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Rli Corp – ‘10-K’ for 12/31/18

On:  Friday, 2/22/19, at 1:59pm ET   ·   For:  12/31/18   ·   Accession #:  84246-19-13   ·   File #:  1-09463

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  As Of                Filer                Filing    For·On·As Docs:Size

 2/22/19  Rli Corp                          10-K       12/31/18   98:37M

Annual Report   —   Form 10-K
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

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 2: EX-21.1     Subsidiaries                                        HTML     38K 
 3: EX-23.1     Consent of Experts or Counsel                       HTML     27K 
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 5: EX-31.2     Certification -- SOA'02 §302                        HTML     32K 
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15: R2          Consolidated Balance Sheets                         HTML    113K 
16: R3          Consolidated Balance Sheets (Parenthetical)         HTML     49K 
17: R4          Consolidated Statements of Earnings and             HTML    107K 
                          Comprehensive Earnings                                 
18: R5          Consolidated Statements of Shareholders' Equity     HTML     69K 
19: R6          Consolidated Statements of Shareholders' Equity     HTML     31K 
                          (Parenthetical)                                        
20: R7          Consolidated Statements of Cash Flows               HTML    141K 
21: R8          Summary of Significant Accounting Policies          HTML    349K 
22: R9          Investments                                         HTML    813K 
23: R10         Policy Acquisition Costs                            HTML     90K 
24: R11         Debt                                                HTML     32K 
25: R12         Reinsurance                                         HTML    199K 
26: R13         Historical Loss and Lae Development                 HTML   2.01M 
27: R14         Income Taxes                                        HTML    173K 
28: R15         Employee Benefits                                   HTML    215K 
29: R16         Statutory Information and Dividend Restrictions     HTML     51K 
30: R17         Commitments and Contingent Liabilities              HTML     50K 
31: R18         Operating Segment Information                       HTML    302K 
32: R19         Unaudited Interim Financial Information             HTML    142K 
33: R20         Schedule I-Summary of Investments-Other Than        HTML    124K 
                          Investments in Related Parties                         
34: R21         Schedule Ii-Condensed Financial Information of      HTML    338K 
                          Registrant (Parent Company)                            
35: R22         Schedule Iii-Supplementary Insurance Information    HTML    309K 
36: R23         Schedule Iv-Reinsurance                             HTML    174K 
37: R24         Schedule V-Valuation and Qualifying Accounts        HTML     71K 
38: R25         Schedule Vi-Supplementary Information Concerning    HTML    114K 
                          Property-Casualty Insurance Operations                 
39: R26         Summary of Significant Accounting Policies          HTML    396K 
                          (Policies)                                             
40: R27         Summary of Significant Accounting Policies          HTML    252K 
                          (Tables)                                               
41: R28         Investments (Tables)                                HTML    804K 
42: R29         Policy Acquisition Costs (Tables)                   HTML     90K 
43: R30         Reinsurance (Tables)                                HTML    194K 
44: R31         Historical Loss and Lae Development (Tables)        HTML   1.99M 
45: R32         Income Taxes (Tables)                               HTML    167K 
46: R33         Employee Benefits (Tables)                          HTML    196K 
47: R34         Statutory Information and Dividend Restrictions     HTML     42K 
                          (Tables)                                               
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49: R36         Operating Segment Information (Tables)              HTML    298K 
50: R37         Unaudited Interim Financial Information (Tables)    HTML    141K 
51: R38         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -        HTML     45K 
                          Description of Business (Details)                      
52: R39         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -        HTML     75K 
                          Accounting Standards (Details)                         
53: R40         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -        HTML     35K 
                          Property and Equipment (Details)                       
54: R41         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -        HTML     87K 
                          Investment in Unconsolidated Investees                 
                          (Details)                                              
55: R42         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -        HTML     72K 
                          Intangible Assets (Details)                            
56: R43         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -        HTML     63K 
                          Earnings Per Share (Details)                           
57: R44         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -        HTML     86K 
                          Changes in Accumulated Other                           
                          Comprehensive Earnings (Details)                       
58: R45         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -        HTML     30K 
                          Insurance Risk (Details)                               
59: R46         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -        HTML     37K 
                          Catastrophe Exposures (Details)                        
60: R47         INVESTMENTS - Net Investment Income (Details)       HTML     45K 
61: R48         INVESTMENTS - Realized and Unrealized Gains         HTML     61K 
                          (Details)                                              
62: R49         INVESTMENTS - Disposition of Fixed Securities and   HTML     49K 
                          Equities (Details)                                     
63: R50         INVESTMENTS - Assets Measured At Fair Value         HTML     82K 
                          (Details)                                              
64: R51         INVESTMENTS - Fixed Income Securities By            HTML     59K 
                          Contractual Maturity (Details)                         
65: R52         INVESTMENTS - Investments In Fixed Income           HTML     81K 
                          Securities (Details)                                   
66: R53         INVESTMENTS - Types of Debt and Equity Securities   HTML     94K 
                          (Details)                                              
67: R54         INVESTMENTS - Portfolio Analysis (Details)          HTML     39K 
68: R55         INVESTMENTS - Other Invested Assets (Details)       HTML     47K 
69: R56         Policy Acquisition Costs (Details)                  HTML     53K 
70: R57         Debt (Details)                                      HTML     59K 
71: R58         REINSURANCE - Summary of Premiums and Losses        HTML     69K 
                          (Details)                                              
72: R59         REINSURANCE - Summary of Reinsurers (Details)       HTML    110K 
73: R60         HISTORICAL LOSS AND LAE DEVELOPMENT - Unpaid        HTML     69K 
                          Losses and Settlement Expenses (Details)               
74: R61         HISTORICAL LOSS AND LAE DEVELOPMENT - Incurred      HTML    331K 
                          Losses and Loss Adjustment Expenses, Net               
                          of Reinsurance (Details)                               
75: R62         HISTORICAL LOSS AND LAE DEVELOPMENT - Cumulative    HTML     80K 
                          Paid Loss and Loss Adjustment Expenses,                
                          Net of Reinsurance (Details)                           
76: R63         HISTORICAL LOSS AND LAE DEVELOPMENT -               HTML     68K 
                          Reconciliation of Incurred and Paid Loss               
                          Development to the Liability for Unpaid                
                          Losses and Settlement Expenses (Details)               
77: R64         HISTORICAL LOSS AND LAE DEVELOPMENT - Reserve       HTML     82K 
                          Development (Details)                                  
78: R65         HISTORICAL LOSS AND LAE DEVELOPMENT -               HTML     49K 
                          Environmental, Asbestos and Mass Tort                  
                          Exposures (Details)                                    
79: R66         Income Taxes (Details)                              HTML    134K 
80: R67         EMPLOYEE BENEFITS - Stock Ownership and Incentive   HTML     56K 
                          Plans (Details)                                        
81: R68         EMPLOYEE BENEFITS - Stock Options and Stock Plans   HTML    150K 
                          (Details)                                              
82: R69         Statutory Information and Dividend Restrictions     HTML     59K 
                          (Details)                                              
83: R70         Commitments and Contingent Liabilities (Details)    HTML     62K 
84: R71         OPERATING SEGMENT INFORMATION - Summary of          HTML    107K 
                          Segments (Details)                                     
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                          (Details)                                              
86: R73         Unaudited Interim Financial Information (Details)   HTML     56K 
87: R74         Schedule I-Summary of Investments-Other Than        HTML     73K 
                          Investments in Related Parties (Details)               
88: R75         Schedule Ii-Condensed Financial Information of      HTML    110K 
                          Registrant (PARENT COMPANY) - Balance                  
                          Sheets (Details)                                       
89: R76         Schedule Ii-Condensed Financial Information of      HTML     48K 
                          Registrant (PARENT COMPANY) - Balance                  
                          Sheets Information (Details)                           
90: R77         Schedule Ii-Condensed Financial Information of      HTML     89K 
                          Registrant (PARENT COMPANY) - Statements               
                          of Earnings and Comprehensive Earnings                 
                          (Details)                                              
91: R78         Schedule Ii-Condensed Financial Information of      HTML    136K 
                          Registrant (PARENT COMPANY) - Statements               
                          of Cash Flows (Details)                                
92: R79         Schedule Iii-Supplementary Insurance Information    HTML     68K 
                          (Details)                                              
93: R80         Schedule Iv-Reinsurance (Details)                   HTML     61K 
94: R81         Schedule V-Valuation and Qualifying Accounts        HTML     35K 
                          (Details)                                              
95: R82         Schedule Vi-Supplementary Information Concerning    HTML     56K 
                          Property-Casualty Insurance Operations                 
                          (Details)                                              
97: XML         IDEA XML File -- Filing Summary                      XML    181K 
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10-K   —   Annual Report
Document Table of Contents

Page (sequential)   (alphabetic) Top
 
11st Page  –  Filing Submission
"Table of Contents
"Part I
"Item 1
"Business
"Item 1A
"Risk Factors
"Item 1B
"Unresolved Staff Comments
"Item 2
"Properties
"Item 3
"Legal Proceedings
"Item 4
"Mine Safety Disclosures
"Part II
"Item 5
"Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
"Item 6
"Selected Financial Data
"Item 7
"Management's Discussion and Analysis of Financial Condition and Results of Operations
"Item 7A
"Quantitative and Qualitative Disclosures About Market Risk
"Item 8
"Financial Statements and Supplementary Data
"Consolidated Balance Sheets
"Consolidated Statements of Earnings and Comprehensive Earnings
"Consolidated Statements of Shareholders' Equity
"Consolidated Statements of Cash Flows
"Notes to Consolidated Financial Statements
"Report of Independent Registered Public Accounting Firm
"Item 9
"Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
"Item 9A
"Controls and Procedures
"Item 9B
"Other Information
"Part III
"Items 10-14
"Part IV
"Item 15
"Exhibits and Financial Statement Schedules
"I. Summary of Investments -- Other than Investments in Related Parties at December 31, 2018
"II. Condensed Financial Information of Registrant, as of and for the three years ended December 31, 2018
"III. Supplementary Insurance Information, as of and for the three years ended December 31, 2018
"IV. Reinsurance for the three years ended December 31, 2018
"V. Valuation and Qualifying Accounts for the three years ended December 31, 2018
"VI. Supplementary Information Concerning Property-Casualty Insurance Operations for the three years ended December 31, 2018

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  rli_Current Folio_10K  

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2018

 

or

 

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                          to                          

 

Commission File Number 001-09463

 

RLI CORP.

(Exact name of registrant as specified in its charter)

 

 

 

 

Delaware

 

37-0889946

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

9025 North Lindbergh Drive, PeoriaIllinois

 

61615

(Address of principal executive offices)

 

(Zip Code)

 

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

 

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

 

 

 

 

Title of each class

 

Name of each exchange on which registered

Common Stock $0.01 par value

 

New York Stock Exchange

 

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

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐ No ☒

 

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

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐

 

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

 

 

 

 

 

 

 

 

Large accelerated filer ☒

 

Accelerated filer ☐

 

Non-accelerated filer ☐

 

Smaller reporting company ☐

 

 

 

 

 

 

Emerging growth company ☐

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

 

The aggregate market value of the registrant’s common stock held by non-affiliates of the Registrant as of June 30, 2018, based upon the closing sale price of the Common Stock on June 30, 2018 as reported on the New York Stock Exchange, was $2,616,706,281. Shares of Common Stock held directly or indirectly by each reporting officer and director along with shares held by the Company ESOP have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

The number of shares outstanding of the Registrant’s Common Stock, $0.01 par value, on February 7, 2019 was 44,512,543.

 

 

 

 

 


 

Table of Contents

DOCUMENTS INCORPORATED BY REFERENCE.

 

Portions of the Registrant’s definitive Proxy Statement for the 2019 annual meeting of shareholders to be held May 2, 2019, are incorporated herein by reference into Part III of this document, including: “Share Ownership of Certain Beneficial Owners,” “Board Meetings and Compensation,” “Compensation Discussion & Analysis,” “Executive Compensation,” “Equity Compensation Plan Information,” “Executive Management,” “Corporate Governance and Board Matters,” “Audit Committee Report” and “Proposal three: Ratification of Selection of Independent Registered Public Accounting Firm.”

 

Exhibit index is located on pages 121-122 of this document, which lists documents filed as exhibits or incorporated by reference herein.

 

2


 

Table of Contents

RLI Corp.

Index to Annual Report on Form 10-K

 

 

 

 

 

 

 

 

Page

Part I 

 

 

 

Item 1.

Business

4

 

Item 1A.

Risk Factors

23

 

Item 1B.

Unresolved Staff Comments

30

 

Item 2.

Properties

30

 

Item 3.

Legal Proceedings

30

 

Item 4.

Mine Safety Disclosures

30

 

 

 

 

Part II 

 

 

 

Item 5.

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

31

 

Item 6.

Selected Financial Data

33

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

34

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

60

 

Item 8.

Financial Statements and Supplementary Data

63

 

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

110

 

Item 9A.

Controls and Procedures

110

 

Item 9B.

Other Information

110

 

 

 

 

Part III 

 

 

 

Items 10-14.

110

 

 

 

 

Part IV 

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

110

 

3


 

Table of Contents

PART I

Item 1.    Business

 

RLI Corp. (the “Company”) was founded in 1965. We underwrite select property and casualty insurance through major subsidiaries collectively known as RLI Insurance Group. We conduct operations principally through three insurance companies. RLI Insurance Company (RLI Ins.), a subsidiary of RLI Corp. and our principal insurance subsidiary, writes multiple lines of insurance on an admitted basis in all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam. Mt. Hawley Insurance Company (Mt. Hawley), a subsidiary of RLI Ins., writes excess and surplus lines insurance on a non-admitted basis in all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam. Contractors Bonding and Insurance Company (CBIC), a subsidiary of RLI Ins., writes multiple lines of insurance on an admitted basis in all 50 states and the District of Columbia. Each of our insurance companies is domiciled in Illinois. We have no material foreign operations.

 

As a specialty insurance company with a niche focus, we offer insurance coverages in the specialty admitted and excess and surplus markets. We distribute our property and casualty insurance through our branch offices that market to wholesale and retail producers. We offer limited coverages on a direct basis to select insureds, as well as various reinsurance coverages. In addition, from time to time, we produce a limited amount of business under agreements with managing general agents under the direction of our product vice presidents.

 

We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed with or furnished to the Securities and Exchange Commission (SEC) available free of charge on our website (rlicorp.com). Information contained on our website is not intended to be incorporated by reference in this annual report and you should not consider that information a part of this annual report. The SEC also maintains a website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding the Company.

