Annual Report — Form 10-K
Filing Table of Contents
Document/Exhibit Description Pages Size
1: 10-K Annual Report 35 160K
2: EX-3.1 Articles of Inc 5 17K
3: EX-3.2 Bylaws 24 88K
4: EX-11 Rli & Subsidiaries 2± 10K
5: EX-13 Selected Financial Data 47± 224K
6: EX-21.1 Subsidiaries of Registrant 1 7K
7: EX-23.1 Consent of Independent Auditors 1 7K
8: EX-27 Exhibit 27 FDS 2 9K
9: EX-28.1 Info From Reports Furnished to State Insurance 1 7K
EX-13 — Selected Financial Data
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SELECTED FINANCIAL DATA
The following is selected financial data of RLI Corp. and Subsidiaries for the
eleven years ended December 31, 1996:
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1986 1987 1988 1989 1990
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OPERATING RESULTS
Gross sales $195,805,801 151,492,336 143,785,384 149,230,331 181,215,877
Total revenue $111,029,407 106,846,379 104,279,172 89,984,262 92,957,578
Net earnings (loss) $10,978,773 13,965,174 7,253,913 8,200,264 14,267,002
Comprehensive earnings (loss) (2) $11,789,807 12,373,916 8,295,719 11,105,089 11,952,060
Net cash provided from operating activities $31,600,447 9,151,857 27,742,205 22,801,043 45,388,065
Net premiums written to statutory surplus 190% 156% 131% 96% 112%
GAAP combined ratio 93.5 84.4 96.1 97.8 85.1
Statutory combined ratio 89.5 84.7 98.3 99.5 92.2
FINANCIAL CONDITION
Total investments $131,902,026 152,777,063 165,956,870 177,025,151 213,160,198
Total assets $321,883,748 364,740,628 372,492,257 402,906,191 432,379,562
Unpaid losses and settlement expenses $159,383,894 194,707,865 217,230,839 230,523,717 235,806,989
Long-term debt $7,000,000 7,000,000 7,000,000 7,000,000 7,000,000
Total shareholders' equity $49,291,745 57,763,851 64,026,271 70,276,175 79,850,942
Statutory surplus $54,063,188 57,453,264 60,151,725 68,571,173 70,409,590
SHARE INFORMATION
Earnings (loss) per share:
Primary $1.46 1.82 .97 1.14 2.02
Fully-diluted (3) $1.46 1.82 .97 1.14 2.02
Comprehensive earnings (loss) per share: (2)
Primary $1.57 1.61 1.11 1.54 1.69
Fully-diluted (3) $1.57 1.61 1.11 1.54 1.69
Cash dividends declared per common share $.22 .25 .27 .30 .34
Book value $6.37 7.73 8.57 9.94 11.29
Closing stock price $11.00 7.70 6.10 6.80 11.60
Stock split 150%
Weighted average number of common shares outstanding:
Primary 7,526,375 7,704,938 7,475,369 7,189,076 7,073,718
Fully-diluted (3) 7,526,375 7,704,938 7,475,369 7,189,076 7,073,718
Common shares outstanding 7,738,619 7,475,369 7,475,369 7,073,718 7,073,718
==================================================================================================================================
(1) 1992 through 1995 information has been restated to include the effect of
the change to the equity method of accounting for the company's former
subsidiary, RLI Vision Corp., renamed Maui Jim, Inc. The financial restatement
represents a change in presentation only and does not have a dilutive effect on
historical periods. See note 1B to the consolidated financial statements.
(2) The requirement to report comprehensive earnings is currently being
considered by the FASB. The primary difference between reporting the company's
GAAP and comprehensive earnings is that comprehensive earnings include
unrealized gains/losses net of tax. GAAP reporting directly credits or charges
shareholders' equity with unrealized gains/losses, rather than including them in
earnings.
18
SELECTED FINANCIAL DATA
The following is selected financial data of RLI Corp. and Subsidiaries for the
eleven years ended December 31, 1996:
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1991 1992(1) 1993(1)
(restated) (restated)
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OPERATING RESULTS
Gross sales 215,497,602 220,048,369 266,480,414
Total revenue 102,342,998 117,581,830 143,100,340
Net earnings (loss) 16,800,050 16,207,127 15,947,627
Comprehensive earnings (loss) (2) 22,430,168 18,547,721 21,175,108
Net cash provided from operating activities 22,918,206 43,618,755 73,629,090
Net premiums written to statutory surplus 95% 110% 94%
GAAP combined ratio 85.2 91.4 97.2
Statutory combined ratio 91.6 95.8 87.9 (4)
FINANCIAL CONDITION
Total investments 237,932,089 281,112,588 401,608,917
Total assets 483,571,862 526,351,331 667,650,378
Unpaid losses and settlement expenses 244,666,938 268,042,761 310,767,026
Long-term debt 7,000,000 7,000,000 53,000,000
Total shareholders' equity 99,677,983 117,392,751 140,706,372
Statutory surplus 88,605,319 100,584,758 152,261,509
SHARE INFORMATION
Earnings (loss) per share:
Primary 2.38 2.26 2.10 (5)
Fully-diluted (3) 2.38 2.26 2.00 (5)
Comprehensive earnings (loss) per share: (2)
Primary 3.17 2.59 2.79 (5)
Fully-diluted (3) 3.17 2.59 2.63 (5)
Cash dividends declared per common share .37 .40 .42
Book value 14.09 16.30 18.25
Closing stock price 13.20 19.80 21.20
Stock split
Weighted average number of common shares outstanding:
Primary 7,073,718 7,158,890 7,599,563
Fully-diluted (3) 7,073,718 7,158,890 8,360,575
Common shares outstanding 7,073,718 7,201,343 7,711,065
1994(1) 1995(1) 1996
(restated) (restated)
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OPERATING RESULTS
Gross sales 295,965,601 293,921,737 301,499,626
Total revenue 156,721,972 155,953,724 155,354,418
Net earnings (loss) (4,775,871) 7,949,541 25,695,721
Comprehensive earnings (loss) (2) (8,512,784) 31,373,771 41,969,893
Net cash provided from operating activities 27,041,297 24,648,625 48,946,600
Net premiums written to statutory surplus 108% 76% 64%
GAAP combined ratio 116.9 107.5 87.4
Statutory combined ratio 116.9 106.5 89.1
FINANCIAL CONDITION
Total investments 413,835,146 471,599,283 537,946,060
Total assets 751,085,888 810,199,958 845,473,784
Unpaid losses and settlement expenses 394,966,040 418,985,960 405,801,220
Long-term debt 52,255,000 46,000,000 46,000,000
Total shareholders' equity 131,169,961 158,607,716 200,039,361
Statutory surplus 136,124,530 172,312,961 207,786,596
SHARE INFORMATION
Earnings (loss) per share:
Primary (0.61) 1.01 3.25
Fully-diluted (3) (0.61) 1.01 2.85
Comprehensive earnings (loss) per share: (2)
Primary (1.09) 4.00 5.32
Fully-diluted (3) (1.09) 3.46 (6) 4.54
Cash dividends declared per common share .45 .51 .55
Book value 16.71 20.20 25.57
Closing stock price 16.40 25.00 33.38
Stock split 125%
Weighted average number of common shares outstanding:
Primary 7,786,004 7,849,799 7,896,463
Fully-diluted (3) 7,786,004 7,849,799 9,665,694
Common shares outstanding 7,849,443 7,850,882 7,821,730
=========================================================================================================
(3) See note 1K to the consolidated financial statements.
(4) Contingent commission income recorded during 1993, from the cancellation of
a multiple-year, retrospectively-rated reinsurance contract, reduced the
statutory expense and combined ratio 10.3 points.
(5) Primary and fully-diluted earnings per share include $.22 per share and
$.20 per share, respectively, related to the initial application of SFAS 109
"Accounting for Income Taxes."
(6) For 1995, fully-diluted earnings per share on a GAAP basis were
anti-dilutive. As such, GAAP fully-diluted and primary earnings per share were
equal. Fully-diluted comprehensive earnings per share, however, were not
anti-dilutive. The number of fully-diluted shares used for this calculation was
9,619,030.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OVERVIEW
RLI Corp. (the Company) is a holding company that underwrites selected property
and casualty insurance through its major subsidiaries collectively known as RLI
Insurance Group (the Group). The Group has accounted for approximately 85% of
consolidated revenue over the last two years by providing property and casualty
coverages primarily for commercial risks. As a niche insurer, the Group offers
products geared to the needs of those insureds generally overlooked by
traditional insurance markets. The Group's product mix is split virtually evenly
between property and casualty coverages.
The property and casualty insurance business is cyclical and influenced by many
factors, including price competition, economic conditions, natural disasters,
interest rates, state regulations, court decisions, and changes in the law. One
of the unique and challenging features of the property and casualty insurance
business is that products must be priced before costs are fully known, because
premiums are charged before claims are incurred.
Property insurance results are subject to the variability introduced by natural
and man-made disasters such as earthquakes, fires and hurricanes. The Company's
major catastrophe exposure is to losses caused by earthquakes, since 70.7% of
the Company's 1996 total property premiums were written in California. The
Company limits its net aggregate exposure to a catastrophic event 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. Utilizing this approach, the Company attempts to limit its
net aggregate exposure to a single catastrophic event to less than 10% of total
shareholders' equity. During 1996, the Company entered into an innovative
financing arrangement, known as Catastrophe Equity Puts, which provides for the
issuance of the Company's convertible preferred shares at a pre-negotiated rate
to restore surplus to a sufficient level and to continue writing business in the
event of a catastrophic loss.
The casualty portion of the Company's business consists largely of commercial
and personal umbrella and general liability coverages. In addition, the Group
provides directors & officers liability, employers excess indemnity (EEI-an
alternative to the Texas state-run workers' compensation system), contract and
miscellaneous surety bonds, and in-home business owners coverage. The casualty
book of business is subject to the risk of accurately estimating losses and
related loss reserves since the ultimate disposition of a casualty claim may
take several years to fully develop. The casualty line is additionally affected
by evolving legislation and court decisions that define the extent of coverage
and the amount of compensation due for injuries or losses.
The consolidated financial statements and related notes found on pages 26-43
should be read in conjunction with the following discussion.
SIGNIFICANT DEVELOPMENTS
OPHTHALMIC MERGER
In November, the Company announced the merger of its ophthalmic services
subsidiary, RLI Vision Corp., with Hester Enterprises, Inc. The resulting
organization operates under the name Maui Jim, Inc. This transaction brings
together the infrastructure of RLI Vision to support the recent booming sales
growth of Maui Jim sunglasses. The Company has a 44% (34% at December 31, 1996)
minority interest in Maui Jim, Inc., which is reflected in the Company's
financial statements as an equity-based investment. Fourth quarter 1996 results
included a one-time charge to the Company of $733,000, or $.06 per share, for
the effect of the change from pooling to purchase accounting stemming from a
1995 RLI Vision Corp. business combination. This change was required because of
the aforementioned merger.
YEAR ENDED DECEMBER 31, 1996, COMPARED
TO YEAR ENDED DECEMBER 31, 1995
Consolidated gross sales--which consist of gross premiums written, net
investment income and realized investment gains (losses)-- totaled $301.5
million, a 2.6% increase from 1995. Consolidated revenue for 1996 was $155.4
million, down 0.4% from the previous year. The decline in revenue was
attributable to lower earned premiums of $130.7 million in 1996 compared to
$133.5 million in 1995. This decrease resulted from the 1995 discontinuation of
certain lines of business as well as the re-underwriting of the property book of
business. As written premiums increased during the year, net earned premiums
grew 4.0% in the fourth quarter of 1996 compared to 1995.
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Year Ended December 31,
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Gross sales (in thousands) 1994 1995 1996
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Gross premiums written $279,428 $271,436 $276,802
Net investment income 20,132 22,029 23,681
Realized investment gains (losses) (3,595) 457 1,017
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Total gross sales $295,965 $293,922 $301,500
================================================================================
Net after-tax earnings for the Company were a record $25.7 million ($3.25 per
share) in 1996 compared to $8.0 million ($1.01 per share) in 1995. The impact in
1995 from the adverse development of Northridge Earthquake claims was a loss of
$18.6 million ($2.37 per share). As of December 31, 1996, the Company had 36
outstanding open earthquake claims
20
out of 688 originally reported as a result of this occurrence. Management
believes the reserve strengthening in the third quarter of 1995 appears adequate
to resolve the Company's remaining liabilities.
During the fourth quarter of 1996, the Company introduced the reporting of
comprehensive earnings in public releases of financial information. Based on an
exposure draft from the Financial Accounting Standards Board, comprehensive
earnings include not only traditional net income but other sources of equity
growth as well. The material adjustment applicable to the Company's net earnings
is the inclusion of net unrealized gains and losses, after tax. The following
table illustrates the Company's per-share comprehensive earnings performance
compared to traditional earnings for the last five years.
