estimated useful lives. Definite-lived intangible assets that were amortized under SFAS 142 during the periods presented relate to our purchase of customer-related and marketing-related intangibles. These intangibles had useful lives ranging from five to 10 years. Amortization of intangible assets was $0.1 million for 2007 compared to $0.4 million for 2006. There was no amortization expense in 2008 as these assets were fully amortized in 2007.

At December 31, 2006, net intangible assets totaled $0.1 million, net of $5.6 million of accumulated amortization, and were included in other assets.

M. 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

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determined. Due to the inherent uncertainty in estimating reserves for losses and settlement expenses, there can be no assurance that the ultimate liability will not exceed recorded amounts. If actual liabilities do exceed recorded amounts, there will be an adverse effect. Furthermore, we may determine that recorded reserves are more than adequate to cover expected losses, as happened during 2004 through 2008, when favorable experience primarily on casualty business led us to reduce our reserves. Based on the current assumptions used in estimating reserves, we believe that our overall reserve levels at December 31, 2008, make a reasonable provision to meet our future obligations. see note 6 for a further discussion of unpaid losses and settlement expenses.

N. INSURANCE REVENUE RECOGNITION: Insurance premiums are recognized ratably over the term of the contracts, net of ceded reinsurance. Unearned premiums are calculated on a monthly pro rata basis.

O. INCOME TAXES: We file a consolidated income tax return. Income taxes are accounted for using the asset and liability method under which deferred income taxes are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities, operating losses, and tax credit carry forwards. The effect on deferred taxes for a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance if it is more-likely-than-not all or some of the deferred tax assets will not be realized.

On January 1, 2007, we adopted the provisions of FIN 48, “Accounting for Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with FASB statement No. 109, “Accounting for Income Taxes.” The adoption of FIN 48 did not have an impact on our financial position or results of operations as we have taken no significant tax positions which would require accrual or disclosure under the new guidance. Penalties and interest are included in tax expense. Although the IRS is not currently examining any of our income tax returns, tax years 2005 through 2008 remain open and are subject to examination.

P. EARNINGS PER SHARE: Pursuant to disclosure requirements contained in SFAS 128, “Earnings per share,” the following represents a reconciliation of the numerator and denominator of the basic and diluted earnings per share (EPS) computations contained in the financial statements.

(in thousands, except per share data)	Income (Numerator)		Shares (Denominator)	Per Share Amount
For the year ended December 31, 2008
Basic EPS
Income available to common shareholders	$	78,676	21,540	$	3.65
Stock options	—		308
Diluted EPS
Income available to common shareholders and assumed conversions	$	78,676	21,848	$	3.60
For the year ended December 31, 2007
Basic EPS
Income available to common shareholders	$	175,867	23,574	$	7.46
Stock options	—		511
Diluted EPS
Income available to common shareholders and assumed conversions	$	175,867	24,085	$	7.30
(For the year ended December 31, 2006
Basic EPS
Income available to common shareholders	$	134,639	24,918	$	5.40
Stock options	—		653
Diluted EPS
Income available to common shareholders and assumed conversions	$	134,639	25,571	$	5.27

Q. COMPREHENSIVE EARNINGS: The difference between our net earnings and our comprehensive earnings is that comprehensive earnings include unrealized gains/losses on our available-for-sale investment securities net of tax, whereas net earnings does not include such amounts, and such amounts are instead directly credited or charged against shareholders’ equity. In reporting the components of comprehensive earnings on a net basis in the income statement, we have used a 35 percent tax rate. Other comprehensive income (loss), as shown in the consolidated statements of earnings and comprehensive earnings, is net of tax expense (benefit) of $(43.3) million, $(5.1) million and $12.0 million, respectively, for 2008, 2007, and 2006.

R. FAIR VALUE DISCLOSURES: The following was considered in the estimation of fair value for each class of financial instruments for which it was practicable to estimate that value. We utilize Interactive Data Corporation (IDC) to

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obtain quoted market prices for our investment securities. We continue to classify our equities as level 1 securities with “an active market.” All bonds are classified as level 2. Because these securities do not always have quoted market prices, other transactional data (prices of similar securities, prices of securities from the same issuer, spreads by issuer, sector, etc.) is used to arrive at the current market price. All but five of our 856 positions were priced through IDC at December 31, 2008. Two of the five positions that were not automatically priced used Bloomberg as the secondary pricing source, while the other three were priced by our custodian, JP Morgan. The total fair value of these five securities was less than $13 million.

Fair value disclosures for investments are included in note 2. Due to the relatively short-term nature of cash, short- term investments, accounts receivable, accounts payable, and short-term debt, their carrying amounts are reasonable estimates of fair value. The fair value of our long-term debt is discussed further in note 4.

S. STOCK-BASED COMPENSATION: We account for stock-based compensation pursuant to statement of Financial Accounting Standards (SFAS) No. 123, “Share-Based Payment,” (SFAS 123R) which requires companies to expense the estimated fair value of employee stock options and similar awards. SFAS 123R requires entities to measure compensation cost for awards of equity instruments to employees based on the grant-date fair value of those awards and recognize compensation expense over the service period that the awards are expected to vest.

We calculate the tax effects of share-based compensation pursuant to SFAS 123(R) and under the alternative transition method provided in Financial Accounting standards Board (“FASB”) staff Position No. SFAS 123(R)-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards.” The alternative transition method included simplified methods to determine the impact on the additional paid-in capital pool (“APIC pool”) and consolidated statements of cash flows of the tax effects of employee share-based compensation awards that were outstanding upon adoption of SFAS 123(R).

See note 8 for further discussion and related disclosures regarding stock options.

T. RISKS AND UNCERTAINTIES: Certain risks and uncertainties are inherent to our day-to-day operations and to the process of preparing our financial statements. The more significant risks and uncertainties, as well as our attempt to mitigate, quantify, and minimize such risks, are presented below and throughout the notes to the consolidated financial statements.

Catastrophe Exposures

Our insurance coverages include exposure to catastrophic events. Our major catastrophe exposure is to losses caused by earthquakes, primarily on the West Coast. Our second largest catastrophe exposure is to losses caused by hurricanes to commercial properties throughout the Gulf and East Coasts, as well as to homes we insure in Hawaii. We monitor these exposures by quantifying our exposed policy limits in each region and by using computer-assisted modeling techniques. Additionally, we further limit our risk to such catastrophes through the purchase of reinsurance. In 2008, our property underwriting was supported by $375 million in excess of a $25 million first dollar retention in traditional catastrophe reinsurance protection, subject to certain retentions by us. The limit decreased to $350 million at July 1, 2008. At January 1, 2009, we renewed our $350 million reinsured limit, subject to certain retentions by us. We actively manage our catastrophe program to keep our net retention in line with risk tolerances and to optimize the risk/return trade off.

Environmental Exposures

We are subject to environmental claims and exposures through our commercial umbrella, general liability, and discontinued assumed reinsurance lines of business. Although exposure to environmental claims exists in these lines of business, we have sought to mitigate or control the extent of this exposure through the following methods: 1) our policies include pollution exclusions that have been continually updated to further strengthen the exclusions, 2) our policies primarily cover moderate hazard risks, and 3) we began writing this business after the insurance industry became aware of the potential pollution liability exposure.

We have made loss and settlement expense payments on environmental liability claims and have loss and settlement expense reserves for others. We include this historical environmental loss experience with the remaining loss experience in the applicable line of business to project ultimate incurred losses and settlement expenses as well as related incurred but not reported (IBNR) loss and settlement expense reserves.

Although historical experience on environmental claims may not accurately reflect future environmental exposures, we have used this experience to record loss and settlement expense reserves in the exposed lines of business. See further discussion of environmental exposures in note 6.

Reinsurance

Reinsurance does not discharge us from our primary liability to policyholders, and to the extent that a reinsurer is unable to meet its obligations, we would be liable. We continuously monitor the financial condition of prospective and existing reinsurers. As a result, we currently purchase reinsurance from a number of financially strong reinsurers. We provide an allowance for reinsurance balances deemed uncollectible. See further discussion of reinsurance exposures in note 5.

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Investment Risk

Our investment portfolio is subject to market, credit, and interest rate risks. The equity portfolio will fluctuate with movements in the overall stock market. While the equity portfolio has been constructed to have lower downside risk than the market, the portfolio is sensitive to movements in the market. The bond portfolio is affected by interest rate changes and credit spreads. We mitigate our interest rate and credit risks by constructing a well-diversified portfolio with high-quality securities.

The prolonged downturn of the global financial markets and economy resulted in significant declines and lack of liquidity in the financial markets. While we maintain a high quality portfolio, it was not immune to the negative swings in the markets. The deterioration was not limited in its scope, as most segments of the financial markets were impacted. As such, this resulted in our total portfolio having a negative return of 4.4 percent for the year. Continued downturns in the financial markets could have a negative effect on our portfolio. However, we manage this risk through asset allocation and security selection.

Liquidity Risk

Liquidity is essential to our business and a key component of our concept of asset-liability matching. Our liquidity may be impaired by an inability to collect premium receivable or reinsurance recoverable balances timely, an inability to sell assets or redeem our investments, an inability to access funds from our insurance subsidiaries, unforeseen outflows of cash or large claim payments, or an inability to access debt or equity capital markets. This situation may arise due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects third parties or us, or even by the perception among market particpants that we, or other market particpants, are experiencing greater liquidity risk. To date, the ongoing liquidity crisis and the loss of confidence in financial institutions has not increased our cost of funding and has not limited our access to some of our traditional sources of liquidity.

Our credit ratings are important to our liquidity. A reduction in our credit ratings could adversely affect our liquidity and competitive position, increase our borrowing costs, or limit our access to the capital markets.

Financial Statements

The preparation of the accompanying consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions about future events. These estimates and the underlying assumptions affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities, and reported amounts of revenues and expenses. The most significant of these amounts is the liability for unpaid losses and settlement expenses. Other estimates include investment valuation, the collectibility of reinsurance balances, recoverability of deferred tax assets, and deferred policy acquisition costs. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. We adjust such estimates and assumptions when facts and circumstances dictate. Illiquid credit markets and volatile equity markets have combined to increase the uncertainty inherent in such estimates and assumptions. Although recorded estimates are supported by actuarial computations and other supportive data, the estimates are ultimately based on our expectations of future events. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in those estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.

External Factors

Our insurance subsidiaries are highly regulated by the states in which they are incorporated and by the states in which they do business. such regulations, among other things, limit the amount of dividends, impose restrictions on the amount and types of investments and regulate rates insurers may charge for various coverages. We are also subject to insolvency and guarantee fund assessments for various programs designed to ensure policyholder indemnification. We generally accrue an assessment during the period in which it becomes probable that a liability has been incurred from an insolvency and the amount of the related assessment can be reasonably estimated.

The National Association of Insurance Commissioners (NAIC) has developed Property-Casualty Risk-Based Capital (RBC) standards that relate an insurer’s reported statutory surplus to the risks inherent in its overall operations. The RBC formula uses the statutory annual statement to calculate the minimum indicated capital level to support asset (investment and credit) risk and underwriting (loss reserves, premiums written, and unearned premium) risk. The NAIC model law calls for various levels of regulatory action based on the magnitude of an indicated RBC capital deficiency, if any. We regularly monitor our subsidiaries’ internal capital requirements and the NAIC’s RBC developments. As of December 31, 2008, we have determined that our capital levels are well in excess of the minimum capital requirements for all RBC action levels and that our capital levels are sufficient to support the level of risk inherent in our operations.

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In addition, ratings are a critical factor in establishing the competitive position of insurance companies. Our insurance companies are rated by A.M. Best, S&P, and Moody’s. Their ratings reflect their opinions of an insurance company’s and an insurance holding company’s financial strength, operating performance, strategic position, and ability to meet its obligations to policyholders.