 

For the year ended December 31, 2018, the following table provides the geographic distribution of our risks insured as represented by direct premiums earned for all coverages:

 

 

 

 

 

 

 

 

 

State

    

Direct Premiums Earned

    

Percent of Total

 

 

 

(in thousands)

 

 

 

California

 

$

141,868

 

15.8

%  

New York

    

 

126,672

 

14.1

%  

Florida

 

 

88,992

 

9.9

%  

Texas

 

 

79,766

 

8.9

%  

Washington

 

 

32,374

 

3.6

%  

New Jersey

 

 

27,754

 

3.1

%  

Illinois

 

 

25,323

 

2.8

%  

Arizona

 

 

24,475

 

2.7

%  

Louisiana

 

 

24,136

 

2.7

%  

Georgia

 

 

21,296

 

2.4

%  

Pennsylvania

 

 

19,529

 

2.2

%  

Ohio

 

 

19,165

 

2.2

%  

Hawaii

 

 

18,575

 

2.1

%  

All Other

 

 

246,309

 

27.5

%  

Total direct premiums earned

 

$

896,234

 

100.0

%  

 

In the ordinary course of business, we rely on other insurance companies to share risks through reinsurance. A large portion of the reinsurance is put into effect under contracts known as treaties and, in some instances, by negotiation on each individual risk (known as facultative reinsurance). We have quota share, excess of loss and catastrophe (CAT) reinsurance contracts that protect against losses over stipulated amounts arising from any one occurrence or event. These arrangements allow the Company to pursue greater diversification of business and serve to limit the maximum net loss on catastrophes and large risks. Reinsurance is subject to certain risks, specifically market risk, which affect the cost of and the ability to secure these contracts, and credit risk, which is the risk that our reinsurers may not pay on losses in a timely fashion or at all. The following table illustrates the degree to which we have utilized reinsurance during the past three years. For an expanded discussion of the impact of reinsurance on our operations, see note 5 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.

 

4


 

Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31,

 

(in thousands)

    

2018

    

2017

    

2016

 

PREMIUMS WRITTEN

 

 

 

 

 

 

 

 

 

 

Direct & Assumed

 

$

983,216

 

$

885,312

 

$

874,864

 

Reinsurance ceded

 

 

(160,041)

 

 

(135,458)

 

 

(133,912)

 

Net

 

$

823,175

 

$

749,854

 

$

740,952

 

PREMIUMS EARNED

 

 

 

 

 

 

 

 

 

 

Direct & Assumed

 

$

938,160

 

$

867,639

 

$

863,180

 

Reinsurance ceded

 

 

(146,794)

 

 

(129,702)

 

 

(134,572)

 

Net

 

$

791,366

 

$

737,937

 

$

728,608

 

 

SPECIALTY INSURANCE MARKET OVERVIEW

 

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

 

SPECIALTY ADMITTED INSURANCE MARKET

 

We write business in the specialty admitted market. Most of these risks are unique and hard to place in the standard admitted market, but for marketing and regulatory reasons, they must remain with an admitted insurance company. The specialty admitted market is subject to greater state regulation than the excess and surplus market, particularly with regard to rate and form filing requirements, restrictions on the ability to exit lines of business, premium tax payments and membership in various state associations, such as state guaranty funds and assigned risk plans. For 2018, our specialty admitted operations produced gross premiums written of $619.6 million, representing approximately 63 percent of our total gross premiums for the year.

 

EXCESS AND SURPLUS INSURANCE MARKET

 

The excess and surplus market focuses on hard-to-place risks. Participating in this market allows the Company to underwrite non-standard risks with more flexible policy forms and unregulated premium rates. This typically results in coverages that are more restrictive and more expensive than in the standard admitted market. The excess and surplus lines regulatory environment and production model also effectively filter submission flow and match market opportunities to our expertise and appetite. According to the 2018 edition of A.M. Best Aggregate & Averages – Property/Casualty, United States & Canada, the excess and surplus market represented approximately $23 billion, or 4 percent, of the entire $642 billion domestic property and casualty industry in 2017, as measured by direct premiums written. Our excess and surplus operations wrote gross premiums of $316.9 million, or 32 percent, of our total gross premiums written in 2018.

 

SPECIALTY REINSURANCE MARKETS

 

We write business in the specialty reinsurance markets. This business is generally written on a portfolio (treaty) basis. We write contracts on an excess of loss and a proportional basis. Contract provisions are written and agreed upon between the company and its reinsurance clients. The business is typically more volatile as a result of unique underlying exposures and excess and aggregate attachments. For 2018, our specialty reinsurance operations wrote gross premiums of $46.7 million, representing approximately 5 percent of our total gross premiums written for the year.

 

BUSINESS SEGMENT OVERVIEW

 

The segments of our insurance operations are casualty, property and surety. For additional information, see note 11 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.

 

5


 

Table of Contents

CASUALTY SEGMENT

 

Commercial Excess and Personal Umbrella

 

Our commercial excess coverage is written in excess of primary liability insurance provided by other carriers and in excess of primary liability written by the Company. The personal umbrella coverage is written in excess of homeowners’ and automobile liability coverage provided by other carriers, except in Hawaii, where some underlying homeowners’ coverage is written by the Company. Net premiums earned from this business totaled $124.4 million, $115.5 million and $111.1 million, or 16 percent, 16 percent and 15 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

General Liability

 

Our general liability business consists primarily of coverage for third-party liability of commercial insureds including manufacturers, contractors, apartments and mercantile. We also offer coverages for security guards and in the specialized areas of onshore energy-related businesses and environmental liability for underground storage tanks, contractors and asbestos and environmental remediation specialists. Net premiums earned from our general liability business totaled $93.9 million, $90.3 million and $86.9 million, or 12 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

Commercial Transportation

 

Our transportation insurance provides commercial automobile liability and physical damage insurance to local, intermediate and long haul truckers, public transportation entities and equipment dealers, along with other types of specialty commercial automobile risks. We also offer incidental, related insurance coverages including general liability, excess liability and motor truck cargo. We produce business through independent agents and brokers nationwide. Net premiums earned from this business totaled $81.1 million, $78.1 million and $81.4 million, or 10 percent, 11 percent and 11 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

Professional Services

 

We offer professional liability coverages focused on providing errors and omission coverage to small to medium-sized design, technical, computer and miscellaneous professionals. Our product suite for these customers also includes a full array of multi-peril package products including general liability, property, automobile, excess liability and workers’ compensation coverages. This business primarily markets its products through specialty retail agents nationwide. Net premiums earned from the professional services group totaled $80.0 million, $78.5 million and $75.9 million, or 10 percent, 11 percent and 10 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

Small Commercial

 

Our small commercial business offers property and casualty insurance coverages to small contractors and other small to medium-sized retail businesses. The coverages included in these packages are predominantly general liability, but also have some inland marine coverages as well as commercial automobile, property and umbrella coverage. These products are primarily marketed through retail agents. Net premiums earned from the small commercial business totaled $51.5 million, $49.6 million and $45.7 million, or 6 percent, 7 percent and 6 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

Executive Products

 

We provide a suite of management liability coverages, such as directors and officers (D&O) liability insurance, fiduciary liability and fidelity coverages, for a variety of risk classes, including both public and private businesses. Our publicly traded D&O appetite generally focuses on offering excess “Side A” D&O coverage (where corporations cannot indemnify the individual directors and officers) as well as excess full coverage D&O. Additionally, we offer representations and warranties coverage for companies involved in mergers and acquisitions, tax liability representations and warranties coverage for companies claiming certain tax credits and excess cyber liability coverage to medium to large size public and private businesses. Net premiums earned from the executive products business totaled $21.3 million, $18.1 million and $18.8 million, or 3 percent, 2 percent and 3 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

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Medical Professional Liability

 

We provide healthcare liability coverage focused on long-term care. In early 2019, we exited the long-term care business on a runoff basis. We also offer medical professional liability insurance specializing in hard-to-place individuals and group physicians. This business is marketed through wholesale brokers and retail agents. Net premiums earned from the medical professional liability business totaled $16.0 million, $17.1 million and $17.4 million, or 2 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

Other Casualty

 

We offer a variety of other smaller products in our casualty segment, including home business insurance, which provides limited liability and property coverage, on and off-site, for a variety of small business owners who work from their own home. We have a quota share reinsurance agreement with Prime Insurance Company and Prime Property and Casualty Insurance Inc., the two insurance subsidiaries of Prime Holdings Insurance Services, Inc. (Prime). We assume general liability, excess, commercial auto, property and professional liability coverages on hard-to-place risks that are written in the excess and surplus and admitted insurance markets. Additionally, we write mortgage reinsurance, which provides credit risk transfer on pools of mortgages, and offer general liability coverage through a general binding authority (GBA) group. Net premiums earned from these lines totaled $55.3 million, $31.4 million and $17.8 million, or 7 percent, 4 percent and 2 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

PROPERTY SEGMENT

 

Commercial Property

 

Our commercial property coverage consists primarily of excess and surplus lines and specialty insurance such as fire, earthquake and difference in conditions (DIC), which can include earthquake, wind, flood and collapse coverages. We provide insurance for a wide range of commercial and industrial risks, such as office buildings, apartments, condominiums, builders’ risks and certain industrial and mercantile structures. Net premiums earned from the commercial property business totaled $71.5 million, $63.1 million and $68.2 million, or 9 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

Marine

 

Our marine coverages include cargo, hull, protection and indemnity (P&I), marine liability, as well as inland marine coverages including builders’ risks and contractors’ equipment. Although the predominant exposures are located within the United States, there is some incidental international exposure written within these coverages. Net premiums earned from the marine business totaled $59.8 million, $50.9 million and $48.3 million, or 8 percent, 7 percent and 7 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

Specialty Personal

 

We offer specialized homeowners’ insurance in select locations, including homeowners’ and dwelling fire insurance through retail agents in Hawaii and a limited amount of homeowners’ insurance in Massachusetts and North Carolina. We also offered recreational vehicle insurance, which we began phasing out towards the end of 2016. Net premiums earned from specialty personal coverages totaled $16.9 million, $20.8 million and $25.0 million, or 2 percent, 3 percent and 3 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

Other Property

 

Our other property coverages consist of newer product offerings, such as general binding authority, and lines which we have recently exited, including property reinsurance. Net premiums earned from these lines totaled $1.1 million, $3.5 million and $10.7 million, or 1 percent or less of total net premiums earned for 2018, 2017 and 2016, respectively.

 

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SURETY SEGMENT

 

Miscellaneous

 

Our miscellaneous surety coverage includes small bonds for businesses and individuals written through independent insurance agencies throughout the United States. Examples of these types of bonds are license and permit, notary and court bonds. These bonds are usually individually underwritten and utilize extensive automation tools for the underwriting and bond delivery to our agents and principals. Net premiums earned from miscellaneous surety coverages totaled $47.0 million, $47.2 million and $46.2 million, or 6 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

Contract

 

We offer bonds for small to medium-sized contractors throughout the United States, underwritten on an account basis. Typically, these are performance and payment bonds for individual construction contracts. These bonds are marketed through a select number of insurance agencies that have surety and construction expertise. We also offer bonds for small and emerging contractors that are reinsured through the Federal Small Business Administration. Net premiums earned from contract surety coverages totaled $28.2 million, $28.6 million and $28.2 million, or 4 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

Commercial

 

We offer a large variety of commercial surety bonds for medium to large-sized businesses across a broad spectrum of industries. These risks are underwritten on an account basis and coverage is marketed through a select number of regional and national brokers with surety expertise. Net premiums earned from commercial surety coverages totaled $26.8 million, $27.6 million and $29.1 million, or 3 percent, 4 percent and 4 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

Energy

 

Our energy surety coverages provide commercial surety bonds for the energy, petrochemical and refining industries both on and off shore. These risks are primarily underwritten on an account basis and are primarily marketed through insurance producers with expertise in these industries. Net premiums earned from energy coverages totaled $16.7 million, $17.6 million and $18.0 million, or 2 percent of total net premiums earned for 2018, 2017 and 2016, respectively.

 

MARKETING AND DISTRIBUTION

 

We distribute our coverages primarily through branch offices throughout the country that market to wholesale and retail brokers and through independent agents.

 

BROKERS

 

The largest volume of broker-generated premium is in our commercial property, general liability, commercial surety, commercial excess, commercial transportation and medical professional liability coverages. This business is produced through independent wholesale and retail brokers.

 

INDEPENDENT AGENTS

 

We target classes of insurance, such as homeowners’ and dwelling fire, home business, surety and personal umbrella, through independent agents. Several of these products involve detailed eligibility criteria, which are incorporated into strict underwriting guidelines and prequalification of each risk using a system accessible by the independent agent. The independent agent cannot bind the risk unless they receive approval from our underwriters or through our automated systems.

 

UNDERWRITING AGENTS

 

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

 

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DIGITAL AND DIRECT

 

We utilize digital efforts to produce and efficiently process and service business including home businesses, high performance drivers, small commercial and personal umbrella risks and surety bonding. On a direct basis, we also assume premium on various reinsurance treaties.

 

COMPETITION

 

Our specialty property and casualty insurance subsidiaries are part of a very competitive industry that is cyclical and historically characterized by periods of high premium rates and shortages of underwriting capacity followed by periods of severe competition and excess underwriting capacity. Within the United States alone, approximately 2,600 companies actively market property and casualty coverages. Our primary competitors in the casualty segment include Arch, Aspen, Chubb, CNA, Great American, Great West, Hartford, Lancer, Markel, Navigators, Protective, RSUI, Sompo, USLI, Travelers and Zurich. Primary competitors in the property segment include Arch, Aspen, Chubb, CNA, Crum & Forster, Great American, Lexington, Sompo and Travelers. Primary competitors in the surety segment are AIG, Arch, Chubb, CNA, Great American, HCC, Navigators, Sompo, Travelers and XL. The combination of coverages, service, pricing and other methods of competition vary from line to line. Our principal methods of meeting this competition are innovative coverages, marketing structure and quality service to the agents and policyholders at a fair price. We compete favorably, in part, because of our sound financial base and reputation, as well as our broad, geographic footprint in all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam. In the casualty, property and surety areas, we have experienced underwriting specialists in our branch and home offices. We continue to maintain our underwriting and marketing standards by not seeking market share at the expense of earnings. We have a track record of withdrawing from markets when conditions become overly adverse, and offering new coverages and programs where the opportunity exists to provide needed insurance coverage with exceptional service on a profitable basis.

 

FINANCIAL STRENGTH RATINGS

 

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

 

 

 

 

 

 

 

 

 

 

 

 

A.M. Best

 

Standard & Poor’s

 

Moody’s

SECURE

 

SECURE

 

STRONG

A++, A+ 

    

Superior

    

AAA 

    

Extremely strong

    

Aaa

    

Exceptional

A, A-

 

Excellent

 

AA

 

Very strong

 

Aa

 

Excellent

B++, B+

 

Very good

 

A  

 

Strong

 

A

 

Good

 

 

 

 

BBB

 

Good

 

Baa

 

Adequate

 

 

 

 

 

 

 

 

 

 

 

 

 

VULNERABLE

 

VULNERABLE

 

WEAK

B, B-

 

Fair 

    

BB 

 

Marginal 

    

Ba 

 

Questionable 

C++, C+

 

Marginal

 

B  

 

Weak

 

B  

 

Poor

C, C-

 

Weak

 

CCC

 

Very weak

 

Caa

 

Very poor

D  

 

Poor

 

CC

 

Extremely weak

 

Ca

 

Extremely poor

E  

 

Under regulatory supervision

 

R  

 

Regulatory action

 

C  

 

Lowest

F  

 

In liquidation

 

 

 

 

 

 

 

 

S  

 

Rating suspended

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Within-category modifiers

 

+,-

 

 

 

1,2,3 (1 high, 3 low)

 

Publications of A.M. Best, Standard & Poor’s and Moody’s indicate that ‘‘A’’ and ‘‘A+’’ ratings are assigned to those companies that, in their opinion, have achieved exceptional overall performance compared to the standards they have established and have a strong ability to meet their obligations to policyholders over a long period of time. In evaluating a company’s financial and operating performance, each of the firms review the company’s profitability, leverage and liquidity, as well as the company’s spread of risk, the quality and appropriateness of its reinsurance, the quality and diversification of its

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assets, the adequacy of its policy and loss reserves, the adequacy of its surplus, its capital structure, its risk management practices and the experience and objectives of its management. These ratings are based on factors relevant to policyholders, agents, insurance brokers and intermediaries and are not specifically related to securities issued by the company.