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Primary Fully Diluted
Net Earnings Comp. Earnings Net Earnings Comp. Earnings
--------------------------------------------------------------------------------
1992 $2.26 $2.59 $2.26 $2.59
1993 2.10 2.79 2.00 2.63
1994 ( .61) (1.09) ( .61) (1.09)
1995 1.01 4.00 1.01 3.46
1996 3.25 5.32 2.85 4.54
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$8.01 $13.61 $7.51 $12.13
================================================================================
As this chart indicates, comprehensive earnings per share for the last five
years exceeds reported net earnings by 70% on a primary basis. As a result,
shareholders' equity reached an unprecedented level of over $200.0 million.
The Company has adopted this concept through its Market Value Potential (MVP)
program, which correlates executive compensation with increased value returned
to shareholders. This is accomplished by awarding bonuses only after equity
growth has exceeded the Company's own cost of capital and the Employee Stock
Ownership Plan contribution.
RLI INSURANCE GROUP
Gross written premiums of $276.8 million were higher than 1995 by 2.0% in total
while gross written premiums from continuing programs rose 4.9%. These modest
increases reflect the Company's focus on underwriting selection even during
periods of trying market conditions. The Group's pretax earnings for 1996 were
$16.4 million, compared to a loss of $9.9 million in 1995 that was impacted by
the strengthening of the Northridge Earthquake reserves.
The Company's property book of business produced the most growth with gross
written premiums of $138.1 million for the year ended 1996, increasing 8.8% over
the same period in 1995. The property line also exhibited considerable
profitability by achieving a GAAP combined ratio of 60.9 in 1996, compared to
63.8 in 1995, excluding the impact of the Northridge Earthquake. The property
GAAP expense ratio for 1996 was 38.5 compared to 43.1 in 1995. This decline was
the result of property reinsurance profit-sharing commissions earned due to
favorable loss experience over the past year.
Casualty gross written premiums declined 4.0% from 1995 to $138.7 million in
1996. Much of this decline was due to the discontinued aviation product line,
where $6.3 million was written in 1995. Other casualty lines were flat or
slightly down in 1996 from 1995, reflecting the Company's commitment to risk
selection even during protracted periods of soft market conditions. The
exception was in the surety product line where 1996 gross written premiums were
$11.6 million compared to $3.7 million in 1995. Reserve strengthening on the
Company's primary general liability line in 1996 affected casualty business
profitability as the GAAP combined ratio rose to 103.0, compared to 99.7 in
1995. Despite this strengthening, total reserve development in 1996 on prior
accident years' reserves was favorable as indicated in note 6 to the financial
statements.
INVESTMENT INCOME
Net dividend and interest income increased 7.5% during 1996. The increase was
due to the growth in invested assets throughout 1996 and substantial cash flow
provided from recoveries from our reinsurers. The Company realized $1.0 million
in capital gains in 1996, compared to $457,000 in 1995. Operating cash flows
were up substantially for 1996, increasing to $48.9 million from $24.6 million
in 1995. All cash flows in excess of current needs were used to reduce
outstanding short term debt, fund our stock repurchase program, purchase equity
securities, and acquire fixed-income instruments, composed of intermediate term,
high grade tax-exempt securities, convertible debenture securities and U.S.
government and agency securities. During 1996, $2.8 million in short term debt
was paid off, and the Company began a $10 million stock repurchase program. By
year end, the Company had repurchased 116,212 shares of stock at a total cost of
$3.0 million.
The yields on the Company's fixed-income investments for the years ended
December 31, 1995 and 1996, respectively, were as follows:
1995 1996
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Taxable 6.84% 6.91%
Tax-exempt 5.06% 4.97%
Yields for 1996 remained relatively stable as a roller coaster bond market saw
yields rise significantly by midyear and then return to levels slightly above
those at year end 1995. Tax-exempt yields were down slightly as substantial
higher yielding securities matured or were called during the year and were
reinvested at the lower current levels. The taxable segment of the portfolio saw
a slight increase in yield through the inclusion of callable agencies and an
extension of the overall portfolio duration.
21
The investment results of the Company for the last five years are shown in the
following table. All amounts are shown in thousands.
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Tax Equivalent
Change in Annualized Annualized
Unrealized Return on Return on
Average Realized Appreciation/ Average Average
Invested Investment Gains Depreciation Invested Invested
Year Assets(1) Income(2)(3) (Losses)(3) (3)(4) Assets Assets
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1992 259,522 13,483 921 3,546 6.9% 8.0%
1993 341,361 16,857 254 7,945 7.3% 8.3%
1994 407,722 20,133 (3,595) (5,749) 2.7% 3.6%
1995 442,717 22,029 457 36,037 13.2% 14.1%
1996 504,773 23,681 1,018 25,033 9.9% 10.7%
5-yr. $390,672 $19,236 $ (189) $13,362 8.3% 9.2%
(1) Average of amounts at beginning and end of year.
(2) Investment income, net of investment expenses, including non-debt interest
expense.
(3) Before income taxes.
(4) Relates to available-for-sale fixed maturities and equity securities.
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The annualized return for 1996 was greatly enhanced by the strong performance of
our equity portfolio, which had unrealized appreciation of $25.8 million.
INTEREST AND GENERAL CORPORATE EXPENSE
Interest expense on debt was $2.8 million in 1996, down 16.1% from 1995. This
decline reflected the refinancing of an Industrial Revenue Bond with short-term
debt at a considerably lower interest rate at the end of 1995. The short-term
debt was subsequently paid off during the first quarter of 1996. General
corporate expenses increased 56.6% in 1996, primarily as a result of accrued
executive bonuses relating to the MVP program.
INCOME TAXES
The Company's effective tax rate in 1996 was 27.1% on pretax earnings of $35.2
million. These earnings include $8.0 million of investment income that is wholly
or partially exempt from federal income tax. In 1995, the Company reported a tax
benefit of $124,000 on pretax earnings of $7.8 million. Non-taxable income for
1995 was $7.4 million.
OUTLOOK FOR 1997
The Company's main focus in 1997 is top line growth. Home office infrastructure
was strengthened in 1996 to aggressively pursue a program of identifying,
evaluating, and pursuing new product opportunities in the coming year. This will
be accomplished either through new strategic alliances with producers on
existing products or by identifying new products that fit the Company's
philosophy as a specialty lines insurer.
PROPERTY INSURANCE
The Company anticipates that both the earthquake and fire property markets will
soften somewhat in 1997, thereby inhibiting significant growth on existing
products. Continued profitability is expected in 1997, absent any significant
catastrophies, due largely to the structure of the property reinsurance program.
The Company's reinsurance protection from earthquake has been continually
strengthened throughout the past two years. In 1997, existing protection will be
maintained at a cost savings of approximately 15%. Additionally, a newly
pioneered equity protection agreement, referred to as CatEPuts-SM-, was forged
in 1996. This program provides access to additional capital in the event a loss
exceeds the Company's current catastrophe reinsurance protection. This strategy
would allow the Company to continue to write business following a large
catastrophic event as the market capacity constricts.
CASUALTY AND OTHER LINES
Company projections for gross written premiums in 1997 include double digit
increases in the commercial umbrella, employers indemnity, professional
liability, and surety lines. The 1996 favorable reserve development, including
reserve strengthening, bodes well for the future profitability of this segment
of the Company's business. The goal for 1997 is to achieve a combined ratio
below 100.0, adding underwriting earnings to the considerable investment income
earned on these products' long-tail reserves.
YEAR ENDED DECEMBER 31, 1995,
COMPARED TO YEAR ENDED DECEMBER 31, 1994
Consolidated 1995 gross sales totaled $293.9 million, a 0.7% decline from 1994.
Consolidated revenue for 1995 was $156.0 million, down 0.5% from 1994. These
decreases were due to the discontinuation of lines of business and a
re-underwriting of the property book of business, resulting in a temporary
decline in premiums. The specific declines from discontinued business were $4.1
million from contact lens and $11.3 million from aviation. These decreases were
partially offset by increases in investment income and capital gains.
Net after-tax earnings for the Company were $8.0 million ($1.01 per share) in
1995, compared to a net after-tax loss in 1994 of $4.8 million ($.61 per share).
The net after-tax impact of the Northridge Earthquake was a loss of $18.6
million ($2.37 per share) in 1995. The effect of the earthquake in 1994 was an
after-tax loss of $25.0 million ($3.21 per share). The following table compares
the Company's operating results for 1995 and 1994. Results are shown as actually
reported as well as adjusted
22
for the Northridge Earthquake. All amounts are shown in thousands, except per
share data.
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Without Earthquake
1994 1995 1994 1995
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Premiums earned $140,184 $133,468 $158,197 $134,695
Other revenue 16,538 22,486 16,538 22,486
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Consolidated revenue 156,722 155,954 174,735 157,181
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Loss and settlement expenses 101,642 85,890 80,466 58,552
Policy acquisition costs 47,106 43,042 48,416 43,042
All other 20,217 19,196 20,217 19,196
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Total expenses 168,965 148,128 149,099 120,790
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Earnings (loss) before income taxes (12,243) 7,826 25,636 36,391
Net earnings (loss) (4,775) 7,950 20,246 26,517
Primary net earnings (loss) per share (0.61) 1.01 2.60 3.38
Operating earnings (loss) per share $(0.31) $0.97 $2.90 $3.34
================================================================================================
In 1994, the Company's board of directors did not authorize a contribution to
the RLI Corp. Employee Stock Ownership Plan and Trust (ESOP). This decision
reduced expenses and thereby enhanced 1994 after-tax earnings by $1.6 million
($.21 per share). Realized capital losses recognized in 1994 reduced after-tax
earnings by $2.4 million ($.30 per share). Realized capital gains in 1995
increased after-tax earnings by $297,000 ($.04 per share).
RLI INSURANCE GROUP
While the effects of the Northridge Earthquake were still being felt in 1995,
they were offset to a large extent by the outstanding results from ongoing
operations of the Group. Including results from the earthquake, the Group's
pretax loss was $9.9 million, which was an improvement of $13.8 million over the
same period in 1994. The Group's overall property loss ratio, including
Northridge, improved 23 points to 75 in 1995 compared to 1994, largely due to
the elimination of unprofitable fire risks.
Gross written premiums in 1995 of $271.4 million were down 2.9%, off slightly
from 1994 results. This was due to the Group's re-underwriting efforts designed
to reduce earthquake exposure through reduced limits, fewer heavily exposed
policies, and attachment at higher levels on large risks. As this
re-underwriting phase was completed toward the end of 1995, property premiums
began to increase. The Group also reduced its fire book of business in selected
areas by focusing on more profitable risks. Net premiums earned also declined
4.8% to $133.5 million. The discontinued aviation and contact lens lines
contributed to this decline.
Excluding the impact of the earthquake, the Group's pretax earnings increased
31.5% to $18.6 million from $14.2 million a year earlier. This improvement was
also reflected in the pre-quake combined ratio, calculated according to GAAP,
which was 86.2 in 1995 compared to 91.1 in 1994. Favorable property loss
experience contributed to this trend. While the pre-quake expense ratio
increased slightly in 1995 due to the decline in earned premiums, actual
operating expenses for the Group declined $6.0 million in 1995 compared to 1994.
Of this amount, $5.3 million was attributable to policy acquisition costs where
gross commission dropped $3.0 million due to the decline in gross written
premiums for 1995. Other insurance expenses were lower due mostly to the sale of
the aviation division, which resulted in 1995 expense savings of $2.1 million.
As described in note 6 of the consolidated financial statements, prior-year loss
reserves developed unfavorably by $23.3 million in 1995. This reflects $27.3
million of development on the Northridge Earthquake claims alone. After
adjusting for the earthquake, favorable development of $4.0 million would have
occurred, compared to unfavorable development of $1.1 million in 1994. The 1995
pre-quake development constitutes 2.0% of the total reserves for net loss and
settlement expenses.
INVESTMENT INCOME
Net dividend and interest income increased 9.4% during 1995. The increase was
due to the growth of assets throughout 1995 and from the reallocation of shorter
term securities into higher yielding, longer term fixed-income securities. The
Company realized $457,000 in capital gains in 1995, compared to $3.6 million in
realized losses in 1994. During 1994, certain equity securities were sold at a
net loss in order to recover $1.3 million in taxes paid on prior-year capital
gains. The opportunity to recover a portion of these tax dollars would have
expired at the end of 1994. Operating cash flows were down slightly for 1995,
declining to $24.6 million from $27.0 million in 1994. All cash flows in excess
of current needs were used to acquire equity securities and fixed-income
instruments composed of intermediate term, high grade tax-exempt securities and
U.S. government and agency securities.
The yields on the Company's fixed-income investments for the years ended
December 31, 1994 and 1995, respectively, were as follows:
1994 1995
--------------------------------------------------------------------------------
Taxable 6.82% 6.84%
Tax-exempt 5.25% 5.06%
In 1995, the bond market saw yields tumble nearly 200 basis points. As a result,
cash flows invested in tax-exempt securities were invested at lower yields. The
taxable segment of the portfolio saw a slight increase in yield through the
inclusion of callable agencies in the portfolio.
23
INTEREST AND GENERAL CORPORATE EXPENSE
Interest expense on debt for 1995 was $3.3 million, down slightly from 1994.