2.  INVESTMENTS

A summary of net investment income is as follows:

NET INVESTMENT INCOME

(in thousands)	2008			2007			2006
Interest on fixed income securities	$	68,290		$	69,481		$	64,486
Dividends on equity securities	13,863			12,252			10,402
Interest on short-term investments	1,484			2,716			2,125
Gross investment income	83,637			84,449			77,013
Less investment expenses	(4,651		)	(5,548		)	(5,688		)
Net investment income	$	78,986		$	78,901		$	71,325

Pretax net realized investment gains (losses) and net changes in unrealized gains (losses) on investments for the years ended December 31 are summarized as follows:

REALIZED/UNREALIZED GAINS

(in thousands)	2008			2007			2006
Net realized Investment gains (losses)
Fixed income
Available-for-sale	$	(8,350	)	$	(966	)	$	(7,351	)
Held-to-maturity	270			89			92
Trading	(123		)	(103		)	(53		)
Equity securities	(38,698		)	29,863			22,374
Other	163			83			15,983
	(46,738		)	28,966			31,045
Net changes in unrealized gains (losses) on investments
Fixed income
Available-for-sale	(21,032		)	14,020			2,323
Held-to-maturity	(425		)	(395		)	(2,030		)
Equity securities	(102,575		)	(28,669		)	32,072
	(124,032		)	(15,044		)	32,365
Net realized investment gains (losses) and changes in unrealized gains (losses) on investments	$	(170,770	)	$	13,922		$	63,410

During 2008, we recorded $46.7 million in net realized losses and the portfolio experienced unrealized losses of $124.0 million. For 2008, the net realized investment losses and changes in unrealized gains (losses) on investments totaled $170.8 million. The majority of our net realized losses and change in unrealized gains were in our equity portfolio. The equity portfolio was impacted by the negative return in the stock market, exposure to the financial sector with preferred stocks, and a flight to quality in the municipal bond market which negatively impacted our high-yield municipal bond mutual fund.

Following is a summary of the disposition of fixed maturities and equities for the years ended December 31, with separate presentations for sales and calls/maturities:

	Proceeds		Gross Realized					Net Realized
(in thousands)	From Sales		Gains		Losses			Gain (Loss)
SALES
2008 —
Available-for-sale	$	143,074	$	4,269	$	(3,759	)	$	510
Held-to-maturity	5,230		179		—			179
Trading	10,885		241		(312		)	(71		)
Equities	89,032		25,959		(30,806		)	(4,847		)
2007 —
Available-for-sale	$	99,360	$	452	$	(1,435	)	$	(983	)
Trading	6,619		25		(128		)	(103		)
Equities	77,040		32,347		(2,484		)	29,863
2006 —
Available-for-sale	$	231,385	$	666	$	(8,076	)	$	(7,410	)
Trading	4,950		17		(70		)	(53		)
Equities	146,635		41,097		(2,519		)	22,374
CALLS/MATURITIES
2008 —
Available-for-sale	$	327,462	$	137	$	—		$	137
Held-to-maturity	28,870		92		(1		)	91
Trading	1,561		1		—			1
2007 —
Available-for-sale	$	199,427	$	38	$	(21	)	$	17
Held-to-maturity	32,722		89		—			89
Trading	1,309		—		—			—
2006 —
Available-for-sale	$	117,204	$	59	$	—		$	59
Held-to-maturity	28,215		92		—			92
Trading	1,083		—		—			—

FAIR VALUE MEASUREMENTS

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

Effective January 1, 2008, we determined the fair values of certain financial instruments based on the fair value hierarchy established in SFAS 157. SFAS 157 requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value.

Level 1: Quoted price (unadjusted) in active markets for identical assets.

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Level 2: Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument.

Level 3: Inputs to the valuation methodology are unobservable for the asset or liability.

SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

To measure fair value, we obtain quoted market prices for our investment securities. If a quoted market price is not available, we use quoted market prices of similar securities.

Assets measured at fair value on a recurring basis as of December 31, 2008, are summarized below:

(in thousands)	Quoted in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)	Total Total
Trading securities	$	—	$	10,020	—	$	10,020
Available-for-sale securities	286,790		1,224,215		—	1,511,005
Total	$	286,790	$	1,234,235	—	$	1,521,025

As noted in the above table, we did not have any assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as of December 31, 2008.

Assets and Liabilities Recorded at Fair Value on a Non-recurring Basis

As allowed under FSP FAS 157-2, Effective Date of FASB Statement No. 157, as of January 1, 2008, we have elected not to fully adopt SFAS 157 and have deferred adoption for certain nonfinancial assets and liabilities. On our balance sheet, this deferral would apply to goodwill.

In addition, the following is a schedule of amortized costs and estimated fair values of investments in fixed income and equity securities as of December 31, 2008 and 2007:

	Amortized				Gross Unrealized
(in thousands)	Cost		Fair Value		Gains		Losses
2008
AVAILABLE-FOR-SALE
U.S. government	$	6,596	$	7,065	$	469	$	—
U.S. agencies	285,937		288,177		2,664		(424		)
Mtge/ABS/CMO*	233,275		231,522		4,239		(5,992		)
Corporate	287,557		270,164		2,647		(20,040		)
States, political subdivisions & revenues	423,311		427,287		8,841		(4,865		)
Fixed maturities	1,236,676		1,224,215		18,860		(31,321		)
Equity securities	251,283		286,790		63,063		(27,556		)
Total available-for-sale	$	1,487,959	$	1,511,005	$	81,923	$	(58,877	)
HELD-TO-MATURITY
U.S. government	$	4,916	$	5,019	$	103	$	—
U.S. agencies	8,960		9,916		956		—
States, political subdivisions & revenues	25,945		26,486		541		—
Total held-to-maturity	$	39,821	$	41,421	$	1,600	$	—
TRADING**
U.S. government	$	1,150	$	1,312	—		—
U.S. agencies	—		—		—		—
Mtge/ABS/CMO*	6,097		5,881		—		—
Corporate	2,935		2,722		—		—
States, political subdivisions & revenues	100		105		—		—
Total trading	$	10,282	$	10,020	—		—
Total	$	1,538,062	$	1,562,446	$	83,523	$	(58,877	)

*Mortgage-backed, asset-backed & collateralized mortgage obligations

**Trading securities are carried at fair value with unrealized gains (losses) included in earnings.

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	Amortized				Gross Unrealized
(in thousands)	Cost		Fair Value		Gains		Losses
2007
AVAILABLE-FOR-SALE
U.S. government	$	6,656	$	6,788	$	132	$	—
U.S. agencies	335,873		339,171		3,298		—
Mtge/ABS/CMO*	294,125		295,274		2,741		(1,592		)
Corporate	229,587		228,183		2,299		(3,703		)
States, political subdivisions & revenues	408,493		413,889		5,784		(388		)
Fixed maturities	1,274,734		1,283,305		14,254		(5,683		)
Equity securities	255,598		393,680		150,937		(12,855		)
Total available-for-sale	$	1,530,332	$	1,676,985	$	165,191	$	(18,538	)
HELD-TO-MATURITY
U.S. government	$	6,250	$	6,382	$	132	$	—
U.S. agencies	8,912		9,630		718		—
States, political subdivisions & revenues	58,486		59,661		1,175		—
Total held-to-maturity	$	73,648	$	75,673	$	2,025	$	—
TRADING**
U.S. government	$	2,150	$	2,221	—		—
U.S. agencies	1,066		1,087		—		—
Mtge/ABS/CMO*	8,051		8,077		—		—
Corporate	3,983		3,921		—		—
States, political subdivisions & revenues	100		107		—		—
Total trading	$	15,350	$	15,413	—		—
Total	$	1,619,330	$	1,768,071	$	167,216	$	(18,538	)

*Mortgage-backed, asset-backed & collateralized mortgage obligations

**Trading securities are carried at fair value with unrealized gains (losses) included in earnings.

MBS/ABS/CMO

The unrealized losses in our MBs/ABs/CMO portfolio are primarily contained in the commercial mortgage-backed securities. These securities were negatively affected in the second half of the year by the overall decline in the real estate market and the lack of liquidity in the credit markets. The securities remain AAA rated and we believe it is probable that we will receive all contractual or estimated cash flows in the form of principal and interest. We have the ability and intent to hold these investments until recovery

in value, which may be maturity, and thus do not consider these investments to be other-than-temporarily impaired at December 31, 2008.

Corporate Bonds

The unrealized losses in the corporate bond portfolio were caused by a general rise in interest rate spreads in 2008. The interest rate spread widening was primarily caused by the financial crisis and slowing economy. The corporate bond portfolio has an overall rating of A and we believe it is probable that we will receive all contractual payments in the form of principal and interest. In addition, we have the ability and intent to hold these investments until a recovery in value, which may be maturity. We do not consider these investments to be other-than-temporarily impaired at December 31, 2008.

Equity Securities

Our equity portfolio consists of common stock, REITs, preferred stocks, exchange traded funds and a high-yield municipal bond fund. The majority of our net unrealized losses are contained within the three exchange traded funds in the portfolio. We began diversifying our equity portfolio towards the end of 2007 with exchange traded funds. The exchange traded funds track various indices and have returns for 2008 consistent with the equity benchmark indices they follow. Given the short amount of time we owned these securities, the ETFs’ position relative to the benchmarks they track, and forecasted recovery periods, we do not consider the exchange traded funds to be other-than-temporarily impaired at December 31, 2008.

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The amortized cost and estimated fair value of fixed income securities at December 31, 2008, by contractual maturity, are shown as follows:

(in thousands)	Amortized Cost		Fair Value
AVAILABLE-FOR-SALE
Due in one year or less	$	16,317	$	16,465
Due after one year through five years	253,210		256,334
Due after five years through 10 years	442,644		433,793
Due after 10 years	524,505		517,623
	$	1,236,676	$	1,224,215
HELD-TO-MATURITY
Due in one year or less	$	12,113	$	12,260
Due after one year through five years	25,320		26,627
Due after five years through 10 years	2,388		2,534
Due after 10 years	—		—
	$	39,821	$	41,421
TRADING
Due in one year or less	$	—	$	—
Due after one year through five years	2,100		2,033
Due after five years through 10 years	2,888		2,774
Due after 10 years	5,294		5,213
	$	10,282	$	10,020
TOTAL FIXED INCOME
Due in one year or less	$	28,430	$	28,725
Due after one year through five years	280,630		284,994
Due after five years through 10 years	447,920		439,101
Due after 10 years	529,799		522,836
	$	1,286,779	$	1,275,656

Expected maturities may differ from contractual maturities due to call provisions on some existing securities and prepayment features on mortgage-backed, asset-backed, and collateralized mortgage obligations. At December 31, 2008, the net unrealized appreciation of available-for-sale fixed maturities and equity securities totaled $23.0 million. At December 31, 2007, the net unrealized appreciation of available-for-sale fixed maturities and equity securities totaled $146.7 million.

The following tables are also used as part of our impairment analysis and illustrate the total value of securities that were in an unrealized loss position as of December 31, 2008, and December 31, 2007, respectively. These tables segregate the securities based on type, noting the fair value, cost (or amortized cost), and unrealized loss on each category of investment as well as in total. The tables further classify the securities based on the length of time they have been in an unrealized loss position.