 

At December 31, 2018, the following ratings were assigned to our insurance companies:

 

 

 

 

A.M. Best

    

 

 

RLI Ins., Mt. Hawley and CBIC* (group-rated)

 

A+, Superior

 

 

 

 

 

Standard & Poor’s

 

 

 

RLI Ins. and Mt. Hawley

 

A+, Strong

 

 

 

 

 

Moody’s

 

 

 

RLI Ins. and Mt. Hawley

 

A2, Good

 


*CBIC is only rated by A.M. Best

 

For A.M. Best, Standard & Poor’s and Moody’s, the financial strength ratings represented above are affirmations of previously assigned ratings. A.M. Best, in addition to assigning a financial strength rating, also assigns financial size categories. In October 2018, RLI Ins., Mt. Hawley and CBIC, which are collectively rated as a group, were assigned a financial size category of “XI” (adjusted policyholders’ surplus of between $750 million and $1 billion). As of December 31, 2018, the policyholders’ statutory surplus of RLI Insurance Group totaled $829.8 million, which continues to result in A.M. Best’s financial size category “XI”.

 

REINSURANCE

 

We reinsure a portion of our insurance exposure, paying or ceding to the reinsurer a portion of the premiums received on such policies. Earned premiums ceded to non-affiliated reinsurers totaled $146.8 million, $129.7 million and $134.6 million in 2018, 2017 and 2016, respectively. Insurance is ceded principally to reduce net liability on individual risks and to protect against catastrophic losses. We use reinsurance as an alternative to using our own capital to take risks and reduce volatility. Retention levels are evaluated each year to maintain a balance between the growth in surplus and the cost of reinsurance. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does make the assuming reinsurer liable to the insurer to the extent of the insurance ceded.

 

Reinsurance is subject to certain risks, specifically market risk (which affects the cost and ability to secure reinsurance contracts) and credit risk (which relates to the ability to collect from the reinsurer on our claims). We purchase reinsurance from financially strong reinsurers. We evaluate reinsurers’ ability to pay based on their financial results, level of surplus, financial strength ratings and other risk characteristics. A reinsurance committee, comprised of senior management, reviews and approves our security guidelines and reinsurer usage. More than 93 percent of our reinsurance recoverables are due from companies with financial strength ratings of “A” or better by A.M. Best and Standard & Poor’s rating services. For more information regarding our largest reinsurers, see note 5 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.

 

We utilize both treaty and facultative reinsurance coverage for our risks. Treaty coverage refers to a reinsurance contract under which the company agrees to cede all risks within a defined class of business to the reinsurer, who agrees to provide coverage on all risks ceded without individual underwriting. Facultative coverage is applied to individual risks at the company’s discretion and is subject to underwriting by the reinsurer. It is used for a variety of reasons, including supplementing the limits provided by the treaty coverage or covering risks or perils excluded from treaty reinsurance.

 

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

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Excluding CAT reinsurance, the table below summarizes the reinsurance treaty coverage currently in effect. We may purchase facultative coverage in excess of the per risk limits shown.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in millions)

 

 

    

 

    

 

    

 

 

    

Per Risk

    

 

 

 

 

 

 

 

Renewal

 

Attachment

 

Limit

 

Maximum

 

Product Line(s) Covered

 

Contract Type

 

Date

 

Point

 

Purchased

 

Retention

*

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

General liability

 

Excess of Loss

 

1/1

 

$

1.0

 

$

9.0

 

$

1.9

 

Commercial excess

    

Excess of Loss

    

1/1

 

 

1.0

 

 

9.0

 

 

1.9

 

Personal umbrella and eXS

 

Excess of Loss

 

1/1

 

 

1.0

 

 

9.0

 

 

1.9

 

Commercial transportation

 

Excess of Loss

 

1/1

 

 

0.5

 

 

4.5

 

 

1.1

 

Package - liability and workers' comp

 

Excess of Loss

 

1/1

 

 

1.0

 

 

10.0

 

 

1.9

 

Workers' compensation catastrophe

 

Excess of Loss

 

1/1

 

 

11.0

 

 

14.0

 

 

 —

**

Medical professional liability

 

Excess of Loss

 

1/1

 

 

1.0

 

 

9.0

 

 

1.9

 

Professional services - professional liability

 

Excess of Loss

 

4/1

 

 

1.0

 

 

9.0

 

 

3.3

 

Executive products

 

Quota Share

 

7/1

 

 

N/A

 

 

25.0

 

 

8.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property - risk cover

 

Excess of Loss

 

1/1

 

 

1.0

 

 

24.0

 

 

1.2

 

Marine

 

Excess of Loss

 

6/1

 

 

2.0

 

 

28.0

 

 

2.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Surety

 

Excess of Loss

 

4/1

 

 

2.0

 

 

73.0

 

 

9.7

***


*Maximum retention includes first-dollar retention plus any co-participation we retain through the reinsurance tower.

**The workers’ compensation catastrophe treaty responds after our package liability and workers’ compensation excess of loss treaty with no additional retention.

***A limited number of commercial and energy surety accounts are permitted to exceed the $75.0 million limit. These accounts are subject to additional levels of review and are monitored on a monthly basis.

 

At each renewal, we consider any plans to change the underlying insurance coverage we offer, as well as updated loss activity, the level of RLI Insurance Group’s surplus, changes in our risk appetite and the cost and availability of reinsurance treaties. In the last renewal cycle, we maintained similar retentions on most lines of business.

 

PROPERTY REINSURANCE — CATASTROPHE COVERAGE

 

Our property CAT reinsurance reduces the financial impact of a CAT event involving multiple claims and policyholders. Reinsurance limits purchased fluctuate due to changes in the amount of exposure we insure, reinsurance costs, insurance company surplus levels and our risk appetite. In addition, we monitor the expected rate of return for each of our CAT lines of business. At high rates of return, we grow the book of business and may purchase additional reinsurance to increase our capacity. As the rate of return decreases, we shrink the book and may purchase less reinsurance as this capacity becomes unnecessary. Our reinsurance coverage for the last three years and for 2019 are shown in the following table:

 

Catastrophe Coverages

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

2018

 

2017

 

2016

 

 

  

First- Dollar
Retention

  

Limit

  

First- Dollar
Retention

  

Limit

  

First- Dollar
Retention

  

Limit

  

First- Dollar
Retention

  

Limit

 

California Earthquake

 

$

25

 

400

 

$

25

 

300

 

$

25

 

300

 

$

25

 

300

 

Non-California Earthquake

 

 

25

 

425

 

 

25

 

325

 

 

25

 

325

 

 

25

 

325

 

Other Perils

 

 

25

 

275

 

 

25

 

225

 

 

25

 

225

 

 

25

 

225

 

 

These CAT limits are in addition to the per-occurrence coverage provided by facultative and other treaty coverages. We have participated in the CAT layers purchased by retaining a percentage of each layer throughout this period. Our participation has varied based on price and the amount of risk transferred by each layer. Since 2014, all layers of the treaty have included one prepaid reinstatement.

 

Our property CAT program continues to be applied on an excess of loss basis. It attaches after all other reinsurance has been considered. Although covered in one program, limits and attachment points differ for California earthquakes and all other

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perils. The following charts use information from our CAT modeling software to illustrate our pre-tax net retention resulting from particular events that would generate the gross losses.

 

Catastrophe - California Earthquake

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

2018

 

2017

 

Projected

    

Ceded

    

Net

    

Ceded

    

Net

    

Ceded

    

Net

 

Gross Loss

 

Losses

 

Losses

 

Losses

 

Losses

 

Losses

 

Losses

 

$

50

 

$

29

 

$

21

 

$

29

 

$

21

 

$

29

 

$

21

 

 

100

 

 

73

 

 

27

 

 

72

 

 

28

 

 

73

 

 

27

 

 

200

 

 

163

 

 

37

 

 

163

 

 

37

 

 

163

 

 

37

 

 

300

 

 

257

 

 

43

 

 

256

 

 

44

 

 

256

 

 

44

 

 

450

 

 

396

 

 

54

 

 

391

 

 

59

 

 

395

 

 

55

 

 

Catastrophe - Other (Earthquake outside of California, Wind, Other)

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

2018

 

2017

 

Projected

    

Ceded

    

Net

    

Ceded

    

Net

    

Ceded

    

Net

 

Gross Loss

 

Losses

 

Losses

 

Losses

 

Losses

 

Losses

 

Losses

 

$

25

 

$

 7

 

$

18

 

$

 6

 

$

19

 

$

 5

 

$

20

 

 

50

 

 

24

 

 

26

 

 

24

 

 

26

 

 

20

 

 

30

 

 

100

 

 

63

 

 

37

 

 

64

 

 

36

 

 

59

 

 

41

 

 

200

 

 

144

 

 

56

 

 

143

 

 

57

 

 

146

 

 

54

 

 

300

 

 

226

 

 

74

 

 

224

 

 

76

 

 

231

 

 

69

 

 

In the above table, projected losses for 2019 were estimated based on our exposure as of December 31, 2018, utilizing the treaty structure in place as of January 1, 2019. All previous years were estimated similarly by utilizing the treaty structure in place at the start of the listed year and the exposure at the end of the previous year.

 

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

 

We continuously monitor and quantify our exposure to catastrophes including earthquakes, hurricanes, floods, convective storms, terrorist acts and other aggregating events. In the normal course of business, we manage our concentrations of exposures to catastrophic events, primarily by limiting concentrations of locations insured to acceptable levels and by purchasing reinsurance. Exposure and coverage detail is recorded for each risk location. We quantify and monitor the total policy limit insured in each geographical region. In addition, we use third-party CAT exposure models and an internally developed analysis to assess each risk to ensure we include an appropriate charge for assumed CAT risks. CAT exposure modeling is inherently uncertain due to the model’s reliance on an infrequent observation of actual events and exposure data, increasing the importance of capturing accurate policy coverage data. The model results are used both in the underwriting analysis of individual risks and at a corporate level for the aggregate book of CAT-exposed business. From both perspectives, we consider the potential loss produced by individual events that represent moderate-to-high loss potential at varying probabilities and magnitudes. In calculating potential losses, we select appropriate assumptions including, but not limited to, loss amplification and loss adjustment expense. We establish risk tolerances at the portfolio level based on market conditions, the level of reinsurance available, changes to the assumptions in the CAT models, rating agency capital constraints, underwriting guidelines and coverages and internal preferences. Our risk tolerances for each type of CAT, and for all perils in aggregate, change over time as these internal and external conditions change. We are required to report to the rating agencies estimated loss to a single event that could include all potential earthquakes and hurricanes contemplated by the CAT modeling software. This reported loss includes the impact of insured losses based on the estimated frequency and severity of potential events, loss adjustment expense, reinstatements paid after the loss, reinsurance recoveries and taxes. Based on the CAT reinsurance treaty purchased on January 1, 2019, there is a 99.6 percent likelihood that the loss will be less than 16.2 percent of policyholders’ surplus as of December 31, 2018. The exposure levels are within our tolerances for this risk.

 

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LOSSES AND SETTLEMENT EXPENSES

 

OVERVIEW

 

Loss and loss adjustment expense (LAE) reserves represent our best estimate of ultimate payments for losses and related settlement expenses from claims that have been reported but not paid and losses that have been incurred but not yet reported to the Company (IBNR). Loss reserves do not represent an exact calculation of liability, but instead represent our estimates, generally utilizing individual claim estimates, actuarial expertise and estimation techniques at a given accounting date. The loss reserve estimates are expectations of what ultimate settlement and administration of claims will cost upon final resolution. These estimates are based on facts and circumstances then known to the Company, review of historical settlement patterns, estimates of trends in claims frequency and severity, projections of loss costs, expected interpretations of legal theories of liability and many other factors. In establishing reserves, we also take into account estimated recoveries from reinsurance, salvage and subrogation. The reserves are reviewed regularly by a team of actuaries we employ.