General corporate expenses dropped $753,000 in 1995 due primarily to the 1994
contribution of $1.0 million to Bradley University to establish an insurance
chair as part of its curriculum.
INCOME TAXES
In 1995, the Company recorded a tax benefit of $124,000 on pretax earnings of
$7.8 million. These earnings include $7.4 million of investment income that is
wholly or partially exempt from federal income tax. In 1994, the loss before
taxes was $12.2 million, with a tax benefit of $7.5 million, producing an
effective rate of 61%. Non-taxable investment income for 1994 was $7.8 million.
The Company had a net operating loss for tax purposes in 1994. The loss was
carried back to 1991 to recover federal and state income taxes paid. In
addition, the Company realized capital losses to be carried back as an offset to
capital gains in previous years. As a result, the Company carried back $3.6
million in capital losses realized in 1994 and recovered $1.3 million of taxes
paid in 1991, 1992, and 1993.
LEGISLATION
NATURAL DISASTER ACT--Recent natural disasters such as Hurricane Andrew, the
Midwestern floods and the Northridge Earthquake have sparked debate on the best
way to provide affordable insurance coverage for such events. Previously, the
Company supported the proposed Natural Disaster Act as the most desirable
alternative. That Act was never passed and the Company is considering other
proposed alternatives.
SUPERFUND REFORM (ENVIRONMENTAL LIABILITY)--In 1996, the president asked
congress to reinstate the corporate levies that provide funds for Superfund
cleanup. Congressional representatives indicate they would not support a
reinstatement but are considering comprehensive reform of this bill that, if
passed, could impose some tax liability on the Company.
PROPOSITION 103 (RATE ROLLBACK INITIATIVE)--In November 1988, California voters
approved Proposition 103, which requires insurance premium rates for certain
lines of business to be rolled back twenty percent (20%) from the rates in
effect in November 1987. During the second quarter of 1996, the Company reached
a settlement with the California Department of Insurance resolving its total
liability for refunds and interest under Proposition 103. The settlement
required the Company to return $2,987,050 in premiums and interest, which
resulted in a 1996 pretax charge of $487,370 to recognize the difference between
the actual settlement and the amount previously accrued. The Company is
currently in the process of issuing refund checks to policyholders.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the primary sources of the Company's liquidity have been funds
generated from insurance premiums (operating activities) and investment income
and maturing investments (investment activities). In addition, the Company has
occasionally received funds from financing activities, such as the sale of
company treasury stock to the Employee Stock Ownership Plan; issuance of common
stock or convertible debentures; and small, short term borrowings.
The Company maintains three sources of credit from two financial institutions:
one $10.0 million secured and committed line of credit that cannot be canceled
during its annual term; one $30.0 million secured line of credit that cannot be
canceled during its annual term; and one $3.0 million secured line of credit for
obtaining letters of credit. At December 31, 1996, the Company had no
outstanding short term debt. Management believes that cash generated from
operations, investments, and cash available from financing activities will
provide sufficient liquidity to meet the Company's anticipated needs over the
next 12 to 24 months.
In 1996, the Company entered into an innovative catastrophe reinsurance and loss
financing program with Centre Reinsurance (Centre Re). The program, called
Catastrophe Equity Puts (CatEPuts)SM, augments the Company's traditional
reinsurance by integrating its loss financing needs with a pre-negotiated sale
of securities linked to exchange-traded shares. CatEPuts allows the Company to
put up to $50.0 million of its convertible preferred shares to Centre Re at a
pre-negotiated rate in the event of a catastrophic loss, provided the loss does
not reduce GAAP equity to less than $55.0 million. CatEPuts is intended to be a
three-year program and is designed to enable the Company to continue operating
after a loss of such magnitude that its reinsurance capacity is exhausted. If
the Company exercises its option to put preferred shares to Centre Re, then
Centre Re, in turn, has the option to reinsure certain business written by the
Company on a prospective basis.
During 1996, the Company generated net operating cash flows of $48.9 million, up
substantially from 1995's $24.6 million. Financing activities included net use
of $2.8 million of funds to retire all short term debt. Additionally, the
Company began a stock repurchase program, repurchasing 116,212 shares at a total
cost of $3.0 million. The remainder of excess operating cash flows were added to
the Company's investment portfolio.
The Company's fixed-income portfolio continues to be biased in favor of U.S.
government and agency securities due to their high liquidity and almost
risk-free nature. As part of its investment strategy, the Company attempts to
avoid exposure to default risk by holding, almost exclusively, securities ranked
in the top two grades of investment quality by Standard & Poor's and Moody's
(i.e., AAA or AA). The majority of the Company's
24
fixed-income portfolio consists of securities rated A or better, with 98% rated
AA or better. Currently, 72.2% of the Company's fixed-income portfolio is
noncallable. Those securities containing call features have been factored into
the overall duration objectives of the portfolio and will not affect efforts to
match assets with anticipated liabilities.
The Company follows a program of matching assets to anticipated liabilities to
ensure its ability to hold securities until maturity. The Company's known debt
and long-term accounts payable are added to the estimate of its unpaid losses
and settlement expenses, by line of business. These anticipated liabilities are
then factored against ultimate payout patterns and the resulting payout streams
are funded with the purchase of fixed-income securities of like maturity.
Management believes that interest rate risk can best be minimized by such
asset/liability matching.
The Company intends to hold 85% of the securities in the Company's fixed-income
portfolio until their contractual maturity. These securities are classified as
held-to-maturity and are carried at amortized cost. The remaining 15% are
classified as available-for-sale and are carried at fair value. Unrealized
capital gains and losses on these securities are excluded from earnings and are
recorded as a separate component of shareholders' equity, net of deferred income
taxes. During 1996, the Company maintained $44.9 million in fixed income
securities within the available-for-sale classification. Although it is likely
that the majority of these securities will be held by the Company to maturity,
they will provide an additional source of liquidity and can be used to react to
future changes in the Company's asset/liability structure.
Equity portfolios increased $35.0 million during 1996. The Company had net
purchases of $9.2 million of common stock, with a portfolio appreciation of
$25.8 million. Capital gains of $124,000 were realized during the year. The
securities within the equity portfolio remain almost equally divided between
conservative, blue-chip stocks growing with market indices, and fundamentally
solid equities generating substantial dividend income.
The National Association of Insurance Commissioners (NAIC) continues its work on
developing a model investment law. This law, which is expected to be passed
during 1997, would regulate insurance company investments. The Company's current
investment portfolio appears to be in compliance with the proposed model
investment law. Management does not feel the proposed model law will affect its
current strategies.
The 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. The RBC
standards became effective for 1994 annual statement filings. The Company
continues to monitor its subsidiaries' internal capital requirements and the
NAIC's RBC developments. The Company has determined that its capital levels are
well in excess of the minimum capital requirements for all RBC action levels.
Management believes that the Company's capital levels are sufficient to support
the level of risk inherent in its operations.
The NAIC has a project to codify statutory accounting practices, the result of
which is expected to constitute the only source of "prescribed" statutory
accounting practices. Accordingly, that project will likely change the
definitions of what comprises prescribed versus permitted statutory accounting
practices and may result in changes to the accounting policies that insurance
enterprises use to prepare their statutory financial statements.
25
CONSOLIDATED BALANCE SHEETS
[Enlarge/Download Table]
December 31, 1995 1996
(restated)
--------------------------------------------------------------------------------------------------------------
Assets
--------------------------------------------------------------------------------------------------------------
Investments:
Fixed maturities:
Held-to-maturity, at amortized cost
(fair value--$260,957,796 in 1995 and $266,025,419 in 1996) $251,637,536 $ 263,282,430
Available-for-sale, at fair value
(amortized cost--$43,990,338 in 1995 and $44,525,564 in 1996) 45,119,811 44,904,303
Equity securities available-for-sale, at fair value
(cost--$102,580,834 in 1995 and $111,773,203 in 1996) 153,957,535 188,935,360
Short-term investments, at cost which approximates fair value 20,884,401 40,823,967
--------------------------------------------------------------------------------------------------------------
Total investments 471,599,283 537,946,060
Cash 3,506,945
Accrued investment income 5,854,731 5,835,885
Premiums and reinsurance balances receivable, net of allowances for
insolvent reinsurers of $16,336,146 in 1995 and $16,897,798 in 1996 36,447,284 37,166,516
Ceded unearned premiums 50,189,740 53,705,078
Reinsurance balances recoverable on unpaid losses and settlement expenses 197,337,466 165,017,149
Deferred policy acquisition costs, net 15,806,911 16,663,603
Property and equipment, at cost, net of accumulated depreciation
of $17,346,327 in 1995 and $19,381,473 in 1996 11,967,331 12,126,552
Income taxes--current 2,488,863
Investment in unconsolidated investee 7,856,130 8,970,691
Other assets 7,145,274 8,042,250
--------------------------------------------------------------------------------------------------------------
Total assets $810,199,958 $845,473,784
==============================================================================================================
Liabilities and Shareholders' Equity
--------------------------------------------------------------------------------------------------------------
Liabilities:
Unpaid losses and settlement expenses $418,985,960 $405,801,220
Unearned premiums 126,013,957 129,781,639
Reinsurance balances payable 37,744,456 23,699,837
Income taxes--current 2,134,692
Income taxes--deferred 4,903,627 17,170,687
Notes payable, short-term 2,800,000
Long-term debt--convertible debentures 46,000,000 46,000,000
Other liabilities 15,144,242 20,846,348
--------------------------------------------------------------------------------------------------------------
Total liabilities 651,592,242 645,434,423
--------------------------------------------------------------------------------------------------------------
Commitments and contingent liabilities
--------------------------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock ($1 par value, authorized 12,000,000 shares in 1995 and
50,000,000 shares in 1996, issued 8,453,449 shares in 1995 and 1996) 8,453,449 8,453,449
Paid-in capital 23,831,969 31,691,793
Net unrealized appreciation of securities, net of tax 34,334,524 50,608,696
Retained earnings 95,378,097 115,164,415
Treasury stock, at cost (602,567 shares in 1995 and 631,719 shares in 1996) (3,390,323) (5,878,992)
--------------------------------------------------------------------------------------------------------------
Total shareholders' equity 158,607,716 200,039,361
--------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $810,199,958 $845,473,784
==============================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
26
CONSOLIDATED STATEMENTS OF EARNINGS
[Enlarge/Download Table]
Years ended December 31, 1994 1995 1996
(restated) (restated)
-----------------------------------------------------------------------------------------------
Net premiums earned $140,184,488 $133,468,133 $130,656,095
Net investment income 20,132,585 22,029,081 23,680,751
Net realized investment gains (losses) (3,595,101) 456,510 1,017,572
-----------------------------------------------------------------------------------------------
156,721,972 155,953,724 155,354,418
-----------------------------------------------------------------------------------------------
Losses and settlement expenses 101,641,666 85,889,995 68,261,307
Policy acquisition costs 47,106,098 43,042,045 29,556,390
Insurance operating expenses 15,142,384 14,470,053 16,441,332
Interest expense on debt 3,431,464 3,347,378 2,808,470
General corporate expenses 2,845,289 2,093,034 3,277,630
-----------------------------------------------------------------------------------------------
170,166,901 148,842,505 120,345,129
-----------------------------------------------------------------------------------------------
Equity in earnings of unconsolidated investee 1,201,965 714,818 230,741
-----------------------------------------------------------------------------------------------
Earnings (loss) before income taxes (12,242,964) 7,826,037 35,240,030
-----------------------------------------------------------------------------------------------
Income tax expense (benefit):
Current (4,585,566) 730,725 6,037,849
Deferred (2,881,527) (854,229) 3,506,460
-----------------------------------------------------------------------------------------------
(7,467,093) (123,504) 9,544,309
-----------------------------------------------------------------------------------------------
Net earnings (loss) $ (4,775,871) $ 7,949,541 $ 25,695,721
===============================================================================================
Earnings per share:
Primary
Net earnings (loss) per share from operations $(0.31) $0.97 $3.17
Realized gains (losses), net of tax (0.30) 0.04 0.08
-----------------------------------------------------------------------------------------------
Primary net earnings (loss) per share $(0.61) $1.01 $3.25
===============================================================================================
Fully diluted
Net earnings (loss) per share from operations $(0.31) $0.97 $2.78
Realized gains (losses), net of tax (0.30) 0.04 0.07
-----------------------------------------------------------------------------------------------
Fully diluted net earnings (loss) per share $(0.61) $1.01 $2.85
===============================================================================================
Weighted average number of common shares outstanding:
Primary 7,786,004 7,849,799 7,896,463
===============================================================================================
Fully diluted 7,786,004 7,849,799 9,665,694
===============================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
27
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
[Enlarge/Download Table]
Net
Unrealized Treasury Total