DECEMBER 31, 2008

(in thousands)	0-12 Mos.			>12 Mos.			Total
U.S. Government
Fair value	$	—		$	—		$	—
Cost or amortized cost	—			—			—
Unrealized loss	—			—			—
U.S. Agency
Fair value	$	34,955		$	—		$	34,955
Cost or amortized cost	35,379			—			35,379
Unrealized loss	(424		)	—			(424		)
Mtge/ABS/CMO*
Fair value	$	38,551		$	16,721		$	55,272
Cost or amortized cost	41,769			19,495			61,264
Unrealized loss	(3,218		)	(2,774		)	(5,992		)
Corporate
Fair value	$	135,865		$	32,737		$	168,602
Cost or amortized cost	149,935			38,707			188,642
Unrealized loss	(14,070		)	(5,970		)	(20,040		)
States, political subdivisions and revenues
Fair value	$	133,515		$	13,250		$	146,765
Cost or amortized cost	137,660			13,970			151,630
Unrealized loss	(4,145		)	(720		)	(4,865		)
Subtotal, debt securities
Fair value	$	342,886		$	62,708		$	405,594
Cost or amortized cost	364,743			72,172			436,915
Unrealized loss	(21,857		)	(9,464		)	(31,321		)
Common stock
Fair value	$	83,406		$	11,912		$	95,318
Cost or amortized cost	106,540			16,076			122,616
Unrealized loss	(23,134		)	(4,164		)	(27,298		)
Preferred stock
Fair value	$	2,613		$	—		$	2,613
Cost or amortized cost	2,871			—			2,871
Unrealized loss	(258		)	—			(258		)
Total
Fair value	$	428,905		$	74,620		$	503,525
Cost or amortized cost	474,154			88,248			562,402
Unrealized loss	(45,249		)	(13,628		)	(58,877		)

*Mortgage-backed, asset-backed & collateralized mortgage obligations

43

DECEMBER 31, 2007

(in thousands)	0-12 Mos.			>12 Mos.			Total
U.S. Government
Fair value	$	—		$	—		$	—
Cost or amortized cost	—			—			—
Unrealized loss	—			—			—
U.S. Agency
Fair value	$	—		$	70		$	70
Cost or amortized cost	—			70			70
Unrealized loss	—			—			—
Mtge/ABS/CMO*
Fair value	$	7,892		$	87,746		$	95,638
Cost or amortized cost	8,000			89,230			97,230
Unrealized loss	(108		)	(1,484		)	(1,592		)
Corporate
Fair value	$	53,846		$	65,185		$	119,031
Cost or amortized cost	55,229			67,505			122,734
Unrealized loss	(1,383		)	(2,320		)	(3,703		)
States, political subdivisions and revenues
Fair value	$	42,218		$	46,604		$	88,822
Cost or amortized cost	42,472			46,738			89,210
Unrealized loss	(254		)	(134		)	(388		)
Subtotal, debt securities
Fair value	$	103,956		$	199,605		$	303,561
Cost or amortized cost	105,701			203,543			309,244
Unrealized loss	(1,745		)	(3,938		)	(5,683		)
Common stock
Fair value	$	56,808		$	—		$	56,808
Cost or amortized cost	64,604			—			64,604
Unrealized loss	(7,796		)	—			(7,796		)
Preferred stock
Fair value	$	29,436		$	—		$	29,436
Cost or amortized cost	34,495			—			34,495
Unrealized loss	(5,059		)	—			(5,059		)
Total
Fair value	$	190,200		$	199,605		$	389,805
Cost or amortized cost	204,800			203,543			408,343
Unrealized loss	(14,600		)	(3,938		)	(18,538		)

*Mortgage-backed, asset-backed & collateralized mortgage obligations

As of December 31, 2008, we held 37 common and preferred stocks that were in unrealized loss positions. The total unrealized loss on these securities was $27.6 million. In considering both the significance and duration of the unrealized loss positions, we have no equity securities in an unrealized loss position of greater than 20 percent for more than six months. The fixed income portfolio contained 229 securities at a loss as of December 31, 2008. Of these 229 securities, 33 have been in an unrealized loss position for more than 12 consecutive months and these collectively represent $9.5 million in unrealized losses. The fixed income unrealized losses can be primarily attributed to spreads widening in the corporate, municipal and mortgage backed security markets. We have the ability and intent to hold these securities to maturity. In addition, we continually monitor the credit quality of our fixed income investments to access if it is probable that we will receive our contractual or estimated cash flows in the form of principal and interest. We consider price declines of securities in our other-than-temporary impairment analysis where such price declines provide evidence of declining credit quality, and we distinguish between price changes caused by credit deterioration, as opposed to rising interest rates.

Factors that we consider in the evaluation of credit quality include:

·changes in technology that may impair the earnings potential of the investment,

·the discontinuance of a segment of the business that may affect the future earnings potential,

·reduction or elimination of dividends,

·specific concerns related to the issuer’s industry or geographic area of operation,

·significant or recurring operating losses, poor cash flows, and/or deteriorating liquidity ratios, and

·downgrade in credit quality by a major rating agency.

Based on our analysis, we’ve concluded that the securities in an unrealized loss position are not other-than temporarily impaired.

During 2008, we recognized impairment losses of $76.2 million. This total includes $64.2 million in equity and $12.0 million in fixed income declines. Of the total charge, $39.7 million came during the fourth quarter as the overall market continued its downward trend. The majority of our other-than-temporary impairment is related to securities in the financial sector and a high-yield municipal bond mutual fund. The impaired securities were negatively impacted by the overall financial crisis and lack of liquidity in the credit markets. There were no losses associated with the other-than-temporary impairment of securities in 2007 or 2006.

At December 31, 2008, we were party to a securities lending program whereby fixed income securities are loaned to third parties, primarily major brokerage firms. At December 31, 2008, fixed maturities with a fair value of $15.4 million were loaned. Agreements with custodian banks facilitating such lending generally require 102 percent of the value of the loaned securities to be separately maintained as collateral for each loan. Pursuant to SFAS 140, an invested asset and a corresponding liability have been recognized for the cash collateral amount. To further minimize the credit risks related to this lending program, we monitor the financial condition of other parties to these agreements.

44

As required by law, certain fixed maturities and short-term investments amounting to $18.3 million at December 31, 2008, were on deposit with either regulatory authorities or banks. Additionally, we have certain fixed maturities held in trust amounting to $10.0 million at December 31, 2008. These funds cover net premiums, losses, and expenses related to a property and casualty insurance program.

3.  POLICY ACQUISITION COSTS

Policy acquisition costs deferred and amortized to income for the years ended December 31 are summarized as follows:

(in thousands)	2008			2007			2006
Deferred policy acquisition costs, beginning of year	$	78,882		$	73,817		$	69,477
Deferred:
Direct commissions	110,985			119,344			126,270
Premium taxes	7,663			6,902			6,483
Other direct underwriting expenses	65,270			60,695			54,946
Ceding commissions	(27,438		)	(31,454		)	(41,520		)
Net deferred	156,480			155,487			146,179
Amortized	156,842			150,422			141,839
Deferred policy acquisition costs, end of year	$	78,520		$	78,882		$	73,817
Policy acquisition costs: Amortized to expense	156,842			150,422			141,839
Period costs: Ceding commission – contingent	(2,683		)	(3,334		)	(3,049		)
Other	9,161			8,522			6,986
Total policy acquisition costs	$	163,320		$	155,610		$	145,776

4.  DEBT

As of December 31, 2008, outstanding debt balances totaled $100.0 million, all of which was our long-term senior notes. The senior notes are rated Baa2 by Moody’s and BBB+ by S&P.

On December 12, 2003, we completed a public debt offering, issuing $100.0 million in senior notes maturing January 15, 2014, and paying interest semi-annually at the rate of 5.95 percent. The notes were issued at a discount resulting in proceeds, net of discount and commission, of $98.9 million. The amount of the discount is being charged to income over the life of the debt on an effective-yield basis. Of the proceeds, capital contributions totaling $65.0 million were made to our insurance subsidiaries to increase their statutory surplus. The balance of the proceeds was used by the holding company to fund investment and operating activities. The estimated fair value for the senior note is $88.5 million. The fair value of our long-term debt is estimated based on the limited observable prices that reflect thinly traded securities.

As of December 31, 2008, we had no short-term debt outstanding as compared to $28.0 million outstanding under reverse repurchase agreements at December 31, 2007. The use and repayment of such agreements remains an investment decision based on whether the allocation of available cash flow to purchase debt securities generates a greater amount of investment income that would be paid in interest expense.

We maintain a revolving line of credit with JP Morgan which permits us to borrow up to an aggregate principal amount of $25.0 million. Under certain conditions, the line may be increased up to an aggregate principal amount of $50.0 million. This facility has a three-year term that expires on May 31, 2011. As of December 31, 2008, no amounts were outstanding on this facility.

We incurred interest expense on debt at the following average interest rates for 2008, 2007, and 2006:

	2008		2007		2006
Line of credit	—		—		—
Reverse repurchase agreements	3.42	%	5.15	%	4.97	%
Total short-term debt	3.42	%	5.15	%	4.97	%
Senior notes	6.02	%	6.02	%	6.02	%
Total debt	5.60	%	5.88	%	5.95	%

Interest paid on outstanding debt for 2008, 2007, and 2006 amounted to $6.7 million, $7.0 million, and $6.6 million, respectively.

5.  REINSURANCE

In the ordinary course of business, the insurance subsidiaries assume and cede premiums with other insurance companies. A large portion of the reinsurance is put into effect under contracts known as treaties and, in some instances, by negotiation on each individual risk (known as facultative reinsurance). In addition, there are several types of treaties including: quota share, excess of loss and catastrophe reinsurance contracts that protect against losses over stipulated amounts arising from any one occurrence or event. The arrangements allow us to pursue greater diversification of business and serve to limit the maximum net loss on catastrophes and large risks. Through the quantification of exposed policy limits in each region and the extensive use of computer-assisted modeling techniques, we monitor the concentration of risks exposed to catastrophic events.

Through the purchase of reinsurance, we generally limit our net loss on any individual risk to a maximum of $2.0 million, although retentions can range from $0.5 million to $7.5 million.

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Premiums written and earned along with losses and settlement expenses incurred for the years ended December 31 are summarized as follows:

(in thousands)	2008			2007			2006
WRITTEN
Direct	$	673,226		$	734,287		$	794,093
Reinsurance assumed	7,943			5,047			4,920
Reinsurance ceded	(167,713		)	(200,571		)	(247,477		)
Net	$	513,456		$	538,763		$	551,536
EARNED
Direct	$	695,824		$	765,894		$	788,904
Reinsurance assumed	5,218			5,729			5,982
Reinsurance ceded	(172,278		)	(227,145		)	(264,548		)
Net	$	528,764		$	544,478		$	530,338
LOSSES AND SETTLEMENT EXPENSES INCURRED
Direct	$	234,121		$	180,140		$	381,661
Reinsurance assumed	7,399			7,746			8,956
Reinsurance ceded	5,654			2,982			(133,728		)
Net	$	247,174		$	190,868		$	256,889

Direct, ceded, and net losses and settlement expenses incurred, as displayed in the table above, were lower in 2007 and 2008 relative to 2006 due to favorable development on prior accident years’ reserves. While we have experienced favorable development in all three years, there was a significant impact to direct, ceded, and net reserves during 2007. This was the direct result of several refinements in our loss reserve methodologies that culminated in significant favorable development on prior years’ reserves. This is further outlined in note 6. Many of our longer-tailed products make extensive use of reinsurance. As a result, the favorable emergence we have seen on an overall basis has had an even more significant impact on our estimates of ceded reserves. This factor influenced the calendar year ceded incurred losses shown in the table for both 2007 and 2008.

At December 31, 2008, we had prepaid reinsurance premiums on paid and unpaid losses and settlement expenses totaling $376.4 million. More than 91 percent of our reinsurance recoverables are due from companies rated “A” or better by A.M. Best and S&P rating services.

The following table displays net reinsurance balances recoverable, including collateral, from our top 10 reinsurers, as of December 31, 2008. All other reinsurance balances recoverable, when considered by individual reinsurer, are less than 2 percent of shareholders’ equity.