 

Net loss and loss adjustment reserves by product line at year-end 2018 and 2017 are illustrated in the following table. LAE is classified in the table as either allocated loss adjustment expense (ALAE) or unallocated loss adjustment expense (ULAE). ALAE refers to estimates of claim settlement expenses that can be identified with a specific claim or case, while ULAE cannot be identified with a specific claim. For a detailed discussion of loss reserves, refer to our critical accounting policy in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(as of December 31, in thousands)

 

2018

 

2017

 

Product Line

    

Case

    

IBNR

    

Total

    

Case

    

IBNR

    

Total

 

Casualty segment net loss and ALAE reserves

    

 

        

    

 

        

    

 

        

    

 

        

    

 

         

    

 

        

 

Commercial excess

 

$

8,172

 

$

122,690

 

$

130,862

 

$

9,724

 

$

99,745

 

$

109,469

 

Personal umbrella

 

 

21,208

 

 

42,203

 

 

63,411

 

 

21,452

 

 

39,395

 

 

60,847

 

General liability

 

 

68,295

 

 

171,640

 

 

239,935

 

 

78,360

 

 

149,102

 

 

227,462

 

Commercial transportation

 

 

87,544

 

 

46,015

 

 

133,559

 

 

81,543

 

 

38,161

 

 

119,704

 

Professional services

 

 

35,127

 

 

85,002

 

 

120,129

 

 

28,543

 

 

81,558

 

 

110,101

 

Small commercial

 

 

19,351

 

 

37,885

 

 

57,236

 

 

12,075

 

 

34,344

 

 

46,419

 

Executive products

 

 

21,617

 

 

47,581

 

 

69,198

 

 

11,327

 

 

44,484

 

 

55,811

 

Medical professional liability

 

 

19,087

 

 

21,058

 

 

40,145

 

 

16,621

 

 

10,526

 

 

27,147

 

Other casualty

 

 

10,763

 

 

49,208

 

 

59,971

 

 

6,595

 

 

31,302

 

 

37,897

 

Property segment net loss and ALAE reserves

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial property

 

 

26,012

 

 

13,021

 

 

39,033

 

 

21,375

 

 

10,615

 

 

31,990

 

Marine

 

 

11,426

 

 

20,189

 

 

31,615

 

 

11,512

 

 

18,095

 

 

29,607

 

Specialty personal

 

 

2,465

 

 

3,490

 

 

5,955

 

 

1,989

 

 

3,525

 

 

5,514

 

Other property

 

 

2,060

 

 

3,751

 

 

5,811

 

 

3,348

 

 

6,682

 

 

10,030

 

Surety segment net loss and ALAE reserves

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Miscellaneous

 

 

2,932

 

 

3,769

 

 

6,701

 

 

2,550

 

 

5,035

 

 

7,585

 

Contract

 

 

4,311

 

 

7,639

 

 

11,950

 

 

(1,939)

 

 

7,638

 

 

5,699

 

Commercial

 

 

137

 

 

5,482

 

 

5,619

 

 

1,686

 

 

6,276

 

 

7,962

 

Energy

 

 

2,195

 

 

3,244

 

 

5,439

 

 

2,843

 

 

2,254

 

 

5,097

 

Latent liability net loss and ALAE reserves

 

 

5,061

 

 

13,828

 

 

18,889

 

 

6,532

 

 

15,795

 

 

22,327

 

Total net loss and ALAE reserves

 

$

347,763

 

$

697,695

 

$

1,045,458

 

$

316,136

 

$

604,532

 

$

920,668

 

ULAE reserves

 

 

 —

 

 

50,891

 

 

50,891

 

 

 —

 

 

48,844

 

 

48,844

 

Total net loss and LAE reserves

 

$

347,763

 

$

748,586

 

$

1,096,349

 

$

316,136

 

$

653,376

 

$

969,512

 

 

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

 

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Significant Risk Factors

 

 

 

 

 

 

 

 

 

 

 

 

 

   

 

   

Emergence

   

 

   

Expected loss

   

Reserve

 

 

Length of

 

patterns relied

 

 

 

ratio

 

estimation

Product line

 

Reserve Tail

 

upon

 

Other risk factors

 

variability

 

variability

Commercial excess

 

Long

 

Internal

 

Low frequency

 

High

 

High

 

 

 

 

 

 

High severity

 

 

 

 

 

 

 

 

 

 

Loss trend volatility

 

 

 

 

 

 

 

 

 

 

Exposure growth

 

 

 

 

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

Exposure changes/mix

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Personal umbrella

 

Medium

 

Internal

 

Low frequency

 

Medium

 

Medium

 

 

 

 

 

 

High severity

 

 

 

 

 

 

 

 

 

 

Loss trend volatility

 

 

 

 

 

 

 

 

 

 

Exposure growth

 

 

 

 

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

General liability

 

Long

 

Internal

 

Exposure changes/mix

 

Medium

 

High

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial transportation

 

Medium

 

Internal

 

High severity

 

Medium

 

Medium

 

 

 

 

 

 

Exposure growth/mix

 

 

 

 

 

 

 

 

 

 

Loss trend volatility

 

 

 

 

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Professional services

 

Medium

 

Internal & external

 

Highly varied exposures

 

Medium

 

Medium

 

 

 

 

 

 

Loss trend volatility

 

 

 

 

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Small commercial

 

Long

 

Internal

 

Exposure growth/mix

 

Medium

 

Medium

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

Small volume

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Executive products

 

Long

 

Internal & significant external

 

Low frequency

 

High

 

High

 

 

 

 

 

 

High severity

 

 

 

 

 

 

 

 

 

 

Loss trend volatility

 

 

 

 

 

 

 

 

 

 

Economic volatility

 

 

 

 

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

Exposure growth/mix

 

 

 

 

 

 

 

 

 

 

Small volume

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Medical professional liability

 

Long

 

External

 

High severity

 

High

 

High

 

 

 

 

 

 

Exposure changes/mix

 

 

 

 

 

 

 

 

 

 

Unforeseen tort potential

 

 

 

 

 

 

 

 

 

 

Small volume

 

 

 

 

 

 

 

 

 

 

Loss trend volatility

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other casualty

 

Medium

 

Internal & external

 

Small volume

 

Medium

 

Medium

 

 

 

 

 

 

 

 

 

 

 

Marine

 

Medium

 

Internal & external

 

Exposure growth/mix

 

High

 

High

 

 

 

 

 

 

 

 

 

 

 

Other property

 

Short

 

Internal

 

CAT aggregation exposure

 

High

 

Medium

 

 

 

 

 

 

Low frequency

 

 

 

 

 

 

 

 

 

 

High severity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Surety

 

Medium

 

Internal

 

Economic volatility

 

Medium

 

Medium

 

 

 

 

 

 

Uniqueness of exposure

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Runoff including asbestos &

 

Long

 

Internal & external

 

Loss trend volatility

 

High

 

High

environmental

 

 

 

 

 

Mass tort/latent exposure

 

 

 

 

 

On a quarterly basis, actuaries perform a ground-up reserve study of the expected value of the unpaid loss and LAE derived using multiple standard actuarial methodologies that are described below. In addition, an emergence analysis is completed quarterly to determine if further adjustments are necessary. The purpose of this analysis is to provide validation of our carried loss reserves. These estimates are then compared to the carried loss reserves to determine the appropriateness of the current reserve balance.

 

The methodologies we have chosen to incorporate are a function of data availability and are reflective of our own book of business. From time to time, we evaluate the need to add supplementary methodologies. New methods are incorporated if it is

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believed they improve the estimate of our ultimate loss and LAE liability. All of the actuarial methods eventually converge to the same estimate as an accident year matures. Our core methodologies are listed below with a short description and their relative strengths and weaknesses:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

RESERVE SENSITIVITIES

 

There are three major parameters that have significant influence on our actuarial estimates of ultimate liabilities by product. They are the actual losses that are reported, the expected loss emergence pattern and the expected loss ratios used in the analyses. If the actual losses reported do not emerge as expected, it may cause the Company to challenge all or some of its previous assumptions. We may change expected loss emergence patterns, the expected loss ratios used in our analysis and/or the weights we place on a given actuarial method. The impact will be much greater and more leveraged for products with longer emergence patterns. Our general liability product is an example of a product with a relatively long emergence pattern. We have constructed a chart that illustrates the sensitivity of our general liability reserve estimates to these key parameters. We believe the scenarios to be reasonable as similar favorable variations have occurred in recent years. For example, while our general liability emergence has ranged from 8 percent to 18 percent favorable over the last three years, our emergence for all products combined, excluding general liability, has ranged from 5 percent to 18 percent favorable. The numbers below are the changes in estimated ultimate loss and ALAE in millions of dollars as of December 31, 2018, resulting from the change in the parameters shown. These parameters were applied to a general liability net loss and LAE reserve balance of $239.9 million,  in addition to associated ULAE and latent liability reserves, at December 31, 2018.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Result from favorable

    

Result from unfavorable

 

(in millions)

 

change in parameter

 

change in parameter

 

 

 

 

 

 

 

 

 

+/-5 point change in expected loss ratio for all accident years

 

$

(9.0)

 

$

9.0

 

 

    

 

 

 

 

 

 

+/-10% change in expected emergence patterns

 

$

(6.5)

 

$

6.2

 

 

 

 

 

 

 

 

 

+/-30% change in actual loss emergence over a calendar year

 

$

(13.3)

 

$

13.3

 

 

 

 

 

 

 

 

 

Simultaneous change in expected loss ratio (5pts), expected emergence patterns (10%), and actual loss emergence (30%).

 

$

(28.1)

 

$

29.1

 

 

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

 

OPERATING RATIOS

 

PREMIUMS TO SURPLUS RATIO

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31,

 

(dollars in thousands)

    

2018

    

2017

    

2016

    

2015

    

2014

 

Statutory net premiums written

 

$

823,175

 

$

749,854

 

$

740,952

 

$

722,189

 

$

703,152

 

Policyholders’ surplus

 

 

829,775

 

 

864,554

 

 

859,976

 

 

865,268

 

 

849,297

 

Ratio

 

 

1.0 to 1

 

 

0.9 to 1

 

 

0.9 to 1

 

 

0.8 to 1

 

 

0.8 to 1

 

 

GAAP AND STATUTORY COMBINED RATIOS

 

Our underwriting experience is best indicated by our GAAP combined ratio, which is the sum of (a) the ratio of incurred losses and settlement expenses to net premiums earned (loss ratio) and (b) the ratio of policy acquisition costs and other operating expenses to net premiums earned (expense ratio). The difference between the combined ratio and 100 reflects the per-dollar rate of underwriting income or loss, with ratios below 100 indicating underwriting profit and ratios above 100 indicating underwriting loss.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31,

 

GAAP

    

2018

    

2017

    

2016

    

2015

    

2014

 

Loss ratio

 

54.1

 

54.4

 

48.0

 

42.7

 

43.2

 

Expense ratio

 

40.6

 

42.0

 

41.5

 

41.8

 

41.3

 

Combined ratio

 

94.7

 

96.4

 

89.5

 

84.5

 

84.5

 

 

We also calculate the statutory combined ratio, which is not indicative of GAAP underwriting income due to accounting for policy acquisition costs differently for statutory accounting purposes compared to GAAP. The statutory combined ratio is the sum of (a) the ratio of statutory loss and settlement expenses incurred to statutory net premiums earned (loss ratio) and (b) the ratio of statutory policy acquisition costs and other underwriting expenses to statutory net premiums written (expense ratio). The difference between the combined ratio and 100 reflects the per-dollar rate of underwriting income or loss.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31,

 

Statutory

    

2018

    

2017

    

2016

    

2015

    

2014

 

Loss ratio

 

54.1

 

54.4

 

48.0

 

42.7

 

43.2

 

Expense ratio

 

39.9

 

41.8

 

41.0

 

41.2

 

40.9

 

Combined ratio

 

94.0

 

96.2

 

89.0

 

83.9

 

84.1

 

 

 

 

 

 

 

 

 

 

 

 

 

P&C industry combined ratio

 

99.4

*

103.9

**

100.7

**

97.9

**

97.2

**


*Source:  Conning (2018). Property-Casualty Forecast & Analysis: By Line of Insurance, Fourth Quarter 2018. Estimated for the year ended December 31, 2018.

**Source:  A.M. Best (2018). Aggregate & Averages – Property/Casualty, United States & Canada. 2014 – 2017.

 

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INVESTMENTS

 

Our investment portfolio serves as the primary resource for loss payments and secondly as a source of income to support operations. Our investment strategy is based on preservation of capital as the first priority, with a secondary focus on growing book value through total return. Investments of the highest quality and marketability are critical for preserving our claims-paying ability. Our portfolio contains no derivatives or off-balance sheet structured investments. In addition, we have a diversified investment portfolio that distributes credit risk across many issuers and a policy that limits aggregate credit exposure. Despite periodic fluctuations in market value, our equity portfolio is part of a long-term asset allocation strategy and has contributed significantly to our growth in book value.

 

Investment portfolios are managed both internally and externally by experienced portfolio managers. We follow an investment policy that is reviewed quarterly and revised periodically, with oversight conducted by our senior officers and board of directors.

 

Our investments include fixed income debt securities, common stock equity securities, exchange traded funds (ETFs) and a small number of limited partnership interests. The fixed income portfolio increased to 80 percent of the total portfolio, while the equity allocation declined to 16 percent of the overall portfolio. Other invested assets represented 2 percent of the total portfolio and include investments in low income housing tax credit partnerships, membership stock in the Federal Home Loan Bank of Chicago and investments in private funds. The remaining 2 percent was made up of cash and cash equivalents. As of December 31, 2018, 84 percent of the fixed income portfolio was rated A or better and 64 percent was rated AA or better.

 

We classify all of the securities in our fixed income portfolio as available-for-sale, which are carried at fair value. Beyond available operating cash flow, the portfolio provides an additional source of liquidity and can be used to address potential future changes in our asset/liability structure.

 

Aggregate maturities for the fixed-income portfolio as of December 31, 2018, are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Par

    

Amortized

    

Fair

    

Carrying

 

(in thousands)

 

Value

 

Cost

 

Value

 

Value

 

2019

 

$

41,303

 

$

41,319

 

$

41,333

 

$

41,333

 

2020

 

 

62,908

 

 

62,723

 

 

62,382

 

 

62,382

 

2021

 

 

133,843

 

 

134,661

 

 

134,556

 

 

134,556

 

2022

 

 

92,805

 

 

93,779

 

 

93,421

 

 

93,421

 

2023

 

 

119,041

 

 

119,991

 

 

120,321

 

 

120,321

 

2024

 

 

101,398

 

 

103,602

 

 

102,314

 

 

102,314

 

2025

 

 

188,572

 

 

190,550

 

 

189,259

 

 

189,259

 

2026

 

 

127,478

 

 

126,953

 

 

125,060

 

 

125,060

 

2027

 

 

120,870

 

 

121,652

 

 

119,678

 

 

119,678

 

2028

 

 

69,847

 

 

72,303

 

 

71,804

 

 

71,804

 

2029

 

 

41,445

 

 

45,912

 

 

47,244

 

 

47,244

 

2030

 

 

36,264

 

 

40,214

 

 

40,595

 

 

40,595

 

2031

 

 

14,510

 

 

16,148

 

 

16,299

 

 

16,299

 

2032

 

 

5,520

 

 

6,405

 

 

6,496

 

 

6,496

 

2033

 

 

5,266

 

 

6,349

 

 

6,314

 

 

6,314

 

2034 and later

 

 

51,490

 

 

53,688

 

 

51,464

 

 

51,464

 

Total excluding

 

 

 

 

 

 

 

 

 

 

 

 

 

Mtge/ABS/CMBS*

 

$

1,212,560

 

$

1,236,249

 

$

1,228,540

 

$

1,228,540

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mtge/ABS/CMBS*

 

$

533,232

 

$

540,216

 

$

531,975

 

$

531,975

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Grand Total

 

$

1,745,792

 

$

1,776,465

 

$

1,760,515

 

$

1,760,515

 


*Mortgage-backed, asset-backed & commercial mortgage-backed

 

We had cash, short-term investments and fixed income securities maturing within one year of $83.0 million at year-end 2018. This total represented 4 percent of cash and investments, compared to 2 percent at year-end 2017. Our short-term investments consist of investments with original maturities of 90 days or less, primarily AAA-rated prime and government money market funds.

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REGULATION

 

STATE REGULATION

 

As an insurance holding company, we, as well as our insurance company subsidiaries, are subject to regulation by the states and territories in which the insurance subsidiaries are domiciled or transact business. Registration in each insurer’s state of domicile requires periodic reporting to such state’s insurance regulatory authority of the financial, operational and management information regarding the insurers within the holding company system. All transactions within a holding company system affecting insurers must have fair and reasonable terms, and the insurers’ policyholders’ surplus following any transaction must be both reasonable in relation to its outstanding liabilities and adequate for its needs. Notice to and, in some cases, consent from regulators is required prior to the consummation of certain transactions affecting insurance company subsidiaries of the holding company system. Each state and territory individually regulates the insurance operations of both insurance companies and insurance agents/brokers. Most insurance regulations are designed to protect the interests of policyholders rather than shareholders and other investors.