Common Paid-in Appreciation Retained Stock Shareholders'
Years ended December 31, Stock Capital of Securities Earnings at Cost Equity
-------------------------------------------------------------------------------------------------------------------------
Balance, January 1, 1994 $6,762,905 $23,986,153 $14,647,207 $ 99,707,102 $(4,396,995) $140,706,372
Net loss (4,775,871) (4,775,871)
Treasury shares reissued
(138,368 shares) 1,517,129 996,246 2,513,375
Unrealized appreciation of
securities from adoption
of SFAS 115 327,707 327,707
Net change in unrealized
appreciation of available-
for-sale securities (4,064,620) (4,064,620)
Dividends declared
($.45 per share) (3,537,002) (3,537,002)
-------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1994 6,762,905 25,503,282 10,910,294 91,394,229 (3,400,749) 131,169,961
Net earnings 7,949,541 7,949,541
Treasury shares reissued
(1,448 shares) 23,241 10,426 33,667
5-for-4 stock split 1,690,544 (1,694,554) (4,010)
Net change in unrealized
appreciation of available-
for-sale securities 23,424,230 23,424,230
Dividends declared
($.51 per share) (3,965,673) (3,965,673)
-------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 8,453,449 23,831,969 34,334,524 95,378,097 (3,390,323) 158,607,716
Net earnings 25,695,721 25,695,721
Treasury shares reissued
(87,060 shares) 1,655,524 552,002 2,207,526
Treasury shares purchased
(116,212 shares) (3,040,671) (3,040,671)
Adjustement to accounting
for business combination
(see note 1B) 6,204,300 (1,570,477) 4,633,823
Net change in unrealized
appreciation of available-
for-sale securities 16,274,172 16,274,172
Dividends declared
($.55 per share) (4,338,926) (4,338,926)
-------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 $8,453,449 $31,691,793 $50,608,696 $115,164,415 $(5,878,992) $200,039,361
=========================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
28
[Enlarge/Download Table]
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1994 (restated) 1995 (restated) 1996
------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
Net earnings (loss) $ (4,775,871) $ 7,949,541 $25,695,721
Adjustments to reconcile net earnings (loss) to net cash
provided by operating activities:
Provision for insolvencies 1,000,000 613,296 1,006,140
Net realized investment losses (gains) 3,595,101 (456,510) (1,017,572)
Depreciation 3,063,478 2,866,105 2,454,543
Other items, net (4,085,962) 696,046 6,378,410
Change in:
Accrued investment income (761,455) (688,648) 18,846
Premiums and reinsurance balances receivable
(net of direct write-offs and commutations) 145,383 (10,977,648) (1,725,372)
Reinsurance balances payable 9,090,049 (2,115,290) (14,044,619)
Ceded unearned premium (7,308,036) (9,211,652) (3,515,338)
Reinsurance balances recoverable on unpaid losses (54,528,764) 2,399,330 32,320,317
Deferred policy acquisition costs (485,817) 3,401,301 (856,692)
Unpaid losses and settlement expenses 84,199,014 24,019,920 (13,184,740)
Unearned premiums 13,785,231 6,196,415 3,767,682
Income taxes:
Current (11,807,562) 1,525,466 4,623,555
Deferred (2,881,527) (854,229) 3,506,460
Changes in investment in unconsolidated investee:
Undistributed earnings (1,201,965) (714,818) (230,741)
Dividends received 3,750,000
------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 27,041,297 24,648,625 48,946,600
------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchase of:
Fixed maturities, held-to-maturity (64,032,621) (59,029,702) (29,681,906)
Fixed maturities, available-for-sale (4,793,980) (9,091,447) (11,792,359)
Equity securities, available-for-sale (18,979,331) (32,221,842) (11,648,835)
Short-term investments, net (6,604,323) (19,939,566)
Property and equipment (3,271,057) (1,647,414) (3,408,835)
Proceeds from sale of:
Fixed maturities, available-for-sale 1,260,031 3,383,745 8,297,553
Equity securities, available-for-sale 22,481,402 17,187,726 2,579,172
Short-term investments, net 28,748,056
Property and equipment 50,496 511,631 795,071
Proceeds from call or maturity of:
Fixed maturities, held-to-maturity 46,181,373 25,234,977 17,380,750
Fixed maturities, available-for-sale 2,335,000 3,730,000 2,860,000
------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (25,373,010) (23,194,270) (44,558,955)
------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Proceeds from issuance of debt 2,800,000
Payments on debt (745,000) (6,255,000) (2,800,000)
Fractional shares paid (4,010)
Treasury shares reissued 2,513,375 33,667 2,207,526
Treasury shares purchased (3,040,671)
Cash dividends paid (3,461,217) (3,849,521) (4,261,445)
------------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (1,692,842) (7,274,864) (7,894,590)
------------------------------------------------------------------------------------------------------------------------
Net decrease in cash (24,555) (5,820,509) (3,506,945)
Cash at beginning of year 9,352,009 9,327,454 3,506,945
------------------------------------------------------------------------------------------------------------------------
Cash at end of year $ 9,327,454 $ 3,506,945 $ 0
========================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. DESCRIPTION OF BUSINESS: RLI Corp. is a holding company that, through its
subsidiaries, underwrites selected property and casualty insurance products.
The property and casualty insurance segment, RLI Insurance Group (the Group), is
composed of two insurance companies. RLI Insurance Company, the principal
subsidiary, writes multiple lines of 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 multiple lines of insurance on an
admitted basis in Kansas and surplus lines insurance in the remaining 49 states,
the District of Columbia, Puerto Rico, the Virgin Islands and Guam.
B. PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION: The accompanying
consolidated financial statements were prepared in conformity with generally
accepted accounting principles (GAAP), which differ in some respects from those
followed in reports to insurance regulatory authorities. The consolidated
financial statements include the accounts of RLI Corp. and its subsidiaries (the
Company). All significant intercompany balances and transactions have been
eliminated.
On December 1, 1996, RLI Vision Corp., the Company's wholly-owned optical goods
distributor, merged with Hester Enterprises, Inc., the manufacturer of Maui Jim
sunglasses. The Company retained a 34% minority interest in the combined entity,
renamed Maui Jim, Inc. The Company accounted for this merger as a non-monetary
exchange of ownership interests with no gain or loss recognized.
As a result of the merger, the Company has presented its minority interest in
Maui Jim, Inc. under the equity method of accounting beginning December 1, 1996.
Additionally, for comparative purposes, the Company has restated prior period
financial information to present its 100% ownership in RLI Vision Corp. under
the equity method. This restatement is a change in presentation only and has no
impact on earnings. In January 1997, the Company paid $3,694,119 for an
additional 10% ownership interest in Maui Jim, Inc., bringing the Company's
total minority interest in Maui Jim, Inc. to 44%.
On May 4, 1995, RLI Vision Corp. acquired through merger Target Industries,
Inc., a wholesale optical goods distributor of contact lenses, Rx spectacles,
frames and sunglasses, located in Cohasset, Massachusetts. As consideration, RLI
Corp. issued 313,500 shares of its common stock. This business combination was
accounted for as a pooling-of-interests. The consolidated financial statements
and related financial information for periods prior to the combination have been
restated to include the accounts and results of operations of Target Industries,
Inc., including Target Industries, Inc. stand-alone net income for the year
ended December 31, 1994 of $225,440.
As a result of the aforementioned merger with Hester Enterprises, Inc., the
accounting for the merger with Target Industries, Inc. as a pooling-of-interests
is no longer applicable. Accordingly, the 1996 financial statements reflect an
adjustment to shareholders' equity of $4,633,823 to recognize the change from
pooling-of-interests to purchase accounting, and a charge to earnings of
$732,847, or $.06 per share, for cumulative goodwill amortization from May 4,
1995, through November 30, 1996. Prior period financial information has not been
restated to reflect this change in accounting due to immateriality.
C. SIGNIFICANT EVENT: On January 17, 1994, an earthquake occurred in the
Northridge, California area. Losses incurred as a result of this earthquake
represent the largest single loss event in the Company's history. The combined
effects of the earthquake-- including losses, expenses and the reduction of
revenue due to reinstatement of reinsurance coverages--reduced 1994 after-tax
earnings by $25.0 million or $3.21 per share.
In September 1995, the Company strengthened loss reserves related to the
Northridge Earthquake. While relatively minor development had occurred
throughout the first six months of 1995, the third quarter claim-by-claim review
indicated that greater future development was likely. The overall impact in 1995
of the Northridge Earthquake was a reduction to after-tax earnings by $18.6
million or $2.37 per share.
This additional development resulted in part from hidden damage and increased
business interruption losses on the Company's excess policies that, in 1994,
were estimated by adjusters to be well within the coverage limits of the primary
and underlying excess layers. Also contributing to the increased development
were unanticipated building code enactments, escalating construction costs, and
the impact of reopened claims as a result of the involvement of public
adjusters.
Following is a summary of the effects of the Northridge Earthquake. All amounts
are shown in thousands, except per share data.
--------------------------------------------------------------------------------
Earthquake Impact 1994 1995
--------------------------------------------------------------------------------
Premiums earned decrease $(18,013) $ (1,227)
--------------------------------------------------------------------------------
Consolidated revenue decrease (18,013) (1,227)
--------------------------------------------------------------------------------
Losses and settlement expense increase (21,176) (27,338)
Policy acquisition costs decrease 1,310
--------------------------------------------------------------------------------
Total expense increase (19,866) (27,338)
--------------------------------------------------------------------------------
Loss before income taxes (37,879) (28,565)
Net loss (25,021) (18,567)
Primary net loss per share $ (3.21) $ (2.37)
================================================================================
30
As of December 31, 1996, the Company had 36 open earthquake claims from a total
of 688 claims reported from this occurrence. No additional development from this
event occurred in 1996. The Company continually monitors all open earthquake
claims and current reserve levels. Management believes that the reserve
strengthening performed in September 1995 was sufficient to resolve the
remaining outstanding liabilities.
D. INVESTMENTS: Effective January 1, 1994, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." This statement requires that
investments in all debt securities and those equity securities with readily
determinable fair values be classified into one of three categories:
held-to-maturity, trading, or available-for-sale.
HELD-TO-MATURITY SECURITIES
Debt securities that the Company has 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. The Company has
classified approximately 85% of its portfolio of debt securities as
held-to-maturity.
TRADING SECURITIES
Debt and equity securities purchased for short-term resale are classified as
trading securities. The Company holds no debt or equity securities in this
category.
AVAILABLE-FOR-SALE SECURITIES
All other debt and equity securities not included in the above categories are
classified as available-for-sale and reported at fair value. Unrealized gains
and losses on these securities are excluded from earnings and reported as a
separate component of shareholders' equity net of deferred income taxes. All of
the Company's equity securities and approximately 15% of debt securities are
classified as available-for-sale.
In December 1995, the Company reclassified $29.8 million of held-to-maturity
debt securities to available-for-sale under the "onetime exemption" permitted by
the Financial Accounting Standards Board. This reclassification resulted in
recording unrealized gains of $0.5 million, net of deferred income taxes.
Short-term investments are carried at cost, which approximates fair value.
The Company continuously monitors the values of its investments in fixed
maturities and equity securities on an ongoing basis. If this review shows that
a decline in fair value is other than temporary, the Company's carrying value in
the investment is reduced to its estimated realizable value through an
adjustment to earnings. Realized gains and losses on disposition of investments
are based on specific identification of the investments sold.
Interest on fixed maturities and short-term investments is credited to earnings
as it accrues. Dividends on equity securities are credited to earnings on the
ex-dividend date.
E. REINSURANCE: Ceded unearned premiums and reinsurance balances recoverable on
unpaid losses and settlement expenses are reported separately as assets, instead
of being netted with the appropriate liabilities, since reinsurance does not
relieve the Company of its legal liability to its policyholders.
The Company continuously monitors the financial condition of its reinsurers. The
Company's policy is to charge to current earnings an estimate of unrecoverable
amounts from troubled or insolvent reinsurers. During 1994, 1995, and 1996, the
Company provided $1,000,000, $613,296, and $1,006,140, respectively, for
uncollectible reinsurance balances.
F. 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 settlement expenses. The estimates are based on
certain actuarial and other assumptions related to the ultimate cost to settle
such claims. Such assumptions are subject to occasional changes due to evolving
economic, social and political conditions. All estimates are periodically
reviewed and, as experience develops and new information becomes known, the
reserves are adjusted as necessary. Such adjustments are reflected in the
results of operations in the period in which they are determined. 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, with a resulting adverse effect on the Company. Based on the current
assumptions used in calculating reserves, management believes that the Company's
overall reserve levels at December 31, 1996, are adequate to meet its future
obligations.
G. REVENUE RECOGNITION: Insurance premiums are recognized ratably over the term
of the contracts, net of ceded reinsurance. Unearned premiums are calculated on
the monthly pro rata basis.
H. POLICY ACQUISITION COSTS: The costs of acquiring insurance
premiums--principally commissions and brokerage, sales compensation, premium
taxes, and other direct underwriting expenses--net of reinsurance commissions
received, are amortized over the life of the policies in order to properly match
policy acquisition costs to the related premium revenue. The method followed in
computing deferred policy acquisition costs limits the amount of such deferred
costs to their estimated realizable value, which gives effect to the premium to
be earned, related investment income, losses and settlement expenses and certain
other costs expected to be incurred as the premium is earned.