REINSURER

	Amounts		A.M Best	S&P
(in thousands)	Recoverable		Rating	Rating
Munich Re America	$	59,716	A+, Superior	AA-, Very Strong
Swiss Re /Westport Ins. Corp.	41,660		A+, Superior	A+, Strong
Endurance Re	40,632		A, Excellent	A, Strong
Axis Re	32,743		A, Excellent	A, Strong
General Cologne Re	31,839		A++, Superior	AAA, Extremely Strong
Berkley Insurance Co.	28,202		A+, Superior	A+, Strong
Toa-Re	17,916		A, Excellent	A+, Strong
Lloyds of London	15,184		A, Excellent	A+, Strong
Ace Property & Casualty	15,078		A+, Superior	A+, Strong
Transatlantic Re	14,892		A, Excellent	AA-, Very Strong

6.  HISTORICAL LOSS AND LAE DEVELOPMENT

The table which follows is a reconciliation of our unpaid losses and settlement expenses (LAE) for the years 2008, 2007, and 2006.

(in thousands)	2008			2007			2006
Unpaid losses and LAE at beginning of year:
Gross	$	1,192,178		$	1,318,777		$	1,331,866
Ceded	(417,250		)	(525,671		)	(593,209		)
Net	$	774,928		$	793,106		$	738,657
Increase (decrease) in incurred losses and LAE:
Current accident year	$	309,512		$	296,047		$	300,292
Prior accident years	(62,338		)	(105,179		)	(43,403		)
Total incurred	$	247,174		$	190,868		$	256,889
Loss and LAE payments for claims incurred:
Current accident year	$	(51,599	)	$	(46,598	)	$	(47,994	)
Prior accident year	(161,476		)	(162,448		)	(154,446		)
Total paid	$	(213,075	)	$	(209,046	)	$	(202,440	)
Net unpaid losses and LAE at end of year	$	809,027		$	774,928		$	793,106
Unpaid losses and LAE at end of year:
Gross	1,159,311			1,192,178			1,318,777
Ceded	(350,284		)	(417,250		)	(525,671		)
Net	$	809,027		$	774,928		$	793,106

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The deviations from our initial reserve estimates appeared as changes in our ultimate loss estimates as we updated those estimates through our reserve analysis process. The recognition of the changes in initial reserve estimates occurred over time as claims were reported, initial case reserves were established, initial reserves were reviewed in light of additional information, and ultimate payments were made on the collective set of claims incurred as of that evaluation date. The new information on the ultimate settlement value of claims is therefore continually updated and revised as this process takes place until all claims in a defined set of claims are settled. As a relatively small insurer, our experience will ordinarily exhibit fluctuations from period to period. While we attempt to identify and react to systematic changes in the loss environment, we also must consider the volume of experience directly available to us, and interpret any particular period’s indications with a realistic technical understanding of the reliability of those observations.

The table below summarizes our prior accident years’ loss reserve development by segment for 2008, 2007, and 2006:

(FAVORABLE)/UNFAVORABLE RESERVE DEVELOPMENT BY SEGMENT

(in thousands)	2008			2007			2006
Casualty	$	(50,562	)	$	(87,397	)	$	(40,030	)
Property	(6,646		)	(6,690		)	(1,784		)
Surety	(5,130		)	(11,092		)	(1,589		)
Total	$	(62,338	)	$	(105,179	)	$	(43,403	)

A discussion of significant components of reserve development for the three most recent calendar years follows:

2008. During 2008, we experienced favorable loss emergence from prior years’ reserve estimates across all of our segments. For our casualty segment, we experienced $50.6 million of favorable development, predominantly from the accident years of 2002-2006. In retrospect, the expected loss ratios initially used to set booked reserves for these accident years have proven to be conservative, which has resulted in loss emergence significantly lower than expected. This is particularly true for our general liability, personal umbrella, and commercial umbrella products, which experienced favorable loss development of $33.1 million, $12.7 million, and $11.8 million, respectively. The construction class was the largest contributor to the favorable emergence in the general liability product. In addition, our program business experienced $9.3 million of unfavorable prior years’ loss development during the year, mostly isolated in accident years 2004-2007. Our experience in the liquor liability class has been particularly adverse. In the past, we relied on external loss development patterns that have not proven predictive of actual emergence. As a result, this class is being re-underwritten and we implemented a more stringent reserving approach in 2008.

Our property segment realized $6.6 million of favorable loss development in 2008. Most of this emergence was in accident years 2005-2007. The construction and fire products were the drivers of the favorable emergence, recording $4.4 million and $4.2 million, respectively. The construction business has been in run-off for three years and recent experience has been much better than expected, with a significant reduction in both frequency and severity of claims. Only a handful of contracts remain open and we have observed little new activity from this product line. Our fire product saw significant favorable emergence from the 2007 accident year, as our year-end 2007 reserves have developed more favorably than originally estimated.

Our surety segment experienced $5.1 million of favorable emergence. Almost all of the favorable emergence is from the 2007 accident year. very little observed loss severity in the commercial surety product resulted in $1.7 million of favorable emergence. Continued improvement in our contract surety loss ratio resulting from past re-underwriting of the business led to $2.5 million of favorable loss reserve development.

2007. We periodically review our loss reserve estimates and underlying actuarial reserving methodologies in order to assess their accuracy and suitability, and to benchmark our reserving practices against industry best practices. A detailed assessment of recent trends and reserve risk factors was undertaken in 2007. As part of our reviews, we performed a more detailed, ground-up analysis of the actuarial estimation risks associated with each of our products and segments, including an assessment of industry information.

Our analyses also revealed that our quarterly actuarial reserve estimates over recent historical periods had shown a downward trend as a result of a moderating loss trend environment, improvements in policy terms and conditions and a favorable underlying exposure mix that occurred during the hard market period from 2001 through 2004.

Based on this review, we made certain refinements to our reserving methodologies to include a more detailed consideration of the impact of risk factors on total recorded reserves through increased internal dialogue among the claim, underwriting, risk management and actuarial departments, greater transparency of the actuarial process and results, and improved reserving diagnostics. Overall, these enhancements and improved information provide better and faster feedback to management regarding loss development resulting in greater overall confidence in the actuarial estimates. This and the increased stability in our business in the last few years diminished the needed level

47

of carried reserves above the actuarial point estimate. We believe that these reserve methodology enhancements improved the overall accuracy of our best estimate of loss and LAE reserves. Over half of the favorable prior years’ loss development was the result of this detailed assessment and resulting changes in our booked reserves.

Our casualty segment was most impacted by prior years’ loss development realizing a total of $87.4 million of favorable emergence. All casualty products were impacted by the enhanced risk assessment previously mentioned. Our general liability, transportation, personal umbrella, and professional liability products realized favorable development of $42.5 million, $19.6 million, $10.5 million, and $8.1 million, respectively. This favorable emergence was concentrated in accident years 2004-2006. As a result of significant favorable loss development observed over the past several years for our general liability product, we reassessed the expected loss ratios used in our actuarial analysis and subsequently lowered them for the construction classes. For our transportation and personal umbrella products, we reassessed and subsequently lowered the loss development factors in our analysis, reflecting our observation that the emergence patterns were more favorable than previously anticipated. Finally, our professional liability products realized actual loss emergence much more favorably than expected.

The property segment realized $6.7 million of favorable prior years’ development. The favorable emergence was realized across almost all of our property products, predominantly in accident years 2005 and 2006. We also executed a favorable reinsurance commutation impacting accident years prior to 2000.

The surety segment realized $11.1 million of favorable prior years’ development. Almost all of the development was the result of the risk reassessment and reflection of significantly lower reserve risk after achieving settlement with the larger banks involved in the CMC litigation (see note 10 for more details).

2006. During 2006, we continued to experience favorable loss development and a reduction in prior years’ loss reserve estimates. Pricing increased substantially and policy terms and conditions became more favorable for most of our products during the 2001-2004 policy years. Many of the improvements in market conditions were difficult to quantify at the time of the original estimate. Our significant growth in premium and exposures made precise quantification of these changes even more challenging. In 2006, losses continued to emerge on the prior accident years much more favorably than we expected when making our original estimates. We experienced favorable development of $43.4 million in aggregate on prior years’ estimates.

Of this decrease to prior years’ loss reserve estimates, approximately $40.0 million occurred in the casualty segment. The development is primarily from our general liability, executive products liability, and employer’s indemnity products. In our general liability product we experienced $25.4 million of favorable development. Most of this development came from the 2004 and 2005 accident years. As part of our normal reserving process, we reviewed the expected loss ratios used in several of our reserving methods. This review confirmed the favorable emergence from 2002-2005 accident years. As a result of this study, the expected loss ratios were reduced for 2004-2006 with the most significant change occurring to the 2005 accident year. Approximately $15.4 million of the favorable general liability development can be attributed to this update in expected loss ratios. The remaining portion of the decrease in prior year’s loss reserve estimate was the result of the continued favorable loss emergence and the natural progression of shifting more weight to our incurred and paid development methods as accident years get older. In our executive products liability business, we experienced $7.4 million of favorable development. Most of this change can be attributed to accident years 2001, 2003, and 2004. The estimates improved as a result of lower than expected loss severity in those accident years. For our employer’s indemnity product, we experienced $5.7 million of favorable development. We experienced significantly less loss emergence than expected for accident years prior to 2003 and benefited from favorable settlements on several claims in accident years 2001-2003.

Overall, our property and surety segments experienced relatively small changes in prior years’ estimates of reserves. However, we experienced $4.2 million of favorable development from 2004 and 2005 hurricane estimates. We also saw $7.2 million of unfavorable development on our construction product that is in runoff. Most of this development came from accident years 2002-2005. The construction emergence pattern revealed itself to be longer than originally anticipated and has not behaved consistent with reporting patterns expected from a property segment. We do not anticipate any further significant deterioration in our estimates.

ENVIRONMENTAL, ASBESTOS, AND MASS TORT EXPOSURES

We are subject to environmental site cleanup, asbestos removal, and mass tort claims and exposures through our commercial umbrella, general liability, and discontinued assumed casualty reinsurance lines of business. The majority of the exposure is in the excess layers of our commercial umbrella and assumed reinsurance books of business.

48

The following table represents inception-to-date paid and unpaid environmental, asbestos, and mass tort claims data (including incurred but not reported losses) as of December 31, 2008, 2007, and 2006:

(in thousands)	2008			2007			2006
LOSS AND LAE PAYMENTS
Gross	$	70,210		$	56,060		$	53,323
Ceded	(39,143		)	(30,607		)	(29,853		)
Net	$	31,067		$	25,453		$	23,470
UNPAID LOSSES AND LAE AT END OF YEAR
Gross	$	65,583		$	67,891		$	48,541
Ceded	(20,407		)	(29,198		)	(25,720		)
Net	$	45,176		$	38,693		$	22,821

Our environmental, asbestos, and mass tort exposure is limited, relative to other insurers, as a result of entering the affected liability lines after the insurance industry had already recognized environmental and asbestos exposure as a problem and adopted appropriate coverage exclusions.

During 2008, payment activity was more than we experienced in 2007, which was not surprising, given the increased amount of case reserve activity during 2007. However, we did not observe a corresponding decrease in case reserves, as gross case reserves decreased by only $4.8 million while net case reserves increased by about $0.5 million. Much of the reported adverse development can be tied to a small number of claims. Two related asbestos claims from our assumed reinsurance book accounted for $2.7 million in gross emergence and $2.1 million in net emergence with large payments being made. A mass tort claim from accident year 2005 against an insured hotel involving carbon monoxide discharge accounted for another $1.6 million direct and $1.0 million net. In light of these developments and a few additional reported claims, we decided to strengthen our IBNR position.

During 2007, while payment activity was less than we experienced in 2006, we experienced an unusual amount of case reserve activity. About two-thirds of the increase in net reserves was from case reserve adjustments. A $4.8 million case reserve increase was posted due to a reversal of a previous court decision for a claim involving pollution during the late 1980s. In addition, an insurance company we reinsured in the early 1980s and that went into liquidation in 1986, reported a number of claims in 2007. The largest of these involves asbestos. Because of this situation, we posted total net case reserves of $2.9 million. Also, a $2.2 million reserve adjustment was made on a 1983 asbestos related claim because the coverage layers below our excess policy had been exhausted. In addition to these case reserve increases, we made a minor adjustment in our emergence pattern assumptions that resulted in an increase in our total reserve position relative to industry benchmarks.