 

Two primary focuses of state regulation of insurance companies are financial solvency and market conduct practices. Regulations designed to ensure financial solvency of insurers are enforced by various filing, reporting and examination requirements. Marketplace oversight is conducted by monitoring and periodically examining trade practices, approving policy forms, licensing of agents and brokers and requiring the filing and, in some cases, approval of premiums and commission rates to ensure they are fair and adequate.

 

Because our insurance company subsidiaries operate in all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam, we must comply with the individual insurance laws, regulations, rules and case law of each state and territory, including those regulating the filing of insurance rates and forms. Each of our three insurance company subsidiaries is domiciled in Illinois, with the Illinois Department of Insurance (IDOI) as its principal insurance regulator.

 

As a holding company, the amount of dividends we are able to pay depends upon the funds available for distribution, including dividends or distributions from our subsidiaries. The insurance laws applicable to our insurance company subsidiaries impose certain restrictions on their ability to pay dividends. The insurance holding company laws require that ordinary dividends paid by an insurance company be reported to the insurer’s domiciliary regulator prior to payment of the dividend and that extraordinary dividends may not be paid without such regulator’s prior approval (or non-disapproval). An extraordinary dividend is generally defined under Illinois law as a dividend that, together with all other dividends made within the past 12 months, exceeds the greater of 100 percent of the insurer’s statutory net income for the 12-month period ending as of December 31 of the preceding year or 10 percent of the insurer’s statutory policyholders’ surplus as of the preceding year-end. Insurance regulators have broad powers to prevent the reduction of statutory surplus to inadequate levels, and there is no assurance that extraordinary dividend payments would be permitted.

 

In addition, changes to the state insurance regulatory requirements are frequent, including changes caused by state legislation, regulations by the state insurance departments and court rulings. State insurance regulators are members of the NAIC. The NAIC is a non-governmental regulatory support organization that seeks to promote uniformity and to enhance state regulation of insurance through various activities, initiatives and programs. Among other regulatory and insurance company support activities, the NAIC maintains a state insurance department accreditation program and proposes model laws, regulations and guidelines for approval by state legislatures and insurance regulators. Such proposed laws and regulations cover areas including risk assessments, corporate governance and financial and accounting rules. To the extent such proposed model laws and regulations are adopted by states, they will apply to insurance carriers.

 

In December 2010, the NAIC adopted amendments to the Insurance Holding Company System Regulatory Act and Model Regulation (Amended Holding Company Model Act). The Amended Holding Company Model Act introduces the concept of “enterprise risk” within an insurance holding company system and imposes more extensive informational requirements on parents and other affiliates of licensed insurers or reinsurers, with the purpose of protecting the licensed companies from enterprise risk, including requiring an annual enterprise risk report by the ultimate controlling person identifying the material risks within the insurance holding company system that could pose enterprise risk to the licensed companies. An enterprise risk is generally defined as an activity or event involving affiliates of an insurer that could have a material adverse effect on the insurer or the insurer’s holding company system. Illinois has adopted a version of the Amended Holding Company Model Act. We are in compliance with the enterprise risk reporting requirements as adopted by Illinois.

 

The Own Risk and Solvency Assessment (ORSA) model act was developed by the NAIC and proposed for adoption by each state insurance regulatory department. Illinois has adopted the Risk Management and ORSA Law, applicable to Illinois-

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domiciled insurance companies meeting certain size requirements, including ours. The ORSA program is a key component of an insurance company’s overall enterprise risk management (ERM) framework, which is the process by which organizations identify, measure, monitor and manage key risks affecting the entire enterprise. An ORSA summary report, filed by the Company with the IDOI each year, is an internal identification, description and assessment of the risks associated with our business plan, and the sufficiency of capital resources to support those risks.

 

The NAIC uses a risk-based capital (RBC) model to monitor and regulate the solvency of licensed property and casualty insurance companies. Illinois has adopted a version of the NAIC’s model law. The RBC calculation is used to measure an insurer’s capital adequacy with respect to: the risk characteristics of the insurer’s premiums written and unpaid losses and loss adjustment expenses, rate of growth and quality of assets, among other measures. Depending on the results of the RBC calculation, insurers may be subject to varying degrees of regulatory action. RBC is calculated annually by insurers, as of December 31 of each year. As of December 31, 2018, each of our insurance company subsidiaries had RBC levels significantly in excess of the company action level RBC, defined as being 200 percent of the authorized control level RBC, which would prompt corrective action under Illinois law.  RLI Ins., our principal insurance company subsidiary, had an authorized control level RBC of $170.9 million compared to actual statutory capital and surplus of $829.8 million as of December 31, 2018, resulting in a statutory capital to authorized control level RBC ratio of 489 percent. The calculation of RBC requires certain judgments to be made, and, accordingly, each of our insurance company subsidiaries’ current RBC may be greater or less than the RBC calculated as of any date of determination.

 

Each of our insurance company subsidiaries is required to file detailed annual reports, including financial statements, in accordance with prescribed statutory accounting rules, with regulatory officials in the jurisdictions in which they conduct business. The quarterly and annual financial reports filed with the states utilize statutory accounting principles (SAP) that are different from U.S. GAAP. As a basis of accounting, SAP was developed to monitor and regulate the solvency of insurance companies. In developing SAP, insurance regulators were primarily concerned with assuring an insurer’s ability to pay all its current and future obligations to policyholders. As a result, statutory accounting focuses on conservatively valuing the assets and liabilities of insurers, generally in accordance with standards specified by the insurer’s domiciliary state. The values for assets, liabilities and equity reflected in financial statements prepared in accordance with U.S. GAAP are usually different from those reflected in financial statements prepared under SAP.

 

As part of their routine regulatory oversight process, state insurance departments conduct periodic detailed examinations, generally once every three to five years, of the books, records, accounts and operations of insurance companies that are domiciled in their states. Examinations are generally carried out in cooperation with the insurance departments of other, non-domiciliary states under guidelines promulgated by the NAIC. The most recent examination report of our insurance company subsidiaries completed by the IDOI was issued on November 27, 2018 for the five-year period ending December 31, 2017. The examination report is available to the public.

 

Each of our insurance company subsidiaries is subject to Illinois laws and regulations that impose restrictions on the amount and type of investments our insurance company subsidiaries may have. Such laws and regulations generally require diversification of the insurer’s investment portfolio and limit the amounts of investments in certain asset categories, such as below investment grade fixed income securities, real estate-related equity, other equity investments and derivatives. Failure to comply with these laws and regulations would generally cause investments that exceed regulatory limitations to be treated as non-admitted assets for measuring statutory surplus and, in some instances, could require the divestiture of such non-qualifying investments.

 

Many jurisdictions have laws and regulations that limit an insurer’s ability to withdraw from a particular market. For example, states may limit an insurer’s ability to cancel or non-renew policies. Furthermore, certain states prohibit an insurer from withdrawing one or more lines of business from the state, except pursuant to a plan that is approved by the state insurance department. The state insurance department may disapprove a withdrawal plan that may lead to marketplace disruption. Laws and regulations that limit cancellation and non-renewal, and that subject program withdrawals to prior approval requirements, may restrict our ability to exit unprofitable marketplaces in a timely manner.

 

Virtually all states require licensed insurers to participate in various forms of guaranty associations in order to bear a portion of the loss suffered by qualified policyholders of insurance companies that become insolvent. Depending upon state law, licensed insurers can be assessed a small percentage of the annual premiums written for the relevant lines of insurance in that state to contribute to paying the claims of insolvent insurers. These assessments may increase or decrease in the future, depending upon the rate of insurance company insolvencies. In some states, these assessments may be wholly or partially recovered through policy fees paid by insureds. We cannot predict the amount and timing of future assessments. Therefore, the

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liabilities we have currently established for these potential assessments may not be adequate and an assessment may materially impact our financial condition.

 

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

 

In light of the number and severity of recent U.S. company data breaches, some states have recently enacted new insurance laws that require certain regulated entities to implement and maintain comprehensive information security programs to safeguard the personal information of insureds. In 2017, the New York State Department of Financial Services (NYDFS) enacted a cybersecurity regulation. This regulation requires banks, insurance companies and other financial services institutions regulated by the NYDFS to establish and maintain a cybersecurity program “designed to protect consumers and ensure the safety and soundness of New York State’s financial services industry.” We are implementing the requirements of the regulation and are in compliance with those phases already enacted. We anticipate that the NYDFS will examine the cybersecurity programs of financial institutions in the future and that may result in additional regulatory scrutiny, expenditure of resources and possible regulatory actions and reputational harm.

 

In October 2017, the NAIC adopted a new Insurance Data Security Model Law. The law is intended to establish the standards for data security and standards for the investigation and notification of data breaches applicable to insurance licensees in states adopting such law, with provisions that are generally consistent with the NYDFS cybersecurity regulation discussed above. As with all NAIC model laws, this model law must be adopted by a state before becoming law in the state. Currently, only South Carolina and Ohio have adopted this model law in some form. Illinois has not adopted a version of the Insurance Data Security Model Law. The NAIC has also adopted a guidance document that sets forth 12 principles for effective insurance regulation of cybersecurity risks. The document is based on similar regulatory guidance adopted by the Securities Industry and Financial Markets Association and the “Roadmap for Cybersecurity Consumer Protections,” which describes the protections to which the NAIC believes consumers should be entitled from their insurance companies, agents and other businesses concerning the collection and maintenance of consumers’ personal information, as well as what consumers should expect when such information has been involved in a data breach. We expect cybersecurity risk management, prioritization and reporting to continue to be an area of significant regulatory focus by such regulatory bodies and self-regulatory organizations.

 

The rates, policy terms and conditions of reinsurance agreements generally are not subject to regulation by any regulatory authority. However, the ability of a ceding insurer to take credit for the reinsurance purchased from reinsurance companies is a significant component of reinsurance regulation. Typically, a ceding insurer will only enter into a reinsurance agreement if it can obtain credit against its reserves on its statutory basis financial statements for the reinsurance ceded to the reinsurer. With respect to U.S.-domiciled ceding companies, credit is usually granted when the reinsurer is licensed or accredited in the state where the ceding company is domiciled. States also generally permit ceding insurers to take credit for reinsurance if the reinsurer is: (i) domiciled in a state with a credit for reinsurance law that is substantially similar to the credit for reinsurance law in the primary insurer’s state of domicile, and (ii) meets certain financial requirements. Credit for reinsurance purchased from a reinsurer that does not meet the foregoing conditions is generally allowed to the extent that such reinsurer secures its obligations with qualified collateral.

 

FEDERAL LEGISLATION AND REGULATION

 

The U.S. insurance industry is not currently subject to any significant federal regulation and instead is regulated principally at the state level. However, the federal Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley Act), the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) and creation of the Federal Insurance Office (summarized below) include elements that affect the insurance industry, insurance companies and public companies such as ours.

 

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The Sarbanes-Oxley Act established several significant corporate governance-related laws and SEC regulations applicable to public companies. The Dodd-Frank Act created significant changes in regulatory structures of banking and other financial institutions, created new governmental agencies (while merging and removing others), increased oversight of financial institutions and enhanced regulation of capital markets. The legislation also mandates new rules affecting executive compensation and corporate governance for public companies such as ours. Federal agencies have been given significant discretion in drafting the rules and regulations that will implement the Dodd-Frank Act. We will continue to monitor, implement and comply with all Dodd-Frank Act-related changes to our regulatory environment. Changes in general political, economic or market conditions, including the latest U.S. presidential and congressional elections, could affect the scope, timing and final implementation of the Dodd-Frank Act. We cannot predict if or when future legislation or administrative guidance will be enacted or issued or what impact any changing regulation may have on our operations.

 

In addition, the Dodd-Frank Act contains insurance industry-specific provisions, including establishment of the Federal Insurance Office (FIO) and streamlining the regulation and taxation of surplus lines insurance and reinsurance among the states. The FIO, part of the U.S. Department of the Treasury, has limited authority and no direct regulatory authority over the business of insurance. The FIO’s principal mandates include monitoring the insurance industry, collecting insurance industry information and data and representing the U.S. with international insurance regulators. Although the FIO does not provide substantive regulation of the insurance industry at this time, we will monitor its activities carefully for any regulatory impact on our company.

 

Furthermore, the Dodd-Frank Act authorized the U.S. Treasury Secretary and the Office of the U.S. Trade Representative to negotiate covered agreements. A covered agreement is an agreement between the U.S. and one or more foreign governments, authorities or regulatory entities, regarding prudential measures with respect to insurance or reinsurance. Pursuant to this authority, in September 2017, the U.S. and the European Union (EU) signed a covered agreement to address, among other things, reinsurance collateral requirements (Covered Agreement). The Covered Agreement became provisionally effective on November 7, 2017, following completion of the EU’s procedural requirements, but must be approved by the European Parliament before treated as “fully” effective. We cannot predict with any certainty whether the Covered Agreement will be implemented or what the impact of such implementation will be on our business.

 

As part of the passage of the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA) in January 2015, the National Association of Registered Agents and Brokers (NARAB) was established by federal law, which is expected to streamline insurance agent/broker licensing. There has been little progress in implementing the provisions of NARAB to date.

 

Other federal laws and regulations apply to many aspects of our company and its business operations. This federal regulation includes, without limitation, laws affecting privacy and data security and credit reporting — examples of which include the Gramm-Leach-Bliley Act, Fair Credit Reporting Act and Fair and Accurate Credit Transactions Act. It also includes international economic and trade sanctions — examples of which include the Office of Foreign Asset Control (OFAC), Foreign Account Tax Compliance Act and the Iran Threat Reduction and Syrian Human Rights Act (ITR/SHR). ITR/SHR generally prohibits U.S. companies from engaging in certain transactions with the government of Iran or certain Iranian businesses, including the provision of insurance or reinsurance. Under ITR/SHR, we must disclose whether RLI Corp. or any of its affiliates knowingly engaged in certain specified activities identified in that law. For the year 2018, neither RLI Corp. nor its affiliates have knowingly engaged in any transaction or dealing reportable under Section 13(r) of the Exchange Act, as required by the ITR/SHR.

 

LICENSES AND TRADEMARKS

 

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

 

EMPLOYEES

 

As of December 31, 2018, we employed a total of 912 associates. Of the 912 total associates, 25 were part-time and 887 were full-time.

 

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FORWARD LOOKING STATEMENTS

 

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

 

Item 1A.  Risk Factors

 

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

 

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

 

·

Competitive pressures impacting our ability to write new business or retain existing business at an adequate rate,

·

Rising levels of loss costs that we cannot anticipate at the time we price our coverages,

·

Volatile and unpredictable developments, including man-made, weather-related and other natural CATs, terrorist attacks or significant price changes of the commodities we insure,

·

Changes in the level of reinsurance capacity,

·

Changes in the amount of losses resulting from new types of claims and new or changing judicial interpretations relating to the scope of insurers’ liabilities and

·

The ability of our underwriters to accurately select and price risk and our claim personnel to appropriately deliver fair outcomes.

In addition, the demand for property and casualty insurance, both admitted and excess and surplus lines, can vary significantly, rising as the overall level of economic activity increases and falling as that activity decreases, causing our revenues to fluctuate. These fluctuations in results of operations and revenues may not reflect long-term results and may cause the price of our securities to be volatile.