I. PROPERTY AND EQUIPMENT: Property and equipment are depreciated on a
straight-line basis for financial statement purposes over periods
31
ranging from three to 10 years for equipment and up to 40 years for buildings
and improvements.
J. INCOME TAXES: The Company files a consolidated income tax return. Tax
provisions are computed and apportioned to the subsidiaries on the basis of
their taxable income.
K. EARNINGS PER SHARE: Primary earnings per share are computed based on the
weighted average number of shares of common stock and common stock equivalents
outstanding during the period.
Fully diluted earnings per share calculations are based on the weighted average
number of shares of common stock and common stock equivalents outstanding for
the period, assuming full conversion of all convertible debentures into common
stock. Net earnings are adjusted for purposes of this calculation to eliminate
interest and amortization of debt issuance costs on the convertible debentures,
net of related income taxes. When the conversion of convertible debentures
increases the earnings per share or reduces the loss per share, the effect on
earnings is antidilutive. Under these circumstances, the fully diluted net
earnings or net loss per share is computed assuming no conversion of the
convertible debentures.
L. FAIR VALUE DISCLOSURES: The following methods were used to estimate the fair
value of each class of financial instruments for which it was practicable to
estimate that value. Fixed maturities and equity securities are valued using
quoted market prices, if available. If a quoted market price is not available,
fair value is estimated using quoted market prices of similar securities. 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. Fair value of long-term debt is based on quoted market prices if
available or quoted market prices of similar issues. Fair value disclosures for
long-term debt are included in note 4.
M. STOCK BASED COMPENSATION: The Company grants to officers stock options for a
fixed number of shares with an exercise price equal to or greater than the fair
market value of the shares at the date of grant. The Company accounts for stock
option grants in accordance with APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and accordingly recognizes no compensation expense for the
stock option grants. See note 8 for further discussion and related disclosures.
N. RISKS AND UNCERTAINTIES: Certain risks and uncertainties are inherent to the
Company's day-to-day operations and to the process of preparing its financial
statements. The more significant risks and uncertainties, as well as the
Company's methods for mitigating, quantifying, and minimizing such, are
presented below and throughout the notes to consolidated financial statements.
CATASTROPHE EXPOSURES
The Company's past and present insurance coverages include exposure to
catastrophic events. Catastrophic events such as earthquakes, floods, and
windstorms are covered by certain of the Company's property policies. The
Company has a concentration of such coverages in California (70.7% of gross
property premiums written during 1996). Using computer-assisted modeling
techniques, the Company quantifies and monitors its exposure to catastrophic
events. The Company limits its risk to such catastrophes through the purchase of
reinsurance. Utilizing the above, the Company attempts to limit its net
aggregate exposure to a single catastrophic event to less than 10% of
shareholders' equity.
ENVIRONMENTAL EXPOSURES
The Company is subject to environmental claims and exposures through its
commercial umbrella, general liability and discontinued assumed reinsurance
lines of business. Although exposure to environmental claims exists in these
lines of business, management has sought to mitigate or control the extent of
this exposure through the following methods: 1) the Company's policies include
pollution exclusions that have been continually updated to further strengthen
the exclusion; 2) the Company's policies primarily cover moderate hazard risks;
and 3) the Company began writing this business after the industry became aware
of the potential pollution liability exposure.
The Company has made loss and settlement expense payments on environmental
liability claims and has loss and settlement expense reserves for others. The
Company includes this historical environmental loss experience with the
remaining loss experience in the applicable line of business to project ultimate
incurred losses and settlement expenses and related "incurred but not reported"
loss and settlement expense reserves.
Although historical experience on environmental claims may not accurately
reflect future environmental exposures, the Company has 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 the Company from its primary liability to
policyholders, and to the extent that a reinsurer is unable to meet its
obligations, the Company would be liable. The Company continuously monitors the
financial condition of prospective and existing reinsurers. As a result, the
Company currently attempts to purchase reinsurance from a limited number of
financially strong reinsurers. The Company provides a reserve for reinsurance
balances deemed uncollectible.
FINANCIAL STATEMENTS
The preparation of the consolidated financial statements in conformity with GAAP
requires management to make estimates and assumptions that
32
affect the reported financial statement balances as well as the disclosure of
contingent assets and liabilites. Actual results could differ from those
estimates. The most significant of these amounts is the liability for unpaid
losses and settlement expenses. Management continually updates its estimates as
additional data becomes available and adjusts the financial statements as deemed
necessary. Other estimates such as the recoverability of reinsurance balances,
deferred tax assets and deferred policy acquisition costs are constantly
monitored, evaluated, and adjusted. Although recorded estimates are supported by
actuarial computations and other supportive data, the estimates are ultimately
based on management's expectations of future events.
EXTERNAL FACTORS
The Company's 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 products. The Company is also subject to insolvency and
guarantee fund assessments for policyholder losses covered by insolvent
insurers. The Company generally accrues the full amount of the assessment upon
notification.
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. The RBC standards
became effective for annual statement filings beginning December 31, 1994. The
Company continuously monitors its subsidiaries' internal capital requirements
and the NAIC's RBC developments. The Company has determined that its capital
levels are well in excess of the minimum capital requirements for all RBC action
levels. Management believes that the Company's capital levels are sufficient to
support the level of risk inherent in its operations.
2. INVESTMENTS
A summary of net investment income is as follows:
[Enlarge/Download Table]
------------------------------------------------------------------------------------------
1994 1995 1996
------------------------------------------------------------------------------------------
Interest on fixed maturities $15,311,817 $17,333,118 $18,862,096
Dividends on equity securities 5,290,715 5,444,146 5,715,310
Interest on short-term investments 1,846,881 1,893,693 1,572,512
------------------------------------------------------------------------------------------
Gross investment income 22,449,413 24,670,957 26,149,918
Less investment expenses 2,316,828 2,641,876 2,469,167
------------------------------------------------------------------------------------------
Net investment income $20,132,585 $22,029,081 $23,680,751
==========================================================================================
Pretax net realized investment gains (losses) and net changes in unrealized
appreciation/depreciation of investments for the years ended December 31 are
summarized as follows:
[Enlarge/Download Table]
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1994 1995 1996
------------------------------------------------------------------------------------------
Net realized investment gains (losses)
Fixed maturities
Held-to-maturity $ 79,124 $(21,428) $ 10,656
Available-for-sale 27,217 6,324 24,043
Equity securities (3,701,442) 471,614 982,873
------------------------------------------------------------------------------------------
(3,595,101) 456,510 1,017,572
------------------------------------------------------------------------------------------
Net changes in unrealized
appreciation/depreciation on investments
Fixed maturities
Held-to-maturity (22,112,459) 21,130,309 (6,577,271)
Available-for-sale (475,597) 1,605,070 (750,734)
Equity securities (5,273,316) 34,432,410 25,785,456
------------------------------------------------------------------------------------------
(27,861,372) 57,167,789 18,457,451
------------------------------------------------------------------------------------------
Net realized investment gains (losses)
and changes in unrealized
appreciation/depreciation
on investments $(31,456,473) $57,624,299 $19,475,023
==========================================================================================
Below is a summary of the disposition of fixed maturities for the years ended
December 31, with separate presentations for sales and calls/maturities.
[Enlarge/Download Table]
Sales
---------------------------------------------------------------------------------------------------------
Proceeds Gross Realized Net Realized
from sales Gains Losses gain (loss)
---------------------------------------------------------------------------------------------------------
1994
Available-for-sale 1,260,031 (603) (603)
1995
Available-for-sale 3,383,745 15,447 (7,875) 7,572
1996
Available-for-sale 8,297,553 84,116 (59,117) 24,999
=========================================================================================================
Calls/Maturities
---------------------------------------------------------------------------------------------------------
Proceeds Gross Realized Net Realized
from sales Gains Losses gain (loss)
---------------------------------------------------------------------------------------------------------
1994
Held-to-maturity 46,181,373 107,106 (27,982) 79,124
Available-for-sale 2,335,000 28,773 (953) 27,820
1995
Held-to-maturity 25,234,977 11,567 (32,997) (21,428)
Available-for-sale 3,730,000 (1,248) (1,248)
1996
Held-to-maturity 17,380,750 11,305 (649) 10,656
Available-for-sale 2,860,000 (956) (956)
=========================================================================================================
33
The following is a schedule of amortized costs and estimated fair values of
investments in fixed maturities and equity securities as of December 31, 1995
and 1996. Estimated fair values for fixed maturities and equity securities are
based on quoted market prices where available, or on values obtained from
independent pricing services.
[Enlarge/Download Table]
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Amortized Estimated Gross Unrealized
Cost Fair Value Gains Losses
---------------------------------------------------------------------------------------------------------
1995
Held-to-maturity
U.S. governments $148,846,846 $156,517,125 $ 7,767,238 $ (96,959)
Foreign governments 498,208 509,260 11,052
States, political subdi-
visions & revenues 102,292,482 103,931,411 1,735,159 (96,230)
---------------------------------------------------------------------------------------------------------
Total held-to-maturity $251,637,536 $260,957,796 $ 9,513,449 $ (193,189)
---------------------------------------------------------------------------------------------------------
Available-for-sale
U.S. governments $ 31,050,335 $ 32,065,236 $ 1,101,235 $ (86,334)
Corporate 2,680,000 2,701,961 25,241 (3,280)
States, political subdi-
visions & revenues 10,260,003 10,352,614 108,283 (15,672)
---------------------------------------------------------------------------------------------------------
Fixed maturities 43,990,338 45,119,811 1,234,759 (105,286)
Equity securities 102,580,834 153,957,535 51,700,372 (323,671)
---------------------------------------------------------------------------------------------------------
Total available-for-sale 146,571,172 199,077,346 52,935,131 (428,957)
---------------------------------------------------------------------------------------------------------
Total $398,208,708 $460,035,142 $62,448,580 $ (622,146)
=========================================================================================================
---------------------------------------------------------------------------------------------------------
Amortized Estimated Gross Unrealized
Cost Fair Value Gains Losses
---------------------------------------------------------------------------------------------------------
1996
Held-to-maturity
U.S. governments $152,612,589 $154,134,493 $ 2,909,178 $ (1,387,274)
States, political subdi-
visions & revenues 110,669,841 111,890,926 1,327,765 (106,680)
---------------------------------------------------------------------------------------------------------
Total held-to-maturity $263,282,430 $266,025,419 $ 4,236,943 $ (1,493,954)
---------------------------------------------------------------------------------------------------------
Available-for-sale
U.S. governments $ 29,461,455 $ 29,681,299 $ 586,656 $ (366,812)
Foreign governments 443,198 435,094 (8,104)
Corporate 7,585,492 7,736,658 186,975 (35,809)
States, political subdi-
visions & revenues 7,035,419 7,051,252 56,454 (40,621)
---------------------------------------------------------------------------------------------------------
Fixed maturities 44,525,564 44,904,303 830,085 (451,346)
Equity securities 111,773,203 188,935,360 77,847,867 (685,710)
---------------------------------------------------------------------------------------------------------
Total available-for-sale 156,298,767 233,839,663 78,677,952 (1,137,056)
---------------------------------------------------------------------------------------------------------
Total $419,581,197 $499,865,082 $82,914,895 $(2,631,010)
=========================================================================================================
The amortized cost and estimated fair value of fixed maturity securities at
December 31, 1996, by contractual maturity, are shown as follows.
[Download Table]
-----------------------------------------------------------------------------------
Amortized Cost Estimated Fair Value
-----------------------------------------------------------------------------------
Held-to-maturity
Due in one year or less $ 15,619,384 $ 15,727,511
Due after one year through five years 100,585,229 103,043,780
Due after five years through ten years 111,941,124 112,010,661
Due after ten years 35,136,693 35,243,467
-----------------------------------------------------------------------------------
$263,282,430 $266,025,419
-----------------------------------------------------------------------------------
Available-for-sale
Due in one year or less $ 1,099,844 $ 1,102,379
Due after one year through five years 22,360,480 22,826,826
Due after five years through ten years 18,207,959 17,997,847
Due after ten years 2,857,281 2,977,251
-----------------------------------------------------------------------------------
$ 44,525,564 $ 44,904,303
-----------------------------------------------------------------------------------
Expected maturities may differ from contractual maturities due to call
provisions present on some existing securities. Management believes the impact
of any calls should be slight and intends to follow its policy of matching
assets against anticipated liabilities.
At December 31, 1995, the net unrealized appreciation of available-for-sale
fixed maturities and equity securities totaled $34,334,524. This amount was net
of deferred taxes of $18,171,600. At December 31, 1996, the net unrealized
appreciation of available-for-sale fixed maturities and equity securities
totaled $50,608,696. This amount is net of deferred taxes of $26,932,200.
The Company is party to a securities lending program whereby fixed-income
securities are loaned to third parties, primarily major brokerage firms. As of
December 31, 1995 and 1996, fixed maturities with a fair value of $59,511,460
and $73,949,327, respectively, were loaned. Agreements with custodian banks
facilitating such lending require a minimum of 102% of the value of the loaned
securities to be separately maintained as collateral for each loan. To further
minimize the credit risks related to this lending program, the Company monitors
the financial condition of counter parties to these agreements.