While our environmental exposure is limited, the ultimate liability for this exposure is difficult to assess because of the extensive and complicated litigation involved in the settlement of claims and evolving legislation on such issues as joint and several liability, retroactive liability, and standards of cleanup. Additionally, we participate primarily in the excess layers of coverage, where accurate estimates of ultimate loss are more difficult to derive than for primary coverage.

7.  INCOME TAXES

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are summarized as follows:

(in thousands)	2008		2007
Deferred tax assets:
Tax discounting of claim reserves	$	32,728	$	35,800
Unearned premium offset	18,843		19,915
Net unrealized depreciation of securities	4,912		—
Other	6,999		10,203
Deferred tax assets before allowance	63,482		65,918
Less valuation allowance	—		—
Total deferred tax assets	$	63,482	$	65,918
Deferred tax liabilities:
Net unrealized appreciation of securities	$	—	$	51,757
Deferred policy acquisition costs	27,482		27,609
Book/tax depreciation	1,823		1,635
Undistributed earnings of unconsolidated investee	9,773		9,700
Other	263		259
Total deferred tax liabilities	39,341		90,960
Net deferred tax asset (liability)	$	24,141	$	(25,042	)

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Income tax expense attributable to income from operations for the years ended December 31, 2008, 2007, and 2006, differed from the amounts computed by applying the U.S. federal tax rate of 35 percent to pretax income from continuing operations as demonstrated in the following table:

(in thousands)	2008			2007			2006
Provision for income taxes at the statutory federal tax rates	$	37,309		$	89,067		$	65,413
Increase (reduction) in taxes resulting from:
Dividends received deduction	(1,830		)	(1,815		)	(1,858		)
ESOP dividends paid deduction	(508		)	(471		)	(469		)
Tax-exempt interest income	(6,418		)	(6,276		)	(5,885		)
Non-recurring tax benefit	—			(2,356		)	(3,171		)
Other items, net	(631		)	460			(1,776		)
Total	$	27,922		$	78,609		$	52,254

Our effective tax rates were 26.2 percent, 30.9 percent, and 28.0 percent for 2008, 2007, and 2006, respectively. Effective rates are dependent upon components of pretax earnings and the related tax effects. The effective rate for 2008 was lower than 2007 and 2006 due to the decrease in underwriting income and net realized losses, which were taxed at 35.0 percent. In addition, changes in items that are non-taxable, such as tax-exempt interest income, impact the effective tax rate. Partially offsetting tax expense in 2007 was a $2.4 million tax benefit recorded in the third quarter to reflect the benefit expected to be realized upon the future payment of certain accrued compensation. Results for 2006 include the favorable resolution of a tax examination. During 2006, the Internal Revenue Service (IRS) concluded an examination of our tax years 2000 through 2004. As a result of this exam, we recorded a $3.2 million tax benefit, resulting from a change in tax estimate related to the sale of assets.

Our net earnings include equity in earnings of unconsolidated investees. These investees do not have a policy or pattern of paying dividends. As a result, we record a deferred tax liability on these earnings at the corporate capital gains rate of 35 percent. In the third quarter of 2008, we received a $4.0 million dividend from Maui Jim. As required by SFAS 109, “Accounting for Income Taxes,” we recognized a $1.1 million tax benefit in 2008 from applying the lower tax rate applicable to affiliated dividends as compared to the corporate capital gains rate on which the deferred tax liabilities were based. This benefit is included in the other items, net caption in the previous table. In the first quarter of 2007, we received a cash dividend of $5.9 million and recognized a $1.7 million tax benefit in 2006 from applying the lower tax rate. A dividend was also paid in 2006 by Maui Jim in the amount of $16.5 million and a $4.6 million tax benefit was recorded in 2005 from applying the lower tax rates. Although a dividend has been received for three straight years, we do not anticipate the payment of dividends to continue and expect to recover our investment through means other than receipt of dividends. On December 28, 2006, we sold our equity investment in TBW. This resulted in a realized capital gain of $16.2 million with a corresponding current tax expense of $5.7 million and the current recognition of tax expense of $5.5 million from the previously deferred tax expense on undistributed earnings of this unconsolidated investee.

We have recorded our deferred tax assets and liabilities using the statutory federal tax rate of 35 percent. We believe it is more likely than not that all deferred tax assets will be recovered given the carry back availability as well as the results of future operations, which will generate sufficient taxable income to realize the deferred tax asset. In addition, we believe when these deferred items reverse in future years, our taxable income will be taxed at an effective rate of 35 percent.

Net federal and state income taxes paid in 2008, 2007, and 2006 amounted to $31.6 million, $87.8 million, and $53.1 million, respectively.

8.  EMPLOYEE BENEFITS

PENSION PLAN

During 2003 through 2006, our board and management took a series of steps to freeze and terminate our defined benefit pension plan. The plan termination was finalized in 2006. All plan distributions were made in late 2006.

In 2006, we paid $14.4 million in benefits and had no remaining benefit obligation at December 31, 2006. We incurred $2.6 million in pension expense in 2006. No expenses were incurred in 2007 or 2008.

In September 2006, the FASB published SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” This statement requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. This statement also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. Because the plan termination was finalized in 2006, the implementation of SFAS 158 had no impact on our financial statements.

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EMPLOYEE STOCK OWNERSHIP, 401(K) AND BONUS AND INCENTIVE PLANS

We maintain an Employee Stock Ownership Plan (ESOP), 401(k), and bonus and incentive plans covering executives, managers, and associates. At the board’s discretion, funding of these plans is primarily dependent upon reaching predetermined levels of operating return on equity and Market Value Potential (MVP). MVP is a compensation model that measures comprehensive earnings against a minimum required return on our capital. Bonuses are earned as we generate earnings in excess of this required return. While some management incentive plans may be affected somewhat by other performance factors, the larger influence of corporate performance ensures that the interests of our executives, managers, and associates correspond with those of our shareholders.

Our 401(k) plan allows voluntary contributions by employees and permits ESOP diversification transfers for employees meeting certain age or service requirements. We provide a basic 401(k) contribution of 3 percent of eligible compensation. Participants are 100 percent vested in both voluntary and basic contributions. Additionally, an annual discretionary profit-sharing contribution may be made to the ESOP and 401(k), subject to the achievement of certain overall financial goals. For plan years prior to 2007, profit- sharing contributions were subject to a five-year cliff vest. For plan year 2007 and later, contributions vest after three years of service.

Our ESOP and 401(k) cover all employees meeting eligibility requirements. ESOP and 401(k) profit-sharing contributions are determined annually by our board of directors and are expensed in the year earned. ESOP and 401(k)-related expenses (basic and profit-sharing) were $8.8 million, $9.8 million and $7.9 million, respectively, for 2008, 2007, and 2006.

During 2008, the ESOP purchased 118,902 shares of RLI stock on the open market at an average price of $53.85 ($6.4 million) relating to the contribution for plan year 2007. Shares held by the ESOP as of December 31, 2008, totaled 1,476,635 and are treated as outstanding in computing our earnings per share. During 2007, the ESOP purchased 90,561 shares of RLI stock on the open market at an average price of $57.92 ($5.2 million) relating to the contribution for plan year 2006. During 2006, the ESOP purchased 94,430 shares of RLI stock on the open market at an average price of $54.19 ($5.1 million) relating to the contribution for plan year 2005.

Annual bonuses are awarded to executives, managers, and associates through our incentive plans, provided certain financial and operational goals are met. Annual expenses for these incentive plans totaled $4.6 million, $15.8 million and $15.1 million for 2008, 2007, and 2006, respectively.

DEFERRED COMPENSATION

We maintain Rabbi Trusts for deferred compensation plans for directors, key employees, and executive officers through which our shares are purchased. The Emerging Issues Task Force consensus on Issue 97-14 governs the accounting for Rabbi Trusts. This issue prescribes an accounting treatment whereby the employer stock in the plan is classified and accounted for as equity, in a manner consistent with the accounting for treasury stock. The deferred compensation obligation is classified as an equity instrument.

The expense associated with funding these plans is recognized through salary and bonus expenses for key employees and executive officers. The expense recognized from the directors’ deferred plan was $0.5 million, $0.5 million and $0.4 million in 2008, 2007, and 2006, respectively.

In 2008, the trusts purchased 18,496 shares of common stock on the open market at an average price of $51.62 ($1.0 million). In 2007, the trusts purchased 13,013 shares of our common stock on the open market at an average price of $56.76 ($0.7 million). In 2006, the trusts purchased 13,913 shares of our common stock on the open market at an average price of $51.61 ($0.7 million). At December 31, 2008, the trusts’ assets were valued at $22.9 million.

STOCK OPTION AND STOCK PLANS

During 1995, we adopted and the shareholders approved a tax-favored incentive stock option plan (the incentive plan). During 1997, the shareholders approved the Outside Directors’ Stock Option Plan (the directors’ plan). Normal vesting for options granted was pro rata over five years under the incentive plan and pro rata over three years under the directors’ plan with a 10-year life for both plans. The plans provided for grants of up to 3,125,000 shares under the incentive plan and 500,000 shares under the directors’ plan. Through May 5, 2005, we had granted 2,640,188 options under these plans.

During 2005, our shareholders approved the RLI Corp. Omnibus Stock Plan (omnibus plan). In conjunction with the adoption of this plan, effective May 5, 2005, options will no longer be granted under the two other option plans previously in existence. The purpose of the omnibus plan is to promote our interests and those of our shareholders by providing our key personnel an opportunity to acquire a proprietary interest in the company and reward them for achieving a high level of corporate performance and to encourage our continued success and growth. Awards under the omnibus plan may be in the form of restricted stock, stock options (both incentive and nonqualified), stock appreciation rights, performance units, as well as other

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stock based awards. Eligibility under the omnibus plan is limited to our employees or employees of any affiliate and to individuals or entities who are not employees but who provide services to us or an affiliate, including services provided in the capacity of consultant, advisor or director. The granting of awards is solely at the discretion of the executive resources committee and the board of directors. The total number of shares of common stock available for distribution under the omnibus plan may not exceed 1,500,000 shares (subject to adjustment for changes in our capitalization). Since 2005, we have granted 948,100 stock options under this plan, including 267,000 in 2008.

Under the omnibus plan, we grant stock options for shares with an exercise price equal to the fair market value of the shares at the date of grant. Options generally vest and become exercisable ratably over a five-year period and have a ten-year life. The related compensation expense is recognized over the requisite service period. In most instances, the requisite service period and vesting period will be the same. For participants who are retirement eligible, defined by the plan as those individuals whose age and years of service equals 75, the requisite service period is deemed to be met and options are immediately expensed on the date of grant. For participants who will become retirement eligible during the vesting period, the requisite service period over which expense is recognized is the period between the grant date and the attainment of retirement eligibility. Shares issued upon option exercise are newly issued shares.

Shares issued may be less than the number of shares actually exercised, as our plan allows participants to swap shares to cover the option exercise price and taxes due upon option exercise. Shares swapped are valued at the closing stock price on the date of option exercise. In these instances, the actual number of shares issued will be less than the options exercised and can result in a decrease to shareholders’ equity. Specifically, when options are exercised with significant intrinsic value (i.e. market value in excess of exercise price) and the exercise is facilitated via a stock swap, amounts withheld for taxes result in a decrease in shareholders’ equity. During 2008, the aggregate intrinsic value of options exercised was $16.6 million. A majority of these options were exercised via stock swaps with taxes withheld at the statutory minimum rate. As shown in the Consolidated Statements of Shareholders’ Equity, the exercise of options in 2008 resulted in a decrease to paid-in-capital, as the taxes withheld pursuant to swaps exceeded amounts paid in for options that were exercised using cash.