 

Adverse changes in the economy could lower the demand for our insurance products and could have an adverse effect on the revenue and profitability of our operations.

 

Factors such as business revenue, construction spending, government spending, the volatility and strength of the capital markets and inflation can all affect the business and economic environment. These same factors affect our ability to generate revenue and profits. Insurance premiums in our markets are heavily dependent on our customer revenues, values transported, miles traveled and number of new projects initiated. In an economic downturn characterized by higher unemployment, declines in construction spending and reduced corporate revenues, the demand for insurance products is adversely affected. Adverse changes in the economy may lead our customers to have less need for insurance coverage, to cancel existing insurance policies, to modify coverage or to not renew with the Company, all of which affect our ability to generate revenue.

 

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

 

We face the risk of property damage resulting from catastrophic events, particularly earthquakes on the West Coast and hurricanes and tropical storms affecting the continental U.S. or Hawaii. We also face risk from lava flows in Hawaii impacting

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our homeowners business and from wildfires, particularly on the West Coast. Since the Northridge, California earthquake in 1994, most of our catastrophe-related claims have resulted from hurricanes and other seasonal storms such as tornadoes and hail storms.

 

The incidence and severity of CATs are inherently unpredictable. The extent of losses from a CAT is a function of both the total amount of insured values in the area affected by the event and the severity of the event. Most CATs are restricted to fairly specific geographic areas. However, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. In addition to hurricanes and earthquakes, CAT losses can be due to windstorms, severe winter weather and fires and may include terrorist events. In addition, climate change could have an impact on longer-term natural CAT trends. Extreme weather events that are linked to rising temperatures, changing global weather patterns, sea, land and air temperatures, as well as sea levels, rain and snow could result in increased occurrence and severity of CATs. CATs can cause losses in a variety of our property and casualty segments, and it is possible that a catastrophic event or multiple catastrophic events could cause the Company to suffer material financial losses. In addition, CAT claim costs may be higher than we originally estimate and could cause substantial volatility in our financial results for any fiscal quarter or year. Our ability to write new business could also be affected. We believe that increases in the value and geographic concentration of insured property, the effects of inflation and the growth of our workers’ compensation business could also increase the severity of claims from CAT events in the future.

 

For information on our approaches to catastrophe risk mitigation, including reinsurance and catastrophe modeling, see the Property Reinsurance – Catastrophe Coverage section within “Item 1. Business” and Note 1.S to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data. However, since our CAT models cannot contemplate all possible CAT scenarios and includes underlying assumptions based on a limited set of actual events, the losses we might incur from an actual catastrophe could be higher than our expectation of losses generated from modeled catastrophe scenarios and our results of operations and financial condition could be materially and adversely affected.

 

Our loss reserves are based on estimates and may be inadequate to cover our actual insured losses, which would negatively impact our profitability.

 

Significant periods of time often elapse between the occurrence of an insured loss, the reporting of the loss to the Company and the payment of that loss. To recognize liabilities for unpaid losses, we establish reserves as balance sheet liabilities representing estimates of amounts needed to pay reported and unreported losses and the related loss adjustment expenses. Loss reserves are estimates of the ultimate cost of claims and do not represent an exact calculation of liability. These estimates are based on historical information and on estimates of future trends that may affect the frequency and severity of claims that may be reported in the future. Estimating loss reserves is a difficult, complex and inherently uncertain process involving many variables and subjective judgments. As part of the reserving process, we review historical data and consider the impact of various factors such as:

 

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Loss emergence and cedant reporting patterns,

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Underlying policy terms and conditions,

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Business and exposure mix,

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Trends in claim frequency and severity,

·

Changes in operations,

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Emerging economic and social trends,

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Inflation and

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Changes in the regulatory and litigation environments.

 

This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. It also assumes adequate historical or other data exists upon which to make these judgments. For more information on the estimates used in the establishment of loss reserves, see the loss and settlement expenses section of our critical accounting policies contained within Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. However, there is no precise method for evaluating the impact of any specific factor on the adequacy of reserves and actual results are likely to differ from original estimates. If the actual amount of insured losses is greater than the amount we have reserved for these losses, our profitability could suffer.

 

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

 

As is typical in our industry, we continually face risks associated with litigation of various types, including general commercial and corporate litigation, and disputes relating to bad faith allegations that could result in the Company incurring losses in excess of policy limits. We are party to a variety of litigation matters throughout the year. Litigation is subject to inherent uncertainties, and if there were an outcome unfavorable to the Company, there exists the possibility of a material adverse impact on our results of operations and financial position in the period in which the outcome occurs. Even if an unfavorable outcome does not materialize, we still may face substantial expense and disruption associated with the litigation.

 

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

 

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

 

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

 

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

 

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

 

We invest the premiums we receive from customers until they are needed to pay expenses or policyholder claims. Funds remaining after paying expenses and claims remain invested and are included in retained earnings. The value of our investment portfolio can fluctuate as a result of changes in the business, financial condition or operating results of the entities in which we invest. In addition, fluctuations can result from changes in interest rates, credit risk, government monetary policies, liquidity of holdings and general economic conditions. The equity portfolio will fluctuate with movements in the overall stock market. While the equity portfolio has been constructed to have lower downside risk than the market, the portfolio is positively correlated with movements in domestic stocks. The bond portfolio is affected by interest rate changes and movement in credit spreads. We attempt to mitigate our interest rate and credit risks by constructing a well-diversified portfolio of high-quality securities with varied maturities. These fluctuations may negatively impact our financial condition. However, we attempt to manage this risk through asset allocation, duration and security selection.

 

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

 

We compete with a large number of other companies in our selected lines of business. During periods of intense competition for premium (soft markets), we are vulnerable to the actions of other companies who may seek to write business without the appropriate regard for risk and profitability. During these times, it is very difficult to grow or maintain premium volume without sacrificing underwriting discipline and income.

 

We face competition from specialty insurance companies, underwriting agencies and intermediaries, as well as diversified financial services companies that are significantly larger than we are and that have significantly greater financial, marketing, management and other resources. We may also face competition from new sources of capital such as institutional investors seeking access to the insurance market, sometimes referred to as alternative capital, which may depress pricing or limit our opportunities to write business. Some of these competitors also have greater experience and market recognition than

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we do. We may incur increased costs in competing for underwriting revenues. If we are unable to compete effectively in the markets in which we operate or expand our operations into new markets, our underwriting revenues may decline, as well as overall business results.

 

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

 

·

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

·

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

·

Programs in which state-sponsored entities provide property insurance in CAT-prone areas or other “alternative markets” types of coverage,

·

Changing practices, which may lead to greater competition in the insurance business and

 

·

The emergence of insurtech companies and the development of new technologies, which may lead to disruption of current business models and the insurance value chain.

 

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

 

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

 

Financial strength ratings are a critical factor in establishing the competitive position of insurance companies. Our insurance companies are rated for overall financial strength by A.M. Best, Standard & Poor’s and Moody’s. A.M. Best, Standard & Poor’s and Moody’s ratings reflect their opinions of our financial strength, operating performance, strategic position and ability to meet our obligations to policyholders, and are not evaluations directed to investors. Our ratings are subject to periodic review by such firms, and the criteria used in the rating methodologies is subject to change; as such, we cannot assure the continued maintenance of our current ratings. All of our ratings were reviewed during 2018. A.M. Best reaffirmed its “A+, Superior” rating for the combined entity of RLI Ins., Mt. Hawley and CBIC (group-rated). Standard & Poor’s reaffirmed our “A+, Strong” rating for the group of RLI Ins. and Mt. Hawley. Moody’s reaffirmed our group rating of “A2, Good” for RLI Ins. and Mt. Hawley. Because these ratings have become an increasingly important factor in establishing the competitive position of insurance companies, if our ratings are reduced from their current levels by A.M. Best, Standard & Poor’s or Moody’s, our competitive position in the industry, and therefore our business, could be adversely affected. A significant downgrade could result in a substantial loss of business, as policyholders might move to other companies with higher claims-paying and financial strength ratings.

 

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

 

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

 

·

Approval of policy forms and premium rates,

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Standards of solvency, including risk-based capital measurements,

·

Licensing of insurers and their producers,

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Restrictions on agreements with our large revenue-producing agents,

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Cancellation and non-renewal of policies,

·

Restrictions on the nature, quality and concentration of investments,

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·

Restrictions on the ability of our insurance company subsidiaries to pay dividends to the Company,

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Restrictions on transactions between insurance company subsidiaries and their affiliates,

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Restrictions on the size of risks insurable under a single policy,

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Requiring deposits for the benefit of policyholders,

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Requiring certain methods of accounting,

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Periodic examinations of our operations and finances,

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Prescribing the form and content of records of financial condition required to be filed and

·

Requiring reserves for unearned premium, losses and other purposes.

 

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

 

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

 

In addition to regulations specific to the insurance industry, including the insurance laws of our principal state regulator (Illinois), as a public company we are also subject to the rules and regulations of the U.S. Securities and Exchange Commission and the New York Stock Exchange (NYSE), each of which regulate many areas such as financial and business disclosures, corporate governance and shareholder matters. We are also subject to the corporation laws of Delaware, where we are incorporated. At the federal level, among other laws, we are subject to the Sarbanes-Oxley Act and the Dodd-Frank Act, each of which regulate corporate governance, executive compensation and other areas, as well as laws relating to federal trade restrictions, privacy/data security and terrorism risk insurance laws. We monitor these laws, regulations and rules on an ongoing basis to ensure compliance and make appropriate changes as necessary. Implementing such changes may require adjustments to our business methods, increases to our costs and other changes that could cause the Company to be less competitive in the industry.

 

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

 

We depend on our ability to attract and retain qualified executive officers, experienced underwriting talent and other skilled employees who are knowledgeable about our business. Providing suitable succession planning for such positions is also important. If we cannot attract or retain top-performing executive officers, underwriters and other employees, if the quality of their performance decreases or if we fail to implement succession plans for our key staff, we may be unable to maintain our current competitive position in the markets in which we operate or expand our operations into new markets.

 

We are an insurance holding company and therefore may not be able to receive adequate or timely dividends from our insurance subsidiaries.

 

RLI Corp. is the holding company for our three insurance operating companies. At the holding company level, our principal assets are the shares of capital stock of our insurance company subsidiaries. We rely largely on dividends from our insurance company subsidiaries to meet our obligations for paying principal and interest on outstanding debt, corporate expenses and dividends to RLI Corp. shareholders. Dividend payments to RLI Corp. from our principal insurance subsidiary are restricted by state insurance laws as to the amount that may be paid without prior approval of the insurance regulatory authorities of Illinois. As a result, we may not be able to receive dividends from such subsidiary at times and in amounts necessary to pay RLI Corp. obligations and desired dividends to shareholders. Ordinary dividends, which may be paid by our principal insurance subsidiary without prior regulatory approval, are subject to certain limitations based upon income, surplus

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and earned surplus. The maximum ordinary dividend distribution from our principal insurance subsidiary in a rolling 12-month period is limited by Illinois law to the greater of 10 percent of RLI Ins. policyholder surplus as of December 31 of the preceding year, or the net income of RLI Ins. for the 12-month period ending December 31 of the preceding year. Ordinary dividends are further restricted by the requirement that they be paid from earned surplus. Any dividend distribution in excess of the ordinary dividend limits is deemed extraordinary and requires prior approval (or non-disapproval) from the IDOI. Because the limitations are based upon a rolling 12-month period, the presence, amount and impact of these restrictions vary over time.

 

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

 

Provisions of our certificate of incorporation and by-laws, as well as applicable Delaware law, federal and state regulations and insurance company regulations may discourage, delay or prevent a merger, tender offer or other change of control that holders of our securities may consider favorable. Some of these provisions impose various procedural and other requirements that could make it more difficult for shareholders to effect certain corporate actions. These provisions could:

 

·

Have the effect of delaying, deferring or preventing a change in control of the Company,

·

Discourage bids for our securities at a premium over the market price,

·

Adversely affect the market price, the voting and other rights of the holders of our securities or

·

Impede the ability of the holders of our securities to change our management.

 

In particular, we are subject to Section 203 of the Delaware General Corporation Law which, under certain circumstances, restricts our ability to engage in a business combination, such as a merger or sale of assets, with any stockholder that, together with affiliates, owns 15 percent or more of our common stock, which similarly could prohibit or delay the accomplishment of a change of control transaction.

 

Any significant interruption in the operation of our facilities, systems and business functions could adversely affect our financial condition and results of operations.

 

We rely on multiple computer systems to interact with producers and customers, issue policies, pay claims, run modeling functions, assess insurance risks and complete various important internal processes including accounting and bookkeeping. Our business is highly dependent on our ability to access these systems to perform necessary business functions. Additionally, some of these systems may include or rely upon third-party systems not located on our premises. Any of these systems may be exposed to unplanned interruption, unreliability or intrusion from a variety of causes, including among others, storms and other natural disasters, terrorist attacks, utility outages or complications encountered as existing systems are replaced or upgraded.

 

Any such issues could materially impact our company including the impairment of information availability, compromise of system integrity/accuracy, misappropriation of confidential information, reduction of our volume of transactions and interruption of our general business. Although we believe our computer systems are securely protected and continue to take steps to ensure they are protected against such risks, we cannot guarantee such problems will not occur. If they do, interruption to our business and damage to our reputation, and related costs, could be significant, which could impair our profitability.

 

Technology breaches or failures, including but not limited to cyber security incidents, could disrupt our operations and result in the loss of critical and confidential information, which could adversely impact our reputation and results of operations.

 

Global cyber security threats can range from uncoordinated individual attempts to gain unauthorized access to our information technology systems and those of our business partners or service providers to sophisticated and targeted measures known as advanced persistent threats. While we, our business partners and service providers employ measures to prevent, detect, address and mitigate these threats (including access controls, data encryption, vulnerability assessments, continuous monitoring of information technology networks and systems and maintenance of backup and protective systems), cyber security incidents, depending on their nature and scope, could potentially result in the misappropriation, destruction, corruption or unavailability of critical data and confidential or proprietary information (our own or that of third parties) and the disruption of business operations. Security breaches could expose the Company to a risk of loss or misuse of our or our customers’ information, litigation and potential liability. In addition, cyber incidents that impact the availability, reliability, speed, accuracy or other proper functioning of our technology systems could impact our operations. We may not have the resources or technical sophistication to anticipate or prevent every type of cyber attack. A significant cyber incident, including system failure, security breach, disruption by malware or other damage could interrupt or delay our operations, result in a violation of

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applicable privacy and other laws, damage our reputation, cause a loss of customers or give rise to remediation costs, monetary fines and other penalties, which could be significant. It is possible that insurance coverage we have in place would not entirely protect the Company in the event that we experienced a cyber security incident, interruption or widespread failure of our information technology systems.

 

We rely on third party vendors for a number of key components of our business.