As required by law, certain fixed maturities and short-term investments
amounting to $13,454,695 at December 31, 1996, were on deposit with either
regulatory authorities or banks. Additionally, the Company has certain fixed
maturities held in trust amounting to $9,567,621 at December 31, 1996. These
funds cover net premiums, losses, and expenses related to a property and
casualty insurance program.
The Company does not invest in derivative securities or collateralized mortgage
obligations (CMOs).
34
3. POLICY ACQUISITION COSTS
Policy acquisition costs deferred and amortized to income for the years ended
December 31 are summarized as follows:
[Enlarge/Download Table]
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1994 1995 1996
---------------------------------------------------------------------------------------------------------
Deferred policy acquisition costs, beginning of year $18,722,395 $19,208,212 $15,806,911
---------------------------------------------------------------------------------------------------------
Deferred:
Direct commissions 47,187,978 44,232,003 46,740,471
Premium taxes 4,135,567 4,185,861 4,034,201
Other direct underwriting
expenses 12,088,813 12,122,153 14,194,203
Ceding commissions (16,939,817) (24,666,527) (31,056,079)
---------------------------------------------------------------------------------------------------------
Net deferred 46,472,541 35,873,490 33,912,796
---------------------------------------------------------------------------------------------------------
Amortized 45,986,724 39,274,791 33,056,104
---------------------------------------------------------------------------------------------------------
Deferred policy acquisition costs, end of year $19,208,212 $15,806,911 $16,663,603
=========================================================================================================
Policy acquisition costs:
Amortized to expense 45,986,724 39,274,791 33,056,104
Period costs:
Ceding commission--contingent 60,227 (456,527) (5,275,063)
Other 1,059,147 4,223,781 1,775,349
---------------------------------------------------------------------------------------------------------
Total policy acquisition costs $47,106,098 $43,042,045 $29,556,390
=========================================================================================================
4. LONG-TERM DEBT
On July 28, 1993, the Company issued $46 million of 6.0% convertible debentures
that mature July 15, 2003, and pay interest semi-annually. The Company received
$45,080,000 in net proceeds from the issue ($46,000,000 principal less $920,000
of underwriting costs incurred) of which $30,500,000 was contributed to the
insurance subsidiaries to increase underwriting capacity and facilitate
expansion of their business. The balance was retained for general corporate
purposes, including debt service and the payment of dividends. All convertible
debentures, unless previously redeemed, are convertible at the option of the
holder at any time before maturity, into RLI Corp. common stock at an adjusted
conversion price of $26.00 per share, subject to further adjustment in certain
events. The Company has the option to redeem the convertible debentures, in
whole or in part, on or after July 15, 1997, at specified redemption prices,
plus accrued interest to redemption date. The convertible debentures are general
unsecured obligations of the Company and rank on a parity with all other
unsecured and unsubordinated indebtedness of the Company. The convertible
debentures include various covenants with which the Company has complied. These
covenants are basic in nature and include maintenance of properties, payment of
taxes, limitations on issuance or disposition of RLI Corp. stock or the stock of
material subsidiaries, and limitations on liens. The estimated fair values of
the convertible debentures at December 31, 1995 and 1996, were $47,800,000 and
$58,400,000, respectively.
On December 1, 1995, the Company retired its 9.75% Industrial Development Bond
of $6,255,000. This tax-exempt issue was obtained by the Company on December
27, 1985, and proceeds were used by the Company to finance a portion of the
acquisition, construction and equipping of an addition to the home office
building and related facilities located in Peoria. The retirement of the debt
included a scheduled principal payment of $815,000, along with the execution by
the Company of its first available call provision, to call the remaining debt of
$5,440,000 at a 102 call premium. The call was financed in part with available
cash, along with short term borrowings totaling $2,800,000.
During the first quarter of 1996, the Company paid off its short term borrowings
of $2,800,000 utilizing excess funds from operations.
Interest paid on outstanding debt for 1994, 1995, and 1996 amounted to
$3,345,714, $3,372,479, and $2,834,192, respectively.
The Company maintains three sources of credit from two financial institutions:
one $10.0 million secured and committed line of credit that cannot be canceled
during its annual term; a $30.0 million secured line of credit that cannot be
canceled during its annual term; and a $3.0 million secured line of credit
available for the issuance of letters of credit. As of December 31, 1996, the
Company had no outstanding short term borrowings.
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
effected under reinsurance contracts known as treaties and, in some instances,
by negotiation on each individual risk. In addition, there are excess of loss
and catastrophe reinsurance contracts that protect against losses over
stipulated amounts arising from any one occurrence or event. The arrangements
provide greater diversification of business and serve to limit the maximum net
loss on catastrophes and large and unusually hazardous risks.
Through the purchase of reinsurance, the Company generally limits the loss on
any individual risk to $1.0 million. Additionally,
through extensive use of computer-assisted modeling techniques, the Company
monitors the concentration of risks exposed to catastrophic events
(predominantly earthquakes). The Company seeks to limit its estimated net
aggregate exposure to a single catastrophic event to less than 10% of
shareholders' equity.
In 1996, the Company entered into an innovative catastrophe reinsurance and loss
financing program with Centre Reinsurance (Centre Re). The
35
program, called Catastrophe Equity Puts (CatEPuts)SM, augments the Company's
traditional reinsurance by integrating its loss financing needs with a
pre-negotiated sale of securities linked to exchange-traded shares. CatEPuts
allows the Company to put up to $50.0 million of its convertible preferred
shares to Centre Re at a pre-negotiated rate in the event of a catastrophic
loss, provided the loss does not reduce GAAP equity to less than $55.0 million.
CatEPuts is intended to be a three-year program and is designed to enable the
Company to continue operating after a loss of such magnitude that its
reinsurance capacity is exhausted. If the Company exercises its option to put
preferred shares to Centre Re, then Centre Re, in turn, has the option to
reinsure certain business written by the Company on a prospective basis.
Premiums written and earned along with losses and settlement expenses incurred
for the years ended December 31 are summarized as follows:
[Enlarge/Download Table]
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WRITTEN 1994 1995 1996
------------------------------------------------------------------------------------------
Direct $279,410,212 $270,887,545 $276,707,492
Reinsurance assumed 17,905 548,601 93,811
Reinsurance ceded (132,766,433) (140,983,251) (144,443,663)
------------------------------------------------------------------------------------------
Net $146,661,684 $130,452,895 $132,357,640
==========================================================================================
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EARNED 1994 1995 1996
------------------------------------------------------------------------------------------
Direct $265,453,514 $264,651,370 $271,551,708
Reinsurance assumed 189,371 588,362 32,713
Reinsurance ceded (125,458,397) (131,771,599) (140,928,326)
------------------------------------------------------------------------------------------
Net $140,184,488 $133,468,133 $130,656,095
==========================================================================================
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LOSSES AND SETTLEMENT EXPENSES INCURRED 1994 1995 1996
------------------------------------------------------------------------------------------
Direct $280,126,708 $160,294,644 $109,527,903
Reinsurance assumed (349,972) 809,657 10,256
Reinsurance ceded (178,135,070) (75,214,306) (41,276,852)
------------------------------------------------------------------------------------------
Net $101,641,666 $ 85,889,995 $68,261,307
==========================================================================================
At December 31, 1996, the Company had prepaid reinsurance premiums and
reinsurance recoverables on paid and unpaid losses and settlement expenses with
American Re-Insurance Company (rated A+ "superior" by A.M. Best Company) that
amounted to $59,492,246. All other reinsurance balances recoverable, when
considered by individual reinsurer, are less than 10% of shareholders' equity.
6. UNPAID LOSSES AND SETTLEMENT EXPENSES
The following table reconciles the Company's liability for unpaid losses and
settlement expenses (LAE) for the three years ended December 31, 1996. Since
reserves are based on estimates, the ultimate net cost may vary from the
original estimate. As adjustments to these estimates become necessary, they are
reflected in current operations. As part of the reserving process, historical
data is reviewed and consideration is given to the anticipated impact of various
factors such as legal developments and economic conditions, including the
effects of inflation. Changes in reserves from the prior years' estimates are
calculated based on experience as of the end of each succeeding year (loss and
LAE development).
[Enlarge/Download Table]
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Year Ended December 31,
(In thousands) 1994 1995 1996
------------------------------------------------------------------------------------------
Unpaid losses and LAE at beginning of year:
Gross $310,767 $394,966 $418,986
Ceded (145,208) (199,737) (197,338)
------------------------------------------------------------------------------------------
Net 165,559 195,229 221,648
------------------------------------------------------------------------------------------
Increase (decrease) in incurred losses and LAE:
Current accident year 100,535 62,619 69,724
Prior accident years 1,107 23,271 (1,463)
------------------------------------------------------------------------------------------
Total incurred 101,642 85,890 68,261
------------------------------------------------------------------------------------------
Loss and LAE payments for claims incurred:
Current accident year (36,501) (10,586) (11,026)
Prior accident years (36,026) (48,023) (37,505)
------------------------------------------------------------------------------------------
Total paid (72,527) (58,609) (48,531)
------------------------------------------------------------------------------------------
Insolvent reinsurer charge off 643 514 607
Loss reserves commuted (88) (1,376) (1,201)
------------------------------------------------------------------------------------------
Net unpaid losses and LAE at end of year $195,229 $221,648 $240,784
==========================================================================================
Unpaid losses and LAE at end of year:
Gross 394,966 418,986 405,801
Ceded (199,737) (197,338) (165,017)
------------------------------------------------------------------------------------------
Net $195,229 $221,648 $240,784
==========================================================================================
During 1994 and 1996, overall development on prior accident-year loss and
settlement expense reserves was insignificant to operating results and recorded
loss and settlement expense reserves. For 1995, however, prior accident-year
development was significantly impacted by the effects of the 1994 Northridge
Earthquake. As previously discussed in note 1, the Company experienced $27.3
million of loss development from this event during calendar year 1995.
The Company is subject to environmental claims and exposures through its
commercial umbrella, general liability, and discontinued assumed reinsurance
lines of business. Within these lines, the Company's environmental exposures
include environmental site cleanup, asbestos removal, and mass tort liability.
The majority of the exposure is in the excess layers of the Company's commercial
umbrella and assumed reinsurance books of business.
The following table represents inception-to-date paid and unpaid environmental
claims data (including incurred but not reported losses) for the periods ended
1994, 1995 and 1996:
36
[Enlarge/Download Table]
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Inception-to-date December 31,
(In thousands) 1994 1995 1996
----------------------------------------------------------------------------------------------------
Loss and LAE payments for claims incurred
Gross $ 3,549 $ 5,117 $ 8,267
Ceded (2,933) (3,842) (5,761)
----------------------------------------------------------------------------------------------------
Net $ 616 $ 1,275 $ 2,506
====================================================================================================
Unpaid losses and LAE at end of year
Gross $15,519 $20,154 $17,596
Ceded (9,875) (13,398) (11,150)
----------------------------------------------------------------------------------------------------
Net $ 5,644 $ 6,756 $ 6,446
====================================================================================================
Although the Company's environmental exposure is limited as a result of entering
the liability lines after the industry had already recognized it as a problem,
management cannot determine the Company's ultimate liability with any reasonable
degree of certainty. This ultimate liability is difficult to assess due to
evolving legislation on such issues as joint and several liability, retroactive
liability, and standards of cleanup. Additionally, the Company participates
primarily in the excess layers, making it even more difficult to assess the
ultimate impact.
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 in the
following table.
[Enlarge/Download Table]
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1994 1995 1996
----------------------------------------------------------------------------------------------------
DEFERRED TAX ASSETS:
Tax discounting of claim reserves $15,402,122 $15,635,860 $12,874,704
Unearned premium offset 5,419,657 5,307,695 5,326,460
Other, net 2,060,970 2,365,467 492,246
----------------------------------------------------------------------------------------------------
22,882,749 23,309,022 18,693,410
Less valuation allowance (300,000) (300,000) (300,000)
----------------------------------------------------------------------------------------------------
Total deferred tax assets $22,582,749 $23,009,022 $18,393,410
----------------------------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES:
Net unrealized appreciation of securities $ 5,764,109 $18,171,600 $26,932,200
Deferred policy acquisition costs 6,722,874 5,532,419 5,832,261
Book/tax depreciation 1,720,598 1,535,324 1,349,846
Other, net 1,519,824 2,673,306 1,449,790
----------------------------------------------------------------------------------------------------
Total deferred tax liabilities 15,727,405 27,912,649 35,564,097
----------------------------------------------------------------------------------------------------
Net deferred tax asset (liability) $ 6,855,344 $(4,903,627) $(17,170,687)
====================================================================================================
Management feels it is more likely than not that a portion of the Company's
deferred tax assets will not be realized. Therefore, an allowance has been
established for certain deferred tax assets that have an indefinite reversal
pattern. Management also believes the Company's remaining deferred tax assets
will be fully realized through deductions against future taxable income.