The following tables summarize option activity in 2008, 2007, and 2006:

	Number of Options Outstanding		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life	Aggregate Intrinsic Value (in 000’s)
Outstanding options at January 1, 2008	1,605,252		$	36.34
Options granted	267,000		$	51.03
Options exercised	(439,404	)	$	22.37		$	16,616
Options cancelled/forfeited	(3,720	)	$	50.04
Outstanding options at December 31, 2008	1,429,128		$	43.35	6.46	$	23,999
Exercisable options at December 31, 2008	853,367		$	37.12	5.07	$	19,645

	Number of Options Outstanding		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life	Aggregate Intrinsic Value (in 000’s)
Outstanding options at January 1, 2007	1,632,019		$	31.30
Options granted	241,300		$	56.15
Options exercised	(261,527	)	$	22.76		$	9,255
Options cancelled/forfeited	(6,540	)	$	49.83
Outstanding options at December 31, 2007	1,605,252		$	36.34	5.84	$	32,822
Exercisable options at December 31, 2007	1,206,951		$	30.57	4.81	$	31,642

	Number of Options Outstanding		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life	Aggregate Intrinsic Value (in 000’s)
Outstanding options at January 1, 2006	1,931,627		$	26.53
Options granted	206,300		$	50.31
Options exercised	(459,828	)	$	18.98		$	15,997
Options cancelled/forfeited	(46,080	)	$	39.48
Outstanding options at December 31, 2006	1,632,019		$	31.30	5.75	$	41,015
Exercisable options at December 31, 2006	1,429,219		$	28.59	5.23	$	39,770

The majority of our options are granted annually at the board meeting in May. In 2008, 267,000 options were granted with an average exercise price of $51.03 and an average fair value of $13.01. Of these grants, 218,000 were granted at the board meeting in May with a calculated fair value of $12.38. We recognized $2.6 million of expense during 2008 related to options vesting. Since options

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granted under our plan are non-qualified, we recorded a tax benefit of $0.9 million related to this compensation expense. Total unrecognized compensation expense relating to outstanding and unvested options was $4.3 million, which will be recognized over the remainder of the vesting period.

In 2007, 241,300 options were granted with an average exercise price of $56.15 and an average fair value of $15.15. Of these grants, 202,600 were granted at the board meeting in May with a calculated fair value of $15.11. We recognized $1.8 million of expense during 2007 related to options vesting. Since options granted under our plan are non-qualified, we recorded a tax benefit of $0.6 million related to this compensation expense. Total unrecognized compensation expense relating to outstanding and unvested options was $3.5 million, which will be recognized over the remainder of the vesting period.

In 2006, 206,300 options were granted with an average exercise price of $50.31 and an average fair value of $13.95. Of these grants, 171,900 were granted at the board meeting in May 2006 with a calculated fair value of $13.97. We recognized $0.8 million of expense during 2006 related to 2006 grants. Since options granted in 2006 were non-qualified, we recorded a tax benefit of $0.3 million in 2006 related to this compensation expense. Total unrecognized compensation expense in 2006 relating to these grants was $1.9 million, which will be recognized over the remainder of the five-year vesting period.

The fair value of options were estimated using a BlackScholes based option pricing model with the following grant-date assumptions and weighted average fair values:

	2008			2007			2006
Weighted-average fair value of grants	$	13.01		$	15.15		$	13.95
Risk-free interest rates	3.29		%	4.56		%	4.99		%
Dividend yield	1.53		%	1.47		%	1.51		%
Expected volatility	24.01		%	21.78		%	22.35		%
Expected option life	6.40 years			6.95 years			6.31 years

The risk-free rate is determined based on U.S. treasury yields that most closely approximate each option’s expected life. The dividend yield is calculated based on the average annualized dividends paid during the most recent five-year period. The expected volatility is calculated by computing the weighted average of the most recent one-year volatility, the most recent volatility based on expected life and the median of the rolling volatilities based on the expected life of RLI stock. The expected option life is determined based on historical exercise behavior and the assumption that all outstanding options will be exercised at the midpoint of the current date and remaining contractual term, adjusted for the demographics of the current year’s grant.

During 2004, the shareholders approved the NonEmployee Directors’ Stock Plan (stock plan). An aggregate of 200,000 shares of common stock is reserved under the stock plan. The stock plan is designed to provide compensation to each nonemployee director in the form of a stock grant at the time of such director’s election or appointment to the board of directors, and future stock grants based on continued service as a director. In conjunction with the shareholders’ approval of the omnibus plan in May 2005, no further awards will be issued under the stock plan. Awards to outside directors will be made under the omnibus plan.

Total shares granted to outside directors under the omnibus plan were 4,700 in 2008, 2,949 in 2007 and 7,267 in 2006. Shares were granted at an average share price of $53.83 in 2008, $57.51 in 2007 and $51.72 in 2006. In 2006, 3,452 of the shares granted were issued under the directors’ deferred plan. We recognized $0.3 million of expense relating to grants in 2008, compared to $0.2 million in 2007 and $0.4 million in 2006.

POST-RETIREMENT BENEFITS OTHER THAN PENSION

In 2002, we began offering certain eligible employees post-employment medical coverage. Under our plan, employees who retire at age 55 or older with 20 or more years of company service may continue medical coverage under our health plan. Former employees who elect continuation of coverage pay the full COBRA (Consolidated Omnibus Budget Reconciliation Act of 1985) rate and coverage terminates upon reaching age 65. We expect a relatively small number of employees will become eligible for this benefit. The COBRA rate established for participating employees has historically covered the cost of providing this coverage.

9.  STATUTORY INFORMATION AND DIVIDEND RESTRICTIONS

Our insurance subsidiaries maintain their accounts in conformity with accounting practices prescribed or permitted by state insurance regulatory authorities that vary in certain respects from GAAP. In converting from statutory to GAAP, typical adjustments include deferral of policy acquisition costs, the inclusion of statutory nonadmitted assets, and the inclusion of net unrealized holding gains or losses in shareholders’ equity relating to fixed maturities.

Year-end statutory surplus presented in the table below includes $31.3 million of RLI stock (cost basis of $64.6 million) held by Mt. Hawley Insurance Company. The Securities Valuation Office provides specific guidance for valuing this investment, which is eliminated in our consolidated financial statements.

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The following table includes selected information for our insurance subsidiaries for the year ending and as of December 31:

(in thousands)	2008		2007		2006
Consolidated net income, statutory basis	$	74,478	$	177,307	$	136,135
Consolidated surplus, statutory basis	$	678,041	$	752,004	$	746,905

Dividend payments to us from our principal insurance subsidiary are restricted by state insurance laws as to the amount that may be paid without prior approval of the regulatory authorities of Illinois. The maximum dividend distribution in a rolling 12-month period is limited by Illinois law to the greater of 10 percent of RLI Ins. policyholder surplus as of December 31 of the preceding year or the net income of the Company for the 12-month period ending December 31 of the preceding year. Stand-alone net income for RLI Ins. was $26.7 million for 2008. Therefore, the maximum dividend distribution that can be paid by RLI Ins. during 2009 without prior approval is $67.8 million which represents 10 percent of RLI Ins.’s policyholder surplus at December 31, 2008. The 12-month rolling limitation for 2008, based on the above criteria, was $126.2 million. In 2008, a total cash dividend of $70.0 million was paid by RLI Ins. These dividends were paid to provide additional capital to RLI Corp. and used for the share repurchase plan, shareholder dividends, interest on senior notes, and general corporate expenses. In 2007, a total cash dividend of $149.7 million was paid by RLI Ins. after obtaining permission for special dividends from the Illinois Department of Insurance.

10.  COMMITMENTS AND CONTINGENT LIABILITIES

We are the plaintiff and a defendant 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. We 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 here as the “investor banks.” The litigation arises out of the equipment and vehicle leasing program of Commercial Money Center (“CMC”). CMC originated leases, procured bonds pertaining to the performance of obligations of each lessee under each lease, and then formed “pools” of such leases that it marketed to banks and other institutional investors. We sued for rescission and/or exoneration of the bonds we issued to CMC and sale and servicing agreements we entered into with CMC and the investor banks, which had invested in CMC’s equipment leasing program. We contend we were 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). We also sued for declaratory relief to determine our rights and obligations, if any, under the instruments. Each investor bank disputes our claims for relief. CMC is currently in Chapter 7 bankruptcy proceedings.

Between the dates of April 4 and April 18, 2002, each investor bank subsequently filed a complaint against us in various state courts, which we removed to U.S. District Courts. Each investor bank sued us on certain bonds we issued to CMC as well as a sale and servicing agreement between the investor bank, CMC and us. Each investor bank sued for breach of contract, bad faith and other extra-contractual theories. We have answered and denied each investor bank’s claim to entitlement to relief. The investor banks claimed entitlement to aggregate payment of approximately $53 million under either the surety bonds or the sale and servicing agreements, plus unknown extra-contractual damages, attorney’s fees and interest. On October 25, 2002, the judicial panel for multi-district litigation (“MDL Panel”) transferred 23 actions pending in five federal districts involving numerous investor banks, five insurance companies and CMC to the Federal District Court for the Northern District of Ohio for consolidated pretrial proceedings, assigning the litigation to the Honorable Kathleen O’Malley.

In the third quarter of 2005, we reached a confidential settlement agreement with Lakeland Bank. This settlement ended our litigation with Lakeland, but did not resolve our pending litigation with the four other investor banks. The settlement with Lakeland related to surety bonds representing approximately 17 percent of the amount to which the five investor banks had claimed entitlement. The settlement did not have a material adverse effect on our financial statements taken as a whole. In addition, in August 2005, the Federal District Court denied outright the investor banks’ motion for judgment on the pleadings and subsequently ordered all remaining cases to mandatory mediation. Mediations held in January 2006 between us and each of the four remaining investor banks did not resolve the claims of those investor banks. In September 2006, the Court issued a case management order governing expert witness discovery and future motion practice. In the second quarter of 2007, we reached a confidential settlement agreement with Sky Bank. In the third quarter of 2007, we reached a confidential settlement agreement with Ameriana Bank. These settlements ended our litigation with Sky Bank and Ameriana Bank but did not resolve our pending litigation with the remaining two investor banks (Bank of Waukegan and Atlantic Coast Federal, whose initial bond penal sum

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claims total approximately $9.3 million). The settlements with Sky Bank and Ameriana Bank related to surety bonds representing approximately 66 percent of the amount to which the five investor banks had claimed entitlement. In the first quarter of 2008, we reached a confidential settlement agreement with the Bank of Waukegan. In the fourth quarter of 2008, we reached a confidential settlement agreement with Atlantic Coast Federal Bank. The settlements with Bank of Waukegan and Atlantic Coast Federal related to surety bonds representing approximately 17 percent of the amount to which the five investor banks had claimed entitlement. With these latter two settlements, we have now reached settlements with each of the five investor banks that had claimed entitlement under the surety bonds issued by RLI.

In addition, we are party to numerous claims and losses that arise in the normal course of our business. Many of such claims or losses involve claims under policies that we underwrite as an insurer. We believe that the resolution of these claims and losses will not have a material adverse effect on our financial condition, results of operations or cash flows. We are also involved in various other legal proceedings and litigation unrelated to our insurance business that arise in the ordinary course of business operations. Management believes that any liabilities that may arise as a result of these legal matters will not have a material adverse effect on our financial condition or operating results.

We have capital lease obligations for leased computers and operating lease obligations for regional office facilities. These leases expire in various years through 2014. Expense associated with these leases totaled $3.9 million in 2008, $3.7 million in 2007 and $3.4 million in 2006. Minimum future rental payments under noncancellable leases are as follows:

(in thousands)
2009	$	3,676
2010	3,257
2011	2,644
2012	2,336
2013	939
2014	96
Total minimum future rental payments	$	12,948

11.  OPERATING SEGMENT INFORMATION

The following table summarizes our segment data as specified by SFAS 131, “Disclosures about segments of an Enterprise and Related Information.” As prescribed by the pronouncement, reporting is based on the internal structure and reporting of information as it is used by management.