 

We contract with a number of third party vendors to support our business. For example, we have license agreements for services that include natural catastrophe modeling, policy management, claims processing, producer management and accounting and financial management. The vendors range from large national companies, who are dominant in their area of expertise and would be difficult to quickly replace, to smaller or start-up vendors with leading technology, but with shorter operating histories and fewer financial resources. Failures of certain vendors to provide services could adversely affect our ability to deliver products and services to our customers, disrupting our business and causing the Company to incur significant expense. If one or more of our vendors fail to protect personal information of our customers, claimants or employees, we may incur operational impairments, or could be exposed to litigation, compliance costs or reputation damage. We maintain a vendor management program to establish procurement policies and to monitor vendor risk, including the financial stability of our critical vendors.

 

If we are unable to keep pace with the technological advancements in the insurance industry, our ability to compete effectively could be impaired.

 

Our operations rely upon complex and expensive information technology systems for interacting with policyholders, brokers and other business partners. The pace at which information systems must be upgraded is continually increasing, requiring an ongoing commitment of significant resources to maintain or upgrade to current standards. We are committed to developing and maintaining information technology systems that will allow our insurance subsidiaries to compete effectively. There can be no assurance that the development of current technology will not result in our being competitively disadvantaged, especially with those companies that have greater resources. If we are unable to keep pace with the advancements being made in technology, our ability to compete with other insurance companies who have advanced technological capabilities will be negatively affected. Further, if we are unable to effectively update or replace our key legacy technology systems as they become obsolete or as emerging technology renders them competitively inefficient, our competitive position and our cost structure could be adversely affected.

 

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

 

Our ability to grow our business depends, in part, on our creation, implementation or acquisition of new insurance products that are profitable and fit within our business model. Our ability to grow profitably requires that we identify market opportunities, which may include acquisitions, and that we attract and retain underwriting and claims expertise to support that growth. New product launches as well as resources to integrate business acquisitions are subject to many obstacles, including ensuring we have sufficient business and systems processes, determining appropriate pricing, obtaining reinsurance, assessing opportunity costs and regulatory burdens and planning for internal infrastructure needs. If we cannot effectively or accurately assess and overcome these obstacles or we improperly implement new insurance products, our ability to grow profitably could be impaired.

 

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

 

Our ability to grow our business depends in part on our ability to access capital when needed. We cannot predict capital market liquidity or the availability of capital. We also cannot predict the extent and duration of future economic and market disruptions, the impact of government interventions into the market to address these disruptions and their combined impact on our industry, business and investment portfolios. If our company needs capital but cannot raise it, our business and future growth could be adversely affected.

 

Our success will depend on our ability to maintain and enhance effective operating procedures and manage risks on an enterprise wide basis.

 

Operational risk and losses can result from, among other things, fraud, errors, failure to document transactions properly, failure to obtain proper internal authorization, failure to comply with regulatory requirements, information technology failures or external events. We continue to enhance our operating procedures and internal controls to effectively support our business

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and our regulatory and reporting requirements. The NAIC and state legislatures have increased their focus on risks within an insurer’s holding company system that may pose enterprise risk to insurers. The Illinois legislature has adopted the Risk Management and ORSA Law, which requires domestic insurers to maintain a risk management framework and establishes a legal requirement for domestic insurers to conduct an ORSA in accordance with the NAIC’s ORSA Guidance Manual. The ORSA Law also provides that, no less than annually, an insurer must submit an ORSA summary report. Under the Illinois insurance holding company laws, on an annual basis, we are also required to file with the IDOI an enterprise risk report, which is intended to identify the material risks within our insurance holding company system that could pose enterprise risk to our insurance company subsidiaries. We operate within an ERM framework designed to assess and monitor our risks. However, assurance that we can effectively review and monitor all risks or that all of our employees will operate within the ERM framework cannot be guaranteed. Assurances that our ERM framework will result in the Company accurately identifying all risks and accurately limiting our exposures based on our assessments also cannot be guaranteed.

 

We may not be able to, or might not choose to, continue paying dividends on our common stock.

 

We have a history of paying regular, quarterly dividends and in recent years have paid special dividends. Any determination to pay either type of dividend to our stockholders in the future will be at the discretion of our board of directors and will depend on our results of operations, financial condition and other factors deemed relevant by our board of directors. Our ability to pay dividends depends largely on our subsidiaries’ earnings and operating capital requirements and is subject to the regulatory, contractual and other constraints of our subsidiaries, including the effect of any such dividends or distributions on the A.M. Best rating or other ratings of our insurance subsidiaries. In addition, we may choose to retain capital to support growth or further mitigate risk, as opposed to returning excess capital to our shareholders.

 

Item 1B. Unresolved Staff Comments

 

None.

 

Item 2.    Properties

 

We own five commercial buildings totaling 173,000 square feet on our 23-acre campus that serves as our corporate headquarters in Peoria, Illinois. All of our branch offices and other company operations lease office space throughout the country. Management considers our office facilities suitable and adequate for our current levels of operations.

 

Item 3.  Legal Proceedings

 

We are party to numerous claims, losses and litigation matters that arise in the normal course of our business. Many of such claims, losses or litigation matters involve claims under policies that we underwrite as an insurer. We believe that the resolution of these claims, losses and litigation matters will not have a material adverse effect on our financial condition, results of operations or cash flows.

 

We are also involved in various other legal proceedings and litigation unrelated to our insurance business from time to time that arise in the ordinary course of business operations. Management believes that any liabilities that may arise as a result of these legal matters will not have a material adverse effect on our financial condition, results of operations or cash flows.

 

Item 4.    Mine Safety Disclosures

 

Not applicable.

 

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PART II

 

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

 

Market Information; Holders; Dividends

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Closing Stock Price

 

Dividends

 

2018

    

High

    

Low

    

Ending

    

Declared

 

1st Quarter

 

$

64.47

 

$

58.71

 

$

63.39

 

$

0.21

 

2nd Quarter

 

 

69.71

 

 

61.74

 

 

66.19

 

 

0.22

 

3rd Quarter

 

 

79.86

 

 

66.53

 

 

78.58

 

 

0.22

 

4th Quarter

 

 

76.82

 

 

64.57

 

 

68.99

 

 

1.22

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Closing Stock Price

    

Dividends

 

2017

    

High

    

Low

    

Ending

    

Declared

 

1st Quarter

 

$

61.61

 

$

57.15

 

$

60.02

 

$

0.20

 

2nd Quarter

 

 

58.67

 

 

53.01

 

 

54.62

 

 

0.21

 

3rd Quarter

 

 

58.68

 

 

51.02

 

 

57.36

 

 

0.21

 

4th Quarter

 

 

60.93

 

 

56.99

 

 

60.66

 

 

1.96

 

 

RLI Corp. common stock trades on the New York Stock Exchange under the symbol RLI. RLI Corp. has paid dividends for 170 consecutive quarters and increased quarterly dividends in each of the last 43 years. In December 2018 and 2017, RLI Corp. paid special cash dividends of $1.00 and $1.75 per share, respectively, to shareholders. As of February 7, 2019, there were 765 registered holders of the Company’s common stock.

 

Performance

 

The following graph provides a five-year comparison of RLI’s total return to shareholders compared to that of the S&P 500 and S&P 500 P&C Index:

 

Picture 1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

    

2013

    

2014

    

2015

    

2016

    

2017

    

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RLI

 

--------------

 

$

100

 

110

 

144

 

154

 

154

 

180

 

S&P 500

 

••••••••••••••••

 

$

100

 

114

 

115

 

129

 

157

 

150

 

S&P 500 P&C Index

 

—  —  —

 

$

100

 

116

 

127

 

147

 

180

 

171

 

 

Assumes $100 invested on December 31, 2013, in RLI, S&P 500 and S&P 500 P&C Index, with reinvestment of dividends. Comparison of five-year annualized total return — RLI: 12.4%, S&P 500: 8.5%, and S&P 500 P&C Index: 11.3%.

 

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Securities Authorized for Issuance under Equity Compensation Plans

 

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

 

Recent Sales of Unregistered Securities; Uses of Proceeds from Registered Securities

 

Not applicable.

 

Equity Repurchases

 

In 2010, our Board of Directors implemented a $100 million share repurchase program. We last repurchased shares in 2011. We have $87.5 million of remaining capacity from the repurchase program. The repurchase program may be suspended or discontinued at any time without prior notice.

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Item 6.    Selected Financial Data

 

The following is selected financial data of RLI Corp. and Subsidiaries for the five years ended December 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(amounts in thousands, except per share data and ratios)

    

2018

    

2017

    

2016

    

2015

    

 

2014

 

 

OPERATING RESULTS

    

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross premiums written

 

$

983,216

 

885,312

 

874,864

 

853,586

 

 

863,848

 

 

Consolidated revenue (1)

 

$

818,123

 

797,224

 

816,328

 

794,634

 

 

775,165

 

 

Net earnings (1)

 

$

64,179

 

105,028

 

114,920

 

137,544

 

 

135,445

 

 

Comprehensive earnings

 

$

30,182

 

140,337

 

113,756

 

89,935

 

 

170,801

 

 

Net cash provided from operating activities

 

$

217,102

 

197,525

 

174,463

 

152,586

 

 

123,085

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FINANCIAL CONDITION

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total investments and cash

 

$

2,194,230

 

2,140,790

 

2,021,827

 

1,951,543

 

 

1,964,285

 

 

Total assets

 

$

3,105,065

 

2,947,244

 

2,777,633

 

2,735,465

 

 

2,774,284

 

 

Unpaid losses and settlement expenses

 

$

1,461,348

 

1,271,503

 

1,139,337

 

1,103,785

 

 

1,121,040

 

 

Total debt

 

$

149,115

 

148,928

 

148,741

 

148,554

 

 

148,367

 

 

Total shareholders’ equity

 

$

806,842

 

853,598

 

823,572

 

823,469

 

 

845,062

 

 

Statutory surplus (2)

 

$

829,775

 

864,554

 

859,976

 

865,268

 

 

849,297

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SHARE INFORMATION

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings per share (1):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

1.45

 

2.39

 

2.63

 

3.18

 

 

3.15

 

 

Diluted

 

$

1.43

 

2.36

 

2.59

 

3.12

 

 

3.09

 

 

Comprehensive earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.68

 

3.19

 

2.60

 

2.08

 

 

3.97

 

 

Diluted

 

$

0.67

 

3.15

 

2.56

 

2.04

 

 

3.90

 

 

Cash dividends declared per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Regular

 

$

0.87

 

0.83

 

0.79

 

0.75

 

 

0.71

 

 

Special

 

$

1.00

 

1.75

 

2.00

 

2.00

 

 

3.00

 

 

Book value per share

 

$

18.13

 

19.33

 

18.74

 

18.91

 

 

19.61

 

 

Closing stock price

 

$

68.99

 

60.66

 

63.13

 

61.75

 

 

49.40

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

44,358

 

44,033

 

43,772

 

43,299

 

 

43,020

 

 

Diluted

 

 

44,835

 

44,500

 

44,432

 

44,131

 

 

43,819

 

 

Common shares outstanding

 

 

44,504

 

44,148

 

43,945

 

43,544

 

 

43,103

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

OTHER NON-GAAP FINANCIAL INFORMATION

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net premiums written to statutory surplus (2)

 

 

99

%  

87

%  

86

%

83

%

 

83

%

 

GAAP combined ratio (3)

 

 

94.7

 

96.4

 

89.5

 

84.5

 

 

84.5

 

 

Statutory combined ratio (2)(3)

 

 

94.0

 

96.2

 

89.0

 

83.9

 

 

84.1

 

 


(1)

Unrealized gains and losses on equity securities were included in consolidated revenue and net earnings in 2018 and flowed through comprehensive earnings in prior years.

(2)

Ratios and surplus information are presented on a statutory basis. As discussed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, statutory accounting principles differ from GAAP and are generally based on a solvency concept. Further discussion is included in note 9 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data. Reporting of statutory surplus is a required disclosure under GAAP.

(3)

See page 35 for information regarding non-GAAP financial measures.

 

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

 

OVERVIEW

 

RLI Corp. is a U.S.-based, specialty insurance company that underwrites select property and casualty insurance through major subsidiaries collectively known as RLI Insurance Group. As a specialty insurance company with a niche focus, we offer insurance coverages in the specialty admitted and excess and surplus markets. Coverages in the specialty admitted market, such as our energy surety bonds, are for risks that are unique or hard-to-place in the standard market, but must remain with an admitted insurance company for regulatory or marketing reasons. In addition, our coverages in the specialty admitted market may be designed to meet specific insurance needs of targeted insured groups, such as our professional liability and package coverages for design professionals and our stand-alone personal umbrella policy. The specialty admitted market is subject to more state regulation than the excess and surplus market, particularly with regard to rate and form filing requirements, restrictions on the ability to exit lines of business, premium tax payments and membership in various state associations, such as state guaranty funds and assigned risk plans. We also underwrite coverages in the excess and surplus market. The excess and surplus market, unlike the admitted market, is less regulated and more flexible in terms of policy forms and premium rates. This market provides an alternative for customers with risks or loss exposures that generally cannot be written in the standard market. This typically results in coverages that are more restrictive and more expensive than coverages in the admitted market. When we underwrite within the excess and surplus market, we are selective in the lines of business and type of risks we choose to write. Using our non-admitted status in this market allows the Company to tailor terms and conditions to manage these exposures effectively. Often, the development of these coverages is generated through proposals brought to the Company by an agent or broker seeking coverage for a specific group of clients or loss exposures. Once a proposal is submitted, our underwriters determine whether it would be a viable product based on our business objectives.

 

We focus on niche markets and developing unique products that are tailored to customers’ needs. We hire underwriters with deep expertise and provide exceptional customer service and support. We maintain a highly diverse product portfolio and underwrite for profit in all market conditions. In 2018, we achieved our 23rd consecutive year of profitability, averaging an 88.1 combined ratio over that period. This drives our ability to provide shareholder returns in three different ways: the underwriting income itself, net investment income from our investment portfolio and long-term appreciation in our equity portfolio. Our investment strategy is based on preservation of capital as the first priority, with a secondary focus on generating total return. The fixed income portfolio consists primarily of highly-rated, diversified, liquid, investment-grade securities. Consistent underwriting income allows a portion of our investment portfolio to be invested in equity securities and other risk asset classes. Our equity portfolio consists of a core stock portfolio weighted toward dividend-paying stocks, as well as exchange traded funds (ETFs). Our minority equity ownership interests in Maui Jim, Inc. (Maui Jim), a manufacturer of high-quality sunglasses, and Prime Holdings Insurance Services, Inc. (Prime), a specialty insurance company, have also enhanced financial results. We have a diversified investment portfolio and closely monitor our investment risks. Despite periodic fluctuations in market value, our equity portfolio is part of a long-term asset allocation strategy and has contributed significantly to our historic growth in book value.

 

We measure the results of our insurance operations by monitoring growth and profitability across three distinct business segments: casualty, property and surety. Growth is measured in terms of gross premiums written, and profitability is analyzed through combined ratios, which are further subdivided into their respective loss and expense components.