Income tax expense attributable to income from operations for the years ended
December 31, 1994, 1995, and 1996 differed from the amounts computed by applying
the U.S. federal tax rate of 35% to pretax income from continuing operations as
demonstrated in the following table.
[Enlarge/Download Table]
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1994 1995 1996
----------------------------------------------------------------------------------------------------
Provision for income taxes at
the statutory federal tax rates $(4,285,037) $2,739,113 $12,334,011
Increase (reduction) in taxes
resulting from:
Dividends received deduction (1,126,519) (1,170,146) (1,216,013)
Dividends paid deduction (258,474) (265,754) (258,252)
Tax exempt interest income (1,607,296) (1,428,846) (1,566,608)
State income tax provision 66,430 127,205 131,755
Other items, net (256,197) (125,076) 119,416
----------------------------------------------------------------------------------------------------
$(7,467,093) $ (123,504) $9,544,309
====================================================================================================
The Company has recorded its deferred tax assets and liabilities using the
statutory federal tax rate of 35%. Management believes when these deferred items
reverse in future years, the Company's taxable income will be taxed at an
effective rate of 35%.
Net federal and state income taxes paid (refunded) in 1994, 1995, and 1996
amounted to $7,221,986, $(794,741), and $1,415,994, respectively.
The Internal Revenue Service (IRS) has examined the Company's income tax returns
through the tax year ended December 31, 1990. In 1994, the Company received tax
refunds from certain of these tax years, the majority of which was previously
accrued. As a result, the Company recorded a tax benefit of $73,893 in 1994 and
received interest from the IRS for the same period of $56,590, which was
recorded as investment income. For 1995, the Company's net taxes refunded
include a $3.9 million refund received as a result of carrying back the 1994 net
operating loss and capital loss to prior years. The IRS is currently examining
the Company's income tax returns through the tax year ended December 31, 1994.
Management believes any tax implication from examinations of these years should
not materially impact the Company's consolidated financial position or results
of operations.
8. EMPLOYEE BENEFITS
PENSION PLAN
The Company maintains a non-contributory defined benefit pension plan covering
substantially all employees meeting age and service requirements. The plan
provides a benefit based on a participant's service and the highest five
consecutive years' average compensation out of the last 10 years. The Company
funds pension costs as accrued, except that in no case will the Company
contribute amounts less than the minimum contribu-
37
tion required under the Employee Retirement Income Security Act of 1974 or more
than the maximum tax deductible contribution for the year. The plan reached the
full funding limitation in 1986 and remained fully funded through 1993. During
1994, 1995, and 1996, the Company made the maximum tax deductible contribution
allowed, totaling $312,740, $397,158, and $413,977, respectively, to adequately
meet the funding requirements of the plan.
The Company has made various amendments to the plan in order to comply with
certain Internal Revenue Code changes.
The components of net periodic pension costs for each of the three years ended
December 31, are as follows:
[Enlarge/Download Table]
----------------------------------------------------------------------------------------------------
1994 1995 1996
----------------------------------------------------------------------------------------------------
Service cost $405,796 $277,870 $419,349
Interest cost 234,127 239,607 270,965
Actual return on assets 190,316 (796,106) (403,266)
Net amortization and deferral (534,183) 486,482 68,323
----------------------------------------------------------------------------------------------------
Net pension expense $296,056 $207,853 $355,371
====================================================================================================
The following table sets forth the plan's funded status at December 31, 1995 and
1996:
--------------------------------------------------------------------------------
1995 1996
--------------------------------------------------------------------------------
Actuarial present value of benefit obligation:
Accumulated benefit obligation:
Vested $3,055,535 $2,855,363
Nonvested 90,201 241,590
--------------------------------------------------------------------------------
$3,145,736 $3,096,953
================================================================================
Projected benefit obligation $3,835,535 $4,039,460
Plan assets at fair market value 3,253,386 3,328,525
--------------------------------------------------------------------------------
Plan assets under
projected benefit obligation $(582,149) $ (710,935)
Unrecognized net asset at January 1,
being amortized over 17.2 years (267,045) (234,479)
Unrecognized prior service cost 12,367 9,316
Unrecognized net loss 307,666 465,543
--------------------------------------------------------------------------------
Accrued pension costs $(529,161) $ (470,555)
================================================================================
At December 31, 1996, plan assets at fair value are comprised of approximately
2% fixed maturities, 96% equity securities and 2% invested cash.
In 1995, the Company used a settlement rate of 7.25%, an increase in salary
levels of 6%, and an expected long-term return on plan assets of 10% in
determining the projected benefit obligation. In 1996, the Company used the
following rates to determine its projected benefit obligation: 7.5% settlement
rate, 6% increase in salary, and 10% expected long-term return on plan assets.
EMPLOYEE STOCK OWNERSHIP AND OFFICER PERFORMANCE INCENTIVE PLANS
The Company has both an Employee Stock Ownership Plan (ESOP) and an Officer
Performance Incentive Plan. In 1996, the Company adopted a new approach for
evaluating the funding of these plans. Called the Market Value Potential (MVP)
plan, the new program is designed to ensure that the interests of company
insiders correspond with those of our shareholders.
MVP requires that the Company generates a return on equity in excess of its cost
of capital, before either the funding of the ESOP or the payment of officer
bonuses. Under MVP, funds in excess of the cost of capital are first designated
to fund the Company's ESOP up to the maximum allowable contribution of 15% of
eligible wages. MVP in excess of the ESOP funding is then shared by the officers
of the Company and its shareholders. Officers can receive a maximum of 8% of the
excess on an after-tax basis, while the remainder is reinvested in the Company
for the benefit of the shareholders. MVP restricts the officer payout in a given
year to 60% of the bonus earned for the previous fiscal year. The remaining 40%
is at risk and is retained by the Company. This amount is posted to a
participant's "bank account" and is subject to achieving the MVP target return
in the succeeding fiscal year. In 1996, $2,810,050 (7.07% of the excess return)
was earned under this plan. The actual payout of $1,686,030 (60% of bonus
earned) occurred in January 1997.
The Company's ESOP is non-leveraged and covers substantially all employees
meeting eligibility requirements. ESOP contributions are determined annually by
the Company's board of directors and are expensed in the year earned. During
1994, 1995, and 1996, the Company recognized expense of $160,154, $2,046,474,
and $2,791,463, respectively, related to the ESOP. At its December 1996 meeting,
the board voted in favor of making a contribution to the ESOP for 1996 based on
the MVP projections for the year. In 1995, the board had authorized this
contribution as well. In 1994, the board did not authorize a contribution based
on that year's projected net loss.
During 1994, the ESOP purchased 124,500 shares of the Company's treasury stock
at an average price of $18.03 ($2,245,050) and 5,000 shares of the Company's
common stock on the open market at an average price of $16.46 ($82,320). During
1995, no shares were purchased. During 1996, the ESOP purchased 76,500 shares of
the Company's treasury stock at an average price of $25.38 ($1,941,288). All
shares held by the ESOP are treated as outstanding in computing the Company's
earnings per share. Dividends on ESOP shares are passed through to the
participants.
38
DIRECTORS DEFERRED COMPENSATION AND EXCESS ESOP
The Company has a deferred compensation plan for directors and an excess ESOP
for key employees through which company shares are purchased for the directors
and key employees. The Company funded the plans by establishing Rabbi Trusts and
by purchasing company treasury shares. Since the assets of the Rabbi Trusts are
subject to claims of the Company's general creditors, such assets are recorded
as other assets in the accompanying balance sheets. A corresponding liability
for the same amount, which represents the Company's liability to its directors
and key employees, is reflected as a component of other liabilities. During
1994, 1995, and 1996, the Company recognized expenses of $81,850, $145,550, and
$139,075, respectively, under these plans. In 1996, the Rabbi Trusts purchased
10,560 shares of the company's treasury stock, at an average price of $25.22
($266,339) and 4,300 shares of the Company's common stock on the open market at
an average price of $32.13 ($138,138). At December 31, 1996, the Trusts' assets
were valued at $4,062,723.
STOCK OPTION PLAN
During 1995, the Company adopted and the shareholders approved an Incentive
Stock Option Plan (the Plan). The Company accounts for the plan in accordance
with APB Opinion No. 25, under which no compensation cost has been recognized.
Had compensation cost for the plan been determined consistent with FASB
Statement No. 123, "Accounting for Stock-Based Compensation," the Company's net
income and earnings per share would have been reduced to the following pro forma
amounts:
--------------------------------------------------------------------------------
1995 1996
--------------------------------------------------------------------------------
Net income: As reported $7,949,541 $25,695,721
Pro forma 7,862,144 25,511,517
--------------------------------------------------------------------------------
Primary EPS: As reported $1.01 $3.25
Pro forma 1.00 3.21
--------------------------------------------------------------------------------
Fully Diluted EPS: As reported $1.01 $2.85
Pro forma 1.00 2.82
================================================================================
These pro forma amounts may not be representative of the effects of FASB
Statement No. 123 on pro forma net income for future years because options vest
over several years and additional awards may be granted in the future.
Under the Plan, an officer may be granted an option to purchase shares at 100%
of the grant date fair market value (110% if the optionee and affiliates own 10%
or more of the shares), payable in cash. An option may be granted only during
the 10-year period ending in May 2005. An optionee must exercise an option
within 10 years (five years if the optionee and affiliates own 10% or more of
the shares) from the grant date, or three months after the optionee ceases to be
an employee, whichever occurs first.
The Company may grant options for up to 1,250,000 shares under the Plan. Through
December 31, 1996, the Company has granted 125,275 options. Under the Plan, the
option exercise price equals the stock's market price on the date of grant and
full vesting occurs at the end of five years.
A summary of the status of the Plan at December 31, 1995 and 1996, and changes
during the years then ended are presented in the table and narrative below:
[Enlarge/Download Table]
--------------------------------------------------------------------------------------------------------------
1995 1996
--------------------------------------------------------------------------------------------------------------
Number Weighted-Average Number Weighted-Average
of Shares Exercise Price of Shares Exercise Price
--------------------------------------------------------------------------------------------------------------
Outstanding at
beginning of year 65,625 $20.60
Granted 65,625 $20.60 59,650 23.45
Exercised
Forfeited 3,975 20.60
Expired
--------------------------------------------------------------------------------------------------------------
Outstanding at
end of year 65,625 20.60 121,300 22.00
--------------------------------------------------------------------------------------------------------------
Exercisable at
end of year 12,550 20.60
Weighted-average fair
value of options
granted during year $ 7.00 $ 7.86
==============================================================================================================
Of the 121,300 options outstanding at December 31, 1996, 61,650 have an exercise
price of $20.60 and a weighted-average remaining contractual life of 8.5 years.
Of these options, 12,550 are exercisable. Of the remaining outstanding options,
56,650 options have exercise prices between $22.88 and $24.00 with a
weighted-average exercise price of $22.97 and a remaining contractual life of
9.3 years, and 3,000 options have an exercise price of $32.50 and a remaining
contractual life of 9.9 years. None of these options was exercisable at December
31, 1996.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1995 and 1996, respectively: risk-free interest
rates of 6.67% and 6.80%; expected dividend yields of 3.14% and 3.15%; expected
lives of 10 years; and expected volatility of 28.46% and 27.34%.
39
POST-RETIREMENT BENEFITS OTHER THAN PENSION
The Company does not provide post-retirement or post-employment benefits to
employees and therefore does not have any liability under SFAS No. 106,
"Employer's Accounting for Post-retirement Benefits Other Than Pensions' or SFAS
No. 112, "Employers' Accounting for Post-employment Benefits."
9. STATUTORY INFORMATION AND DIVIDEND RESTRICTIONS
The Company's 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. Reconciliations of net
income and shareholders' equity (statutory surplus), as reported in conformity
with statutory reporting practices to that reported in the accompanying
financial statements on the basis of GAAP, are shown as follows:
[Enlarge/Download Table]
----------------------------------------------------------------------------------------------------
Year ended December 31,
Net Income (Loss) 1994 1995 1996
----------------------------------------------------------------------------------------------------
Consolidated net income (loss),
statutory basis $(4,057,703) $12,638,658 $29,486,443
Proposition 103 liability (71,280) 2,499,680
Deferred policy acquisition costs 485,817 (3,401,296) 856,692
Deferred income tax benefit (expense) 2,881,527 854,229 (3,506,460)
Net income of non-insurance operations,
interest expense on debt and
general corporate expense (3,114,127) (2,038,397) (3,605,318)
Other (900,105) (103,653) (35,316)
----------------------------------------------------------------------------------------------------
As reported in accompanying
financial statements $(4,775,871) $ 7,949,541 $25,695,721
====================================================================================================
----------------------------------------------------------------------------------------------------
December 31,
Shareholders' Equity 1995 1996
----------------------------------------------------------------------------------------------------
Consolidated surplus, statutory basis $172,312,961 $207,786,596
Deferred policy acquisition costs 15,806,911 16,663,603
Non-admitted assets 2,237,739 1,862,610
Proposition 103 liability (2,499,680)
Deferred tax liability (4,903,627) (17,170,687)
Statutory liability for reinsurance 2,045,800 3,813,800
Proceeds from RLI Corp. debt
contributed to RLI Insurance Co. (30,500,000) (30,500,000)
Equity of non-insurance companies 2,854,479 17,038,853
Other 1,253,133 544,586
----------------------------------------------------------------------------------------------------
As reported in accompanying financial statements $158,607,716 $200,039,361
====================================================================================================
Dividend payments to the Company from its principal insurance subsidiary are
restricted by state insurance laws as to the amount that may be paid without
prior notice or approval of the regulatory authorities of Illinois and
California. The maximum dividend distribution is limited by Illinois and
California law to the greater of: 10% of RLI Insurance Company's policyholder
surplus as of December 31 of the preceding year, or the net income of RLI
Insurance Company for the 12-month period ending December 31 of the preceding
year. Therefore, the maximum dividend distribution that can be paid by RLI
Insurance Company during 1997 without prior notice or approval amounts to
$26,864,913--RLI Insurance Company's 1996 statutory net income. The actual
amount paid to the Company during 1996 was $17,000,637.
10. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is involved in certain legal proceedings and disputes considered by
management to be ordinary and incidental to the business, or which have no
foundation in fact. Management believes that valid defenses exist as to all such
litigation and disputes and is of the opinion that these will not have a
material effect on the Company's financial statements.
In November 1988, California voters approved Proposition 103, which requires
insurance rates for certain lines of business to be rolled back 20% from the
rates in effect in November 1987. Beginning in 1989 and ending in 1994, the
Company deferred premium revenue of $1,449,200 and accrued interest in the
amount of $1,050,480 to cover the proposed rollback. No additional provision was
made during 1995 and the total funds accrued for rollback remained $2,499,680 at
December 31, 1995.
During 1996, the Company reached a settlement with the California Department of
Insurance resolving its total liability for refunds and interest under
Proposition 103. The settlement requires the Company to pay $2,987,050 in
refunds and interest. In the second quarter of 1996, the Company recorded a
pretax charge of $487,370 to record the difference between the actual settlement
and the amount previously accrued. The Company is currently in the process of
issuing refund checks to policyholders.
The Company leases regional office facilities and automobiles under operating
leases expiring in various years through 2001. Minimum future rental payments
under noncancellable operating leases are as follows:
1997 $ 592,020
1998 468,913
1999 381,719
2000 278,097
2001 158,952
-----------
Total minimum future rental payments $1,879,701
===========
40
11. INDUSTRY SEGMENT INFORMATION
Selected information by industry segment for 1994, 1995, and 1996 is summarized
in the chart below.
RLI Insurance Group: Specialty coverages of property and casualty insurance
provided on a direct basis, primarily on commercial risks.
Investment Income: Net interest and dividend income from the fixed maturities,
equity securities and short-term investments of RLI Corp. and RLI Insurance
Group.
[Enlarge/Download Table]
---------------------------------------------------------------------------------------------------------
Earnings (loss)
Segment Data Revenue before income taxes Assets
---------------------------------------------------------------------------------------------------------
1994 (restated)--
RLI Insurance Group $140,184,488 $(23,705,660) $730,755,447
Net investment income 20,132,585 20,132,585
Net realized investment losses (3,595,101) (3,595,101)
Equity in earnings of unconsolidated investee 1,201,965
General corporate and interest expense (6,276,753) 20,330,441
---------------------------------------------------------------------------------------------------------
Consolidated $156,721,972 $(12,242,964) $751,085,888
=========================================================================================================
1995 (restated)--
RLI Insurance Group $133,468,133 $(9,933,960) $787,812,455
Net investment income 22,029,081 22,029,081
Net realized investment gains 456,510 456,510
Equity in earnings of unconsolidated investee 714,818
General corporate and interest expense (5,440,412) 22,387,503
---------------------------------------------------------------------------------------------------------
Consolidated $155,953,724 $ 7,826,037 $810,199,958
=========================================================================================================
1996--
RLI Insurance Group $130,656,095 $16,397,066 $809,315,884
Net investment income 23,680,751 23,680,751
Net realized investment gains 1,017,572 1,017,572
Equity in earnings of unconsolidated investee 230,741
General corporate and interest expense (6,086,100) 36,157,900
---------------------------------------------------------------------------------------------------------
Consolidated $155,354,418 $35,240,030 $845,473,784
=========================================================================================================
41
12. UNAUDITED INTERIM FINANCIAL INFORMATION
Selected quarterly information is as follows:
[Enlarge/Download Table]
------------------------------------------------------------------------------------------------------------------------
1995 (restated) First Second Third Fourth Year
------------------------------------------------------------------------------------------------------------------------
Net premiums earned $35,562,960 $33,226,482 $32,170,742 $32,507,949 $133,468,133
Net investment income 5,400,021 5,280,007 5,628,253 5,720,800 22,029,081
Net realized investment gains (losses) (29,391) 136,542 11,297 338,062 456,510
Earnings (loss) before income taxes 7,080,846 7,493,101 (15,941,982) 9,194,072 7,826,037
Net earnings (loss) 5,336,931 5,479,819 (9,560,670) 6,693,461 7,949,541
Primary earnings (loss) per share* $0.68 $0.70 $(1.22) $0.85 $1.01
Fully diluted earnings (loss) per share* $0.60 $0.62 $(1.22) $0.75 $1.01
========================================================================================================================
1996
------------------------------------------------------------------------------------------------------------------------
Net premiums earned $32,166,978 $32,390,263 $32,294,530 $33,804,324 $130,656,095
Net investment income 5,727,445 6,091,854 5,819,777 6,041,675 23,680,751
Net realized investment gains (losses) 141,310 (36,190) 37,671 874,781 1,017,572
Earnings before income taxes 7,336,099 8,862,237 9,406,763 9,634,931 35,240,030
Net earnings 5,515,896 6,380,662 6,798,678 7,000,485 25,695,721
Primary earnings per share* $0.70 $0.80 $0.86 $0.89 $3.25
Fully diluted earnings per share* $0.62 $0.71 $0.75 $0.78 $2.85
========================================================================================================================
*Since the weighted-average shares for the quarters are calculated independently
of the weighted-average shares for the year, and due to the exclusion of the
antidilutive effects as discussed in note 1K, quarterly earnings per share may
not total to annual earnings per share.
42
REPORT OF INDEPENDENT AUDITORS
The board of directors and shareholders
RLI Corp.
We have audited the accompanying consolidated balance sheets of RLI Corp. and
Subsidiaries as of December 31, 1996 and 1995, and the related consolidated
statements of earnings, shareholders' equity, and cash flows for each of the
years in the three-year period ended December 31, 1996. 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 generally accepted auditing
standards. 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 RLI Corp. and
Subsidiaries at December 31, 1996 and 1995, and the results of their operations
and their cash flows for each of the years in the three-year period ended
December 31, 1996, in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
January 21, 1997
KPMG Peat Marwick LLP
Certified Public Accountants
Peat Marwick Plaza
303 East Wacker Drive
Chicago, Illinois 60601
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 generally accepted accounting principles and
include amounts that are based on management's estimates and judgments.
The accompanying financial statements have been audited by KPMG Peat Marwick LLP
(KPMG), independent certified public accountants, selected by the audit
committee and approved by the shareholders. Management has made available to
KPMG all 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.
Management has established and maintains a system of internal controls
throughout its operations that are 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. The system of internal controls
provides for appropriate division of responsibility and is documented by written
policies and procedures that are updated by management as necessary. Certain
aspects of these systems and controls are tested periodically by the company's
internal auditor. As part of its audit of the financial statements, which is
performed in accordance with generally accepted auditing standards, KPMG
considers certain aspects of the system of internal controls to the extent
necessary to form an opinion on the financial statements and not to provide
assurance on the system of internal controls. Management considers the
recommendations of its internal auditor and independent public accountants
concerning the Company's internal controls and takes the necessary actions that
are cost effective in the circumstances to respond appropriately to the
recommendations presented. Management believes that as of December 31, 1996, the
Company's system of internal controls was adequate to accomplish the objectives
described herein.
The audit committee is comprised solely of five non-employee directors and is
charged with general supervision of the audits, examinations and inspections of
the books and accounts of RLI Corp. and Subsidiaries. It also recommends to the
board of directors the firm of independent public accountants to be engaged to
audit the annual consolidated financial statements, and it meets regularly with
those independent public accountants and with management, both separately and
together. The independent public accountants and the internal auditor have ready
access to the audit committee.
Gerald D. Stephens, CPCU
president, RLI Corp.
Joseph E. Dondanville, CPA
vice president, chief financial officer, RLI Corp.
43
INVESTOR INFORMATION
ANNUAL MEETING
The annual meeting of shareholders will be held at 2:00 p.m., local time, on
May 1, 1997, at the company's offices at 9025 North Lindbergh Drive, Peoria, IL.
REQUESTS FOR ADDITIONAL INFORMATION
Additional copies of this report and the Annual Report to the Securities and
Exchange Commisssion, Form 10-K, will be furnished without charge to any
shareholder. Simply contact the treasurer at our corporate headquarters.
"Street Name" shareholders wishing to have their names placed on a mailing list
to receive copies of annual reports, quarterly reports, and other shareholder
materials should also indicate their desire to the treasurer at the corporate
headquarters.
COMMON STOCK/CONVERTIBLE DEBENTURE SYMBOLS
RLI common stock (NYSE): RLI
RLI convertible debenture (NYSE): RLIS
TRADING AND DIVIDEND INFORMATION
The following table sets forth the high and low sale prices, as well as the
closing prices, for the common stock for the indicated periods as reported by
the NYSE. The table also indicates cash dividends as declared by the company.
Stock Price Dividends
High Low Close Declared
--------------------------------------------------------------------------------
1995
1st Quarter 19 1/10 16 3/10 18 7/10 $.12
2nd Quarter 23 1/4 18 6/10 22 3/4 .13
3rd Quarter 23 5/8 21 7/8 22 3/8 .13
4th Quarter 25 21 3/4 25 .13
--------------------------------------------------------------------------------
1996
1st Quarter 25 7/8 24 1/4 24 3/4 $.13
2nd Quarter 24 3/8 22 3/8 24 3/8 .14
3rd Quarter 26 1/8 23 3/8 26 .14
4th Quarter 33 1/2 26 33 3/8 .14
--------------------------------------------------------------------------------
RLI Corp. normally pays dividends four times a year, usually on January 15,
April 15, July 15 and October 15. The company has paid and increased dividends
for 20 consecutive years. Since 1989, RLI dividends qualify for the enterprise
zone dividend subtraction modification for Illinois state income tax returns.
DIVIDEND DIRECT DEPOSIT PLAN
Shareholders may have their dividends deposited directly into their checking,
savings or money market accounts. If you wish to sign up for this Plan, send
your request to "Shareholder Information" at the following transfer agent and
registrar address.
DIVIDEND REINVESTMENT PLAN
An Automatic Dividend Reinvestment and Stock Purchase Plan is offered to
shareholders of RLI on a voluntary basis. As a shareholder, you may add to your
holdings in the following ways: Shares purchased with dividends are purchased as
an open market transaction. Optional cash payments may also be made, in any
amount, from $25 to $2,000 per month to purchase shares also as an open market
transaction. The company pays the additional costs associated with the open
market purchases, which will have a slight tax impact on participating
shareholders. A summary outlining the provisions of the plan and an enrollment
form may be obtained by contacting "Shareholder Information" at the following
transfer agent and registrar address.
SHAREHOLDER INQUIRIES
Shareholders of record requesting information concerning individual account
balances, stock certificates, dividends, stock transfers or address corrections
should contact the transfer agent and registrar at:
Norwest Bank Minnesota, N.A.
161 North Concord Exchange
P.O. Box 64854
South St. Paul, MN 55164-0854
Phone: (800) 468-9716
Internet: SHAREOWNER@AOL.COM
BONDHOLDER INQUIRIES
Inquiries concerning lost bonds, interest payments, changes of address, and
other matters relating to ownership should be directed to RLI's convertible debt
trustee:
Norwest Corporate Trust Services
Sixth & Marquette
Minneapolis, MN 55479-0069
Phone: (612) 667-9764
STOCK OWNERSHIP
At December 31, 1996, stock ownership was as follows:
SHARES %
------------------------------------------------
Insiders 725,685 9.28
ESOP 1,258,335 16.09
Institutions 3,443,924 44.03
Other Public 2,393,786 30.60
------------------------------------------------
7,821,730 100.00%
CONTACTING RLI
CORPORATE HEADQUARTERS
9025 North Lindbergh Drive
Peoria, IL 61615-1431
(309) 692-1000
(800) 331-4929
Fax: (309) 692-1068
Internet: HTTP://WWW.RLICORP.COM
FINANCIAL INFORMATION
For management's perspective on specific issues, call RLI Treasurer Mike Price
direct at (309) 693-5880.
49
Dates Referenced Herein and Documents Incorporated by Reference
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