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Rli Corp – ‘10-K’ for 12/31/97

As of:  Thursday, 3/26/98   ·   For:  12/31/97   ·   Accession #:  1047469-98-11755   ·   File #:  1-09463

Previous ‘10-K’:  ‘10-K’ on 3/25/97 for 12/31/96   ·   Next:  ‘10-K’ on 3/26/99 for 12/31/98   ·   Latest:  ‘10-K’ on 2/22/19 for 12/31/18

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

 3/26/98  Rli Corp                          10-K       12/31/97    9:253K                                   Merrill Corp/New/FA

Annual Report   —   Form 10-K
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K        Annual Report                                         34    174K 
 2: EX-13       Annual or Quarterly Report to Security Holders        56±   255K 
 3: EX-21.1     Subsidiaries of the Registrant                         1      6K 
 4: EX-23.1     Consent of Experts or Counsel                          1      7K 
 5: EX-27.1     Financial Data Schedule (Pre-XBRL)                     2     11K 
 6: EX-27.2     Financial Data Schedule (Pre-XBRL)                     2     11K 
 7: EX-27.3     Financial Data Schedule (Pre-XBRL)                     2     11K 
 8: EX-27.4     Financial Data Schedule (Pre-XBRL)                     2     11K 
 9: EX-28.1     Information from a Report Furnished to State           1      7K 
                          Insurance Regulatory Authorities                       

10-K   —   Annual Report
Document Table of Contents

Page (sequential) | (alphabetic) Top
11st Page   -   Filing Submission
2Item 1. Business
19Item 2. Properties
"Item 3. Legal Proceedings
"Item 4. Submission of Matters to A Vote of Security Holders
"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
"Item 6. Selected Financial Data
"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
"Item 8. Financial Statements and Supplementary Data
20Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 -------------------------------------------------- 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 0-6612 ---------------------------------------------------------- RLI CORP. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Illinois 37-0889946 ---------------------------------------- -------------------------------------- (State or other jurisdiction of (I.R.S. Employers Identification No.) incorporation or organization) 9025 North Lindbergh Drive, Peoria, Illinois 61615 --------------------------------------------- -------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (309) 692-1000 ----------------------------- Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered ------------------- ----------------------------------------- Common Stock $1.00 par value New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: NONE Indicate by check mark 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. X Yes No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the Registrant, based upon the closing sale price of the Common Stock on February 27, 1998 as reported on the New York Stock Exchange, was $354,629,102. Shares of