 

The casualty portion of our business consists largely of commercial excess, personal umbrella, general liability, transportation and executive products coverages, as well as package business and other specialty coverages, such as professional liability and workers’ compensation for office-based professionals. We also offer fidelity and crime coverage for commercial insureds and select financial institutions and medical and healthcare professional liability coverage. The casualty business is subject to the risk of estimating losses and related loss reserves because the ultimate settlement of a casualty claim may take several years to fully develop. The casualty segment is also subject to inflation risk and may be affected by evolving legislation and court decisions that define the extent of coverage and the amount of compensation due for injuries or losses.

 

Our property segment is comprised primarily of commercial fire, earthquake, difference in conditions and marine coverages. We also offer select personal lines policies, including homeowners’ coverages. Our property reinsurance and recreational vehicle (RV) products are in runoff after we began curtailing offerings at the end of 2015 and 2016, respectively. Property insurance results are subject to the variability introduced by perils such as earthquakes, fires and hurricanes. Our major catastrophe exposure is to losses caused by earthquakes, primarily on the West Coast. Our second largest catastrophe exposure is to losses caused by wind storms to commercial properties throughout the Gulf and East Coast, as well as to homes we insure in Hawaii. We limit our net aggregate exposure to a catastrophic event by minimizing the total policy limits written in a particular region, purchasing reinsurance and maintaining policy terms and conditions throughout market cycles. We also

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use computer-assisted modeling techniques to provide estimates that help the Company carefully manage the concentration of risks exposed to catastrophic events.

 

The surety segment specializes in writing small to large-sized commercial and contract surety coverages, as well as those for the energy, petrochemical and refining industries. We also offer miscellaneous bonds including license and permit, notary and court bonds. Often, our surety coverages involve a statutory requirement for bonds. While these bonds typically maintain a relatively low loss ratio, losses may fluctuate due to adverse economic conditions affecting the financial viability of our principals. The contract surety product guarantees the construction work of a commercial contractor for a specific project. Generally, losses occur due to the deterioration of a contractor’s financial condition. This line has historically produced marginally higher loss ratios than other surety lines during economic downturns.

 

GAAP, NON-GAAP AND PERFORMANCE MEASURES

 

Throughout this annual report, we include certain non-generally accepted accounting principles (“non-GAAP”) financial measures. Management believes that these non-GAAP measures better explain the Company’s results of operations and allow for a more complete understanding of the underlying trends in the Company’s business. These measures should not be viewed as a substitute for those determined in accordance with generally accepted accounting principles in the United States of America (GAAP). In addition, our definitions of these items may not be comparable to the definitions used by other companies.

 

Following is a list of non-GAAP measures found throughout this report with their definitions, relationships to GAAP measures and explanations of their importance to our operations.

 

Underwriting Income

 

Underwriting income or profit represents one measure of the pretax profitability of our insurance operations and is derived by subtracting losses and settlement expenses, policy acquisition costs and insurance operating expenses from net premiums earned, which are all GAAP financial measures. Each of these captions is presented in the statements of earnings but is not subtotaled. However, this information is available in total and by segment in note 11 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data. The nearest comparable GAAP measure is earnings before income taxes which, in addition to underwriting income, includes net investment income, net realized gains or losses, net unrealized gains or losses on equity securities in 2018, general corporate expenses, debt costs and our portion of earnings from unconsolidated investees.

 

Combined Ratio

 

The combined ratio, which is derived from components of underwriting income, is a common industry performance measure of profitability for underwriting operations and is calculated in two components. First, the loss ratio is losses and settlement expenses divided by net premiums earned. The second component, the expense ratio, reflects the sum of policy acquisition costs and insurance operating expenses divided by net premiums earned. All items included in these components of the combined ratio are presented in our GAAP consolidated financial statements. The sum of the loss and expense ratios is the combined ratio. The difference between the combined ratio and 100 reflects the per-dollar rate of underwriting income or loss. For example, a combined ratio of 90 implies that for every $100 of premium we earn, we record $10 of underwriting income.

 

Net Unpaid Loss and Settlement Expenses

 

Unpaid losses and settlement expenses, as shown in the liabilities section of our balance sheets, represents the total obligations to claimants for both estimates of known claims and estimates for incurred but not reported (IBNR) claims. The related asset item, reinsurance balances recoverable on unpaid losses and settlement expense, is the estimate of known claims and estimates of IBNR that we expect to recover from reinsurers. The net of these two items is generally referred to as net unpaid loss and settlement expenses and is commonly used in our disclosures regarding the process of establishing these various estimated amounts.

 

CRITICAL ACCOUNTING POLICIES

 

In preparing the consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the

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consolidated financial statements and the reported amounts of revenues and expenses for the reporting period. Actual results could differ significantly from those estimates.

 

The most critical accounting policies involve significant estimates and include those used in determining the liability for unpaid losses and settlement expenses, investment valuation and other-than-temporary impairment (OTTI), recoverability of reinsurance balances, deferred policy acquisition costs and deferred taxes.

 

LOSSES AND SETTLEMENT EXPENSES

 

Overview

 

Loss and loss adjustment expense (LAE) reserves represent our best estimate of ultimate payments for losses and related settlement expenses from claims that have been reported but not paid and those losses that have occurred but have not yet been reported to the Company. Loss reserves do not represent an exact calculation of liability, but instead represent our estimates, generally utilizing individual claim estimates, actuarial expertise and estimation techniques at a given accounting date. The loss reserve estimates are expectations of what ultimate settlement and administration of claims will cost upon final resolution. These estimates are based on facts and circumstances then known to the Company, review of historical settlement patterns, estimates of trends in claims frequency and severity, projections of loss costs, expected interpretations of legal theories of liability and many other factors. In establishing reserves, we also take into account estimated recoveries from reinsurance, salvage and subrogation. The reserves are reviewed regularly by a team of actuaries we employ.

 

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

 

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

 

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

 

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

 

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

 

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

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Our IBNR reserving process involves three steps: (1) an initial IBNR generation process that is prospective in nature,  (2) a loss and LAE reserve estimation process that occurs retrospectively and (3) a subsequent discussion and reconciliation between our prospective and retrospective IBNR estimates, which includes changes in our provisions for IBNR where deemed appropriate. These three processes are discussed in more detail in the following sections.

 

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

 

Our best estimate of ultimate loss and LAE reserves are proposed by our lead reserving actuary and approved by our Loss Reserve Committee (LRC). The LRC is made up of various members of the management team including the lead reserving actuary, chief executive officer, chief operating officer, chief financial officer, general counsel and other selected executives. We do not use discounting (recognition of the time value of money) in reporting our estimated reserves for losses and settlement expenses. Based on current assumptions used in calculating reserves, we believe that our reserve levels at December 31, 2018, make a reasonable provision to meet our future obligations.

 

Initial IBNR Generation Process

 

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

 

For most property products, we use an alternative method of determining an appropriate provision for initial IBNR. Since this segment is characterized by a shorter period of time between claim occurrence and claim settlement, the IBNR reserves are determined by IBNR percentages applied to premium earned. The percentages are determined based on expected loss ratios and loss development assumptions. The loss development assumptions are typically based on historical reporting patterns but could consider alternative sources of information. The IBNR percentages are reviewed and updated periodically. No deductions for paid or case reserves are made. This alternative method of determining initial IBNR allows incurred losses and ALAE to react more rapidly to the actual emergence and is more appropriate for our property products where final claim resolution occurs over a shorter period of time.

 

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

 

The initial loss and ALAE ratios that are applied to earned premium are reviewed at least semi-annually. Prospective estimates are made based on historical loss experience adjusted for exposure mix, price change and loss cost trends. The initial loss and ALAE ratios also reflect our judgment as to estimation risk. We consider estimation risk by product and coverage within product, if applicable. A product with greater volatility and uncertainty has greater estimation risk. Products or coverages with higher estimation risk include, but are not limited to, the following characteristics:

 

·

Significant changes in underlying policy terms and conditions,

·

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

·

Small volume or lacking internal data requiring significant utilization of external data,

·

Unique reinsurance features including those with aggregate stop-loss, reinstatement clauses, commutation provisions or clash protection,

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·

Longer emergence patterns with exposures to latent unforeseen mass tort,

·

Assumed reinsurance businesses where there is an extended reporting lag and/or a heavier utilization of ceding company data and claims and product expertise,

·

High severity and/or low frequency,

·

Operational processes undergoing significant change and/or

·

High sensitivity to significant swings in loss trends, economic change or judicial change.

 

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

 

Loss and LAE Reserve Estimation Process

 

Estimates of the expected value of the unpaid loss and LAE are derived using standard actuarial methodologies on a quarterly basis. In addition, an emergence analysis is completed quarterly to determine if further adjustments are necessary. These estimates are then compared to the carried loss reserves to determine the appropriateness of the current reserve balance.

 

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

 

In addition to the review of historical claim reporting and payment patterns, we also incorporate estimated losses relative to premium (loss ratios) by year into the analysis. The expected loss ratios are based on a review of historical loss performance, trends in frequency and severity and price level changes. The estimates are subject to judgment including consideration given to available internal and industry data, growth and policy turnover, changes in policy limits, changes in underlying policy provisions, changes in legal and regulatory interpretations of policy provisions and changes in reinsurance structure. For the most current year, these are equivalent with the ratios used in the initial IBNR generation process. Increased recognition is given to actual emergence as the years age.

 

We use historical development patterns, expected loss ratios and standard actuarial methods to derive an estimate of the ultimate level of loss and LAE payments necessary to settle all the claims occurring as of the end of the evaluation period.

 

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

 

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

 

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

 

·

Loss payment patterns,

·

Loss reporting patterns,

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·

Frequency and severity trends,

·

Underlying policy terms and conditions,

·

Business or exposure mix,

·

Operational or internal processes affecting the timing of loss and LAE transactions,

·

Regulatory and legal environment and/or

·

Economic environment.

 

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

 

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

 

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

 

Determination of Our Best Estimate

 

Upon completion of our loss and LAE estimation analysis, the results are discussed with the LRC. As part of this discussion, the analysis supporting the actuarial central estimate of the IBNR reserve by product is reviewed. The actuaries also present explanations supporting any changes to the underlying assumptions used to calculate the indicated central estimate. A review of the resulting variance between the indicated reserves and the carried reserves takes place. Our actuaries make a recommendation to management in regards to booked reserves that reflect their analytical assessment and view of estimation risk. After discussion of these analyses and all relevant risk factors, the LRC determines whether the reserve balances require adjustment. Resulting reserve balances have always fallen within our actuaries’ reasonable range of estimates.

 

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

 

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

 

Actuarial methods attempt to quantify future outcomes. However, insurance companies are subject to unique exposures that are difficult to foresee at the point coverage is initiated and, often, many years subsequent. Judicial and regulatory bodies involved in interpretation of insurance contracts have increasingly found opportunities to expand coverage beyond that which was intended or contemplated at the time the policy was issued. Many of these policies are issued on an “all risk” and occurrence basis. Aggressive plaintiff attorneys have often sought coverage beyond the insurer’s original intent including court interpretations of exclusionary language.

 

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

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

 

Loss reserve estimates are subject to a high degree of variability due to the inherent uncertainty of ultimate settlement values. Periodic adjustments to these estimates will likely occur as the actual loss emergence reveals itself over time. Our loss reserving processes reflect accepted actuarial practices and our methodologies result in a reasonable provision for reserves as of December 31, 2018.

 

INVESTMENT VALUATION AND OTTI

 

Throughout each year, we and our investment managers buy and sell securities to achieve investment objectives in accordance with investment policies established and monitored by our board of directors and executive officers.

 

Equity securities are carried at fair value with unrealized gains and losses recorded within net earnings in 2018. Prior to 2018, unrealized gains and losses on equity securities were recognized through other comprehensive earnings. We classify our investments in fixed income securities into one of three categories: trading, held-to-maturity or available-for-sale. We do not hold any securities classified as trading or held-to-maturity. Available-for-sale securities are carried at fair value with unrealized gains and losses recorded as a component of comprehensive earnings and shareholders’ equity, net of deferred income taxes.

 

Fair value is defined as the price in the principal market that would be received for an asset to facilitate an orderly transaction between market participants on the measurement date.

 

We determined the fair value of certain financial instruments based on their underlying characteristics and relevant transactions in the marketplace. We maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

We regularly evaluate our fixed income securities using both quantitative and qualitative criteria to determine impairment losses for other-than-temporary declines in the fair value of the investments. The following are some of the key factors we consider for determining if a security is other-than-temporarily impaired:

 

·

The length of time and the extent to which the fair value has been less than amortized cost,

·

The probability of significant adverse changes to the cash flows,

·

The occurrence of a discrete credit event resulting in the issuer defaulting on a material obligation, the issuer seeking protection from creditors under the bankruptcy laws, or the issuer proposing a voluntary reorganization under which creditors are asked to exchange their claims for cash or securities having a fair value substantially lower than par value of their claims or

·

The probability that we will recover the entire amortized cost basis of our fixed income securities prior to maturity.

 

Quantitative criteria considered during this process include, but are not limited to: the degree and duration of current fair value as compared to the amortized cost of the security, degree and duration of the security’s fair value being below cost and whether the issuer is in compliance with the terms and covenants of the security. Qualitative criteria include the credit quality, current economic conditions, the anticipated speed of cost recovery, the financial health of and specific prospects for the issuer, as well as the absence of intent to sell or requirement to sell securities prior to recovery. In addition, we consider price declines in our OTTI analysis when they provide evidence of declining credit quality, and we distinguish between price changes caused by credit deterioration as opposed to rising interest rates.

 

Key factors that we consider in the evaluation of credit quality include:

 

·

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

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·

The discontinuance of a segment of business that may affect future earnings potential,

·

Reduction or elimination of dividends,

·

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

·

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

·

A downgrade in credit quality by a major rating agency.

 

For mortgage-backed securities and asset-backed securities that have significant unrealized loss positions and major rating agency downgrades, credit impairment is assessed using a cash flow model that estimates likely payments using security-specific collateral and transaction structure. All of our mortgage-backed and asset-backed securities remain AAA-rated by one of the major rating agencies and the fair value is not significantly less than amortized cost.

 

Under current accounting standards, an OTTI write-down of debt securities, where fair value is below amortized cost, is triggered by circumstances where (1) an entity has the intent to sell a security, (2) it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis or (3) the entity does not expect to recover the entire amortized cost basis of the security. If an entity intends to sell a security or if it is more likely than not the entity will be required to sell the security before recovery, an OTTI write-down is recognized in earnings equal to the difference between the security’s amortized cost and its fair value. If an entity does not intend to sell the security or it is not more likely than not that it will be required to sell the security before recovery, the OTTI write-down is separated into an amount representing the credit loss, which is recognized in earnings, and the amount related to all other factors, which is recognized in other comprehensive income.

 

Part of our evaluation of whether particular securities are other-than-temporarily impaired involves assessing whether we have both the intent and ability to continue to hold equity securities in an unrealized loss position. For fixed income securities, we consider our intent to sell a security (which is determined on a security-by-security basis) and whether it is more likely than not we will be required to sell the security before the recovery of our amortized cost basis. Significant changes in these factor