The segments of our insurance operations include casualty, property, and surety. The casualty segment includes liability coverages where loss and related settlement expenses are subject to greater estimation, as the ultimate disposition of claims may take several years to fully develop. Policy coverage is more significantly impacted by evolving legislation and court decisions.

The property segment is comprised of insurance coverages providing physical damage coverage for commercial and personal risks. These risks are exposed to a variety of perils including earthquakes, fires, and hurricanes. Losses are developed in a relatively short period of time.

The surety segment offers a selection of small and medium-size commercial coverages related to the statutory requirement for bonds on construction and energy-related projects. The results of this segment are generally characterized by relatively low loss ratios. Expense ratios tend to be higher due to the high volume of transactions at lower premium levels and higher commissions.

Net investment income is the by-product of the interest and dividend income streams from our investments in fixed income and equity securities. Interest and general corporate expenses include the cost of debt and other director and shareholder relations costs incurred for the benefit of the corporation, but not attributable to the operations of our insurance segments. Investee earnings represent our share in Maui Jim earnings and, through 2006, TBW earnings. We own approximately 40 percent of Maui Jim, which operates in the sunglass and optical goods industries, and, up until the sale in December, 2006, 21 percent of TBW, a mortgage origination company; both companies are privately held.

The following table provides financial data used by management. The net earnings of each segment are before taxes, and include revenues (if applicable), direct product or segment costs (such as commissions, claims costs, etc.), as well as allocated support costs from various overhead departments. While depreciation and amortization charges have been included in these measures via our expense allocation system, the related assets are not allocated for management use and, therefore, are not included in this schedule.

REVENUES

(in thousands)	2008			2007		2006
Casualty	$	313,481		$	343,402	$	348,217
Property	146,863			138,367		122,581
Surety	68,420			62,709		59,540
Segment totals before income taxes	$	528,764		$	544,478	$	530,338
Net investment income	78,986			78,901		71,325
Net realized gains (losses)	(46,738		)	28,966		31,045
Total	$	561,012		$	652,345	$	632,708

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DEPRECIATION AND AMORTIZATION

(in thousands)	2008		2007		2006
Casualty	$	1,648	$	1,825	$	2,086
Property	872		891		963
Surety	604		588		501
Segment totals before income taxes	$	3,124	$	3,304	$	3,550

NET EARNINGS (LOSSES)

(in thousands)	2008			2007			2006
Casualty	$	46,507		$	101,863		$	68,393
Property	15,813			30,569			4,988
Surety	20,743			23,333			10,675
Net Underwriting Income	$	83,063		$	155,765		$	84,056
Net investment income	78,986			78,901			71,325
Realized gains (losses)	(46,738		)	28,966			31,045
General corporate expense and interest on debt	(13,557		)	(16,471		)	(14,650		)
Equity in earnings of unconsolidated investees	4,844			7,315			15,117
Total earnings before income taxes	$	106,598		$	254,476		$	186,893
Income taxes	27,922			78,609			52,254
Total	$	78,676		$	175,867		$	134,639

The following table further summarizes revenues by major product type within each segment:

(in thousands)	2008		2007		2006
CASUALTY
General liability	$	140,891	$	167,876	$	180,037
Commercial and personal umbrella	65,091		66,281		64,730
Commercial transportation	46,710		49,119		48,285
Specialty program business	31,425		29,362		25,507
Executive products	13,846		12,029		13,040
Other	15,518		18,735		16,618
Total	$	313,481	$	343,402	$	348,217
PROPERTY
Commercial property	$	85,271	$	92,634	$	91,507
Marine	48,166		32,868		16,785
Other property	13,426		12,865		14,289
Total	$	146,863	$	138,367	$	122,581
SURETY	$	68,420	$	62,709	$	59,540
Grand total	$	528,764	$	544,478	$	530,338

12.  UNAUDITED INTERIM FINANCIAL INFORMATION

Selected quarterly information is as follows:

(in thousands, except per share data)	First		Second		Third			Fourth			Year
2008
Net premiums earned	$	135,965	$	132,295	$	130,850		$	129,654		$	528,764
Net investment income	19,258		19,605		19,844			20,279			78,986
Net realized investment gains (losses)	3,741		8,075		(24,212		)	(34,342		)	(46,738		)
Earnings before income taxes	35,961		57,121		7,696			5,820			106,598
Net earnings	25,459		38,650		8,586			5,981			78,676
Basic earnings per share(1)	$	1.16	$	1.80	$	0.40		$	0.28		$	3.65
Diluted earnings per share(1)	$	1.14	$	1.77	$	0.40		$	0.28		$	3.60
2007
Net premiums earned	$	137,977	$	137,488	$	134,111		$	134,902		$	544,478
Net investment income	18,990		19,077		20,433			20,401			78,901
Net realized investment gains	4,625		14,967		3,822			5,552			28,966
Earnings before income taxes	47,138		73,847		87,355			46,136			254,476
Net earnings	32,517		49,853		61,539			31,958			175,867
Basic earnings per share(1)	$	1.35	$	2.09	$	2.61		$	1.41		$	7.46
Diluted earnings per share(1)	$	1.32	$	2.04	$	2.56		$	1.38		$	7.30

(1) Since the weighted-average shares for the quarters are calculated independently of the weighted-average shares for the year, quarterly earnings per share may not total to annual earnings per share.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders
RLI Corp.:

We have audited the accompanying consolidated balance sheets of RLI Corp. and subsidiaries (the Company) as of December 31, 2008 and 2007, and the related consolidated statements of earnings and comprehensive earnings, cash flows, and shareholders’ equity for each of the years in the three-year period ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 25, 2009, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

Chicago, Illinois

February 25, 2009

57

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders
RLI Corp.:

We have audited RLI Corp. and Subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report on Controls and Procedures. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2008 and 2007, and the related consolidated statements of earnings and comprehensive earnings, cash flows, and shareholders’ equity for each of the years in the three-year period ended December 31, 2008, and our report dated February 25, 2009, expressed an unqualified opinion on those consolidated financial statements.

Chicago, Illinois

February 25, 2009

58

STATEMENT OF FINANCIAL REPORTING RESPONSIBILITY

The management of RLI Corp. and Subsidiaries is responsible for the preparation and for the integrity and objectivity of the accompanying financial statements and other financial information in this report. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include amounts that are based on management’s estimates and judgments.

Management has established and maintains internal control throughout its operations that is designed to provide assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use, and the execution and recording of transactions in accordance with management’s authorization. Internal control provides for appropriate division of responsibility and is documented by written policies and procedures that are updated by management as necessary. Management considers the recommendations of its internal auditor and independent registered public accounting firm concerning the Company’s internal control and takes the necessary actions that are cost effective in the circumstances to respond appropriately to the recommendations presented.

The accompanying financial statements have been audited by KPMG LLP (KPMG), an independent registered public accounting firm selected by the audit committee and approved by the shareholders. Management has made available to KPMG all of the Company’s financial records and related data, including minutes of directors’ meetings. Furthermore, management believes that all representations made to KPMG during its audit were valid and appropriate.

The audit committee is comprised of four independent directors and is charged with general supervision of the audits, examinations and inspections of the books and accounts of RLI Corp. and Subsidiaries. The independent registered public accounting firm and the internal auditor have ready access to the audit committee.

Jonathan E. Michael

President, CEO

Joseph E. Dondanville, CPA

Senior Vice President, CFO

59

REPORT ON CONTROLS AND PROCEDURES

CONCLUSION REGARDING THE EFFECTIVENESS OF DISCLOSURE CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this annual report.

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control — Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2008.

Our internal control over financial reporting as of December 31, 2008 has been audited by KPMG, an independent registered public accounting firm, as stated in their report which is included herein.

Jonathan E. Michael
President, CEO

Joseph E. Dondanville, CPA
Senior Vice President, CFO

60

GLOSSARY

ADMITTED COMPANY

An insurer domiciled in one state licensed to do business in one or more other states.

COMBINED RATIO (GAAP)

A common measurement of underwriting profit (less than 100) or loss (more than 100). The sum of the expense and the loss ratios, which are based on premiums earned.

COMBINED RATIO (STATUTORY)

The same as a GAAP combined ratio, except in calculating the expense ratio, the denominator used is net premiums written instead of net premiums earned.

COMPREHENSIVE EARNINGS

The sum of net after-tax earnings and net after-tax unrealized gains (losses) on investments.

COMMERCIAL GENERAL LIABILITY INSURANCE

Liability coverage for all premises and operations, other than personal, for non-excluded general liability hazards.

CONSOLIDATED REVENUE

Net premiums earned plus net investment income and realized gains (losses).

DIFFERENCE IN CONDITIONS (DIC) INSURANCE

Coverage for loss normally excluded in standard commercial or personal property policies, particularly flood and earthquake.

EXCESS INSURANCE

A policy or bond covering against certain hazards, only in excess of a stated amount.

EXPENSE RATIO

The percentage of the premium used to pay all the costs of acquiring, writing and servicing business.

FIRE INSURANCE

Property insurance on which the predominant peril is fire, but generally includes wind and other lines.

GAAP

Generally accepted accounting principles.

HARD/FIRM MARKET

When the insurance industry has limited capacity available to handle the amount of business written, creating a seller’s market, driving insurance prices upward.

INLAND MARINE INSURANCE

Property coverage for perils arising from transportation of goods or covering types of property that are mobile, and other hazards.

LOSS RATIO

The percentage of premium used to pay for losses incurred.

MARKET CAP

Sort for market capitalization. The value of a company as determined by the market. Multiply the share price by the number of outstanding shares. Can change daily.

MARKET VALUE POTENTIAL (MVP)

An RLI incentive plan covering all employees that requires we first generate a return in excess of our cost of capital, aligning our interests with those of shareholders.

PROFESSIONAL LIABILITY INSURANCE

Insures against claims for damages due to professional misconduct or lack of ordinary care in the performance of a service.

REINSURER/REINSURANCE

A company that accepts part or all of the risk of loss covered by another insurer. Insurance for insurers.

RESERVES

Funds set aside by an insurer for meeting estimated obligations when due. Periodically readjusted.

SOFT MARKET

When the insurance industry has excess capacity to handle the amount of business written, creating a buyer’s market, lowering insurance prices overall.

STANDARD LINES VS. SPECIALTY LINES

Those insurance coverages or target market segments that are commonly insured through large, admitted insurers using standard forms and pricing are in contrast to unique insurance coverages or selected market niches that are served by only a single insurer or a select group of insurers, often with unique coverage forms and pricing approach.

SURETY BOND

Provides for compensation if specific acts are not performed within a stated period.

SURPLUS LINES COMPANY

In most states, an insurer not licensed to do business in that state, but which may sell insurance in the state if admitted insurers decline to write a risk.

TRANSPORTATION INSURANCE

Coverage for transporting people or goods by land. For RLI, this involves motor vehicle transportation and focuses on automobile liability and physical damage, with incidental public liability, umbrella and excess liability, and motor truck cargo insurance.

UNREALIZED GAINS (LOSSES)

The result of an increase (decrease) in fair value of an asset which is not recognized in the traditional statement of income. The difference between an asset’s fair and book values.

61

SELECTED FINANCIAL DATA

The following is selected financial data of RLI Corp. and Subsidiaries for the 11 years ended December 31, 2008.

(amounts in thousands, except per share data)	2008			2007		2006		2005		2004
OPERATING RESULTS
Gross premiums written(1)	$	681,169		739,334		799,013		756,012		752,588
Consolidated revenue	$	561,012		652,345		632,708		569,302		578,800
Net earnings	$	78,676		175,867		134,639		107,134		73,036
Comprehensive earnings (loss)(2)	$	(1,895	)	166,423		156,999		83,902		81,354
Net cash provided from operating activities	$	161,334		127,023		171,775		198,027		188,962
FINANCIAL CONDITION
Total investments	$	1,658,828		1,839,777		1,828,241		1,697,791		1,569,718
Total assets	$	2,419,401		2,626,523		2,771,296		2,735,870		2,468,775
Unpaid losses and settlement expenses	$	1,159,311		1,192,178		1,318,777		1,331,866		1,132,599
Total debt	$	100,000		127,975		100,000		115,541		146,839
Total shareholders’ equity	$	708,154		774,422		756,520		692,941		623,661
Statutory surplus(3)	$	678,141		752,004		746,905		690,547		605,967	(6)
SHARE INFORMATION
Net earnings per share:
Basic	$	3.65		7.46		5.40		4.21		2.90
Diluted	$	3.60		7.30		5.27		4.07		2.80
Comprehensive earnings (loss) per share:(2)
Basic	$	(0.09	)	7.06		6.30		3.30		3.23
Diluted	$	(0.09	)	6.91		6.14		3.19		3.12
Cash dividends declared per share	$	0.99		0.87		0.75		0.63		0.51
Book value per share	$	32.98		34.95		31.17		27.12		24.64
Closing stock price	$	61.16		56.79		56.42		49.87		41.57
Stock split
Weighted average shares outstanding:(4)(7)
Basic	21,540			23,574		24,918		25,459		25,223
Diluted	21,848			24,085		25,571		26,324		26,093
Common shares outstanding	21,474			22,155		24,273		25,551		25,316
OTHER NON-GAAP FINANCIAL INFORMATION(1)
Net premiums written to statutory surplus(3)	76		%	72	%	74	%	72	%	84	%
GAAP combined ratio(5)	84.2			71.4		84.1		86.0		92.2
Statutory combined ratio(3) (5)	85.7			73.3		84.0		86.7		93.8

62

(amounts in thousands, except per share data)	2003			2002		2001		2000		1999		1998
OPERATING RESULTS
Gross premiums written (1)	$	742,477		707,453		511,985		437,867		339,575		291,073
Consolidated revenue	$	519,886		382,153		309,354		263,496		225,756		168,114
Net earnings	$	71,291		35,852		31,047		28,693		31,451		28,239
Comprehensive earnings (loss)(2)	$	97,693		13,673		11,373		42,042		20,880		51,758
Net cash provided from operating activities	$	191,019		161,971		77,874		53,118		58,361		23,578
FINANCIAL CONDITION
Total investments	$	1,333,360		1,000,027		793,542		756,111		691,244		677,294
Total assets	$	2,134,364		1,719,327		1,390,970		1,281,323		1,170,363		1,012,685
Unpaid losses and settlement expenses	$	903,441		732,838		604,505		539,750		520,494		415,523
Total debt	$	147,560	(6)	54,356		77,239		78,763		78,397		39,644
Total shareholders’ equity	$	554,134		456,555	(4)	335,432		326,654		293,069		293,959
Statutory surplus(3)	$	546,586	(6)	401,269	(4)	289,997		309,945		286,247		314,484
SHARE INFORMATION
Net earnings per share:
Basic	$	2.84		1.80		1.58		1.46		1.55		1.34
Diluted	$	2.76		1.75		1.55		1.44		1.54		1.33
Comprehensive earnings (loss) per share:(2)
Basic	$	3.89		0.69		0.58		2.14		1.03		2.46
Diluted	$	3.78		0.67		0.57		2.11		1.02		2.43
Cash dividends declared per share	$	0.40		0.35		0.32		0.30		0.28		0.26
Book value per share	$	22.02		18.50	(4)	16.92		16.66		14.84		14.22
Closing stock price	$	37.46		27.90		22.50		22.35		17.00		16.63
Stock split				200	%(7)							125	%
Weighted average shares outstanding:(4)(7)
Basic	25,120			19,937		19,630		19,634		20,248		21,028
Diluted	25,846			20,512		20,004		19,891		20,444		21,276
Common shares outstanding	25,165			24,681		19,826		19,608		19,746		20,670
OTHER NON-GAAP FINANCIAL INFORMATION(1)
Net premiums written to statutory surplus(3)	87		%	103	%	109	%	84	%	79	%	46	%
GAAP combined ratio(5)	92.0			95.6		97.2		94.8		91.2		88.2
Statutory combined ratio(3) (5)	93.1			92.4		95.8		95.8		90.1		88.4

(1)	See page 2-3 for information regarding non-GAAP financial measures.
(2)	See note 1.Q to the consolidated financial statements.
(3)	Ratios and surplus information are presented on a statutory basis. As discussed further in the MD&A and note 9, statutory accounting principles differ from GAAP and are generally based on a solvency concept. Reporting of statutory surplus is a required disclosure under GAAP.
(4)	On December 26, 2002, we closed an underwritten public offering of 4.8 million shares of common stock. This offering generated $115.1 million in net proceeds. Of this, $80.0 million was contributed to the insurance subsidiaries. Remaining funds were used to pay down lines of credit.
(5)	The GAAP and statutory combined ratios are impacted by favorable development on prior accident years’ loss reserves. See note 6 for further discussion.
(6)	On December 12, 2003, we successfully completed a public debt offering, issuing $100.0 million in Senior Notes maturing January 15, 2014. This offering generated proceeds, net of discount and commission, of $98.9 million. Of the proceeds, capital contributions were made in 2003 and 2004 to our insurance subsidiaries to increase their statutory surplus in the amounts of $50.0 million and $15.0 million, respectively. Remaining funds were retained at the holding company.
(7)	On October 15, 2002, our stock split on a 2-for-1 basis. All share and per share data has been retroactively stated to reflect this split.

63

INVESTOR INFORMATION

ANNUAL MEETING

The annual meeting of shareholders will be held at 2 p.m., CDT, on May 7, 2009, at our offices at 9025 N. Lindbergh Drive, Peoria, Ill.

TRADING AND DIVIDEND INFORMATION

	Closing Stock Price						Dividends
2008	High		Low		Ending		Declared
1st Quarter	$	56.68	$	48.48	$	49.57	$	.23
2nd Quarter	54.03		46.93		49.47		.25
3rd Quarter	66.61		44.64		62.09		.25
4th Quarter	62.38		46.71		61.16		.26

	Closing Stock Price						Dividends
2007	High		Low		Ending		Declared
1st Quarter	$	58.38	$	51.00	$	54.93	$	.20
2nd Quarter	58.11		54.79		55.95		.22
3rd Quarter	60.82		55.82		56.72		.22
4th Quarter	60.60		55.13		56.79		.23

RLI common stock trades on the New York Stock Exchange under the symbol RLI. RLI has paid and increased dividends for 33 consecutive years.

STOCK OWNERSHIP

December 31, 2008	Shares	%
Insiders	2,255,824	10.5
ESOP	1,476,635	6.9
Institutions & other public	17,741,970	82.6
Total outstanding	21,474,429	100.0

SHAREHOLDER INQUIRIES

Shareholders of record with requests concerning individual account balances, stock certificates, dividends, stock transfers, tax information or address corrections should contact the transfer agent and registrar:

Wells Fargo Shareholder Services

P.O. Box 64854

St. Paul, MN 55164-0854

Phone: (800) 468-9716 or (651) 450-4064

Fax: (651) 450-4033

Email: stocktransfer@wellsfargo.com

DIVIDEND REINVESTMENT PLANS

If you wish to sign up for an automatic dividend reinvestment and stock purchase plan or to have your dividends deposited directly into your checking, savings or money market accounts, send your request to the transfer agent and registrar.

REQUESTS FOR ADDITIONAL INFORMATION

Electronic versions of the following documents are, or will be made, available on our website: 2008 summary annual report; 2008 financial report; 2009 proxy statement; 2008 annual report on form 10-K; code of conduct, corporate governance guidelines; and charters of the executive resources, audit, finance and investment, strategy, and nominating/corporate governance committees of our board. Printed copies of these documents are available without charge to any shareholder. To be placed on a mailing list to receive shareholder materials, contact our corporate headquarters.

COMPANY FINANCIAL STRENGTH RATINGS

A.M. Best:	A+ (Superior)	RLI Group
Standard & Poor’s:	A+ (Strong)	RLI Insurance Company
	A+ (Strong)	Mt. Hawley Insurance Company
Moody’s:	A2 (Good)	RLI Insurance Company
	A2 (Good)	Mt. Hawley Insurance Company
	A2 (Good)	RLI Indemnity Company

CONTACTING RLI

For investor relations requests and management’s perspective on specific issues, contact John Robison, treasurer, at (309) 693-5846 or at john.robison@rlicorp.com.

Turn to the back cover for corporate headquarters contact information.

Find comprehensive investor information at www.rlicorp.com.

64

DIFFERENT WORKS

9025 N. Lindbergh Drive, Peoria, IL 61615-1431  T 309-692-1000, 800-331-4929  F 309-693-1068
www.rlicorp.com  ©RLI Corp. 2009  RLI-2.5M-309

65

EX-21.1

Exhibit 21.1

Subsidiaries of the Registrant

The following companies are subsidiaries of the Registrant as of December 31, 2008.

Name	Jurisdiction of Incorporation	Percentage Ownership
RLI Insurance Company	Illinois	100	%
Mt. Hawley Insurance Company	Illinois	100	%
RLI Indemnity Company	Illinois	100	%
RLI Aviation, Inc.	Illinois	100	%
RLI Underwriting Services, Inc.	Illinois	100	%
RLI Insurance Ltd.	Bermuda	100	%
RLI Insurance Agency Ltd.	Canada	100	%
Underwriters Indemnity General Agency, Inc.	Texas	100	%
Safe Fleet Insurance Services, Inc.	California	100	%

59

EX-23.1

Exhibit 23.1

Consent of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

RLI Corp.:

We consent to the incorporation by reference in the registration statements on Form S-8 (Nos. 333-01637, 333-28625, 333-117714 and 333-125354) of RLI Corp. of our reports dated February 25, 2009, with respect to the consolidated balance sheets of RLI Corp. and Subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of earnings and comprehensive earnings, cash flows, and shareholders’ equity for each of the years in the three-year period ended December 31, 2008, and all related financial statement schedules and the effectiveness of internal control over financial reporting as of December 31, 2008, which reports are incorporated by reference in, or appear in, the December 31, 2008 annual report on Form 10-K of RLI Corp.

/s/ KPMG LLP

Chicago, Illinois

February 25, 2009

60

EX-31.1

Exhibit 31.1

CERTIFICATION

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

I, Jonathan E. Michael, certify that:

I have reviewed this annual report on Form 10-K of RLI Corp.

Based on my knowledge, this 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 report;

Based on my knowledge, the financial statements, and other financial information included in this 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 report;

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-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:       February 25, 2009

/s/ Jonathan E. Michael

Jonathan E. Michael

President & CEO

61

EX-31.2

Exhibit 31.2

CERTIFICATION

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

I, Joseph E. Dondanville, certify that:

I have reviewed this annual report on Form 10-K of RLI Corp.

Based on my knowledge, this 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 report;

Based on my knowledge, the financial statements, and other financial information included in this 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 report;

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-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:       February 25, 2009

/s/ Joseph E. Dondanville

Joseph E. Dondanville

Senior VP, Chief Financial Officer

62

EX-32.1

Exhibit 32.1

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 Annual Report of RLI Corp. (the “Company”) on Form 10-K for the period ending December 31, 2008 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 results of operations of the Company.

/s/ Jonathan E. Michael

Jonathan E. Michael

President & CEO

February 25, 2009

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EX-32.2

Exhibit 32.2

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 Annual Report of RLI Corp. (the “Company”) on Form 10-K for the period ending December 31, 2008 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 results of operations of the Company.

/s/ Joseph E. Dondanville

Joseph E. Dondanville

Senior VP, Chief Financial Officer

February 25, 2009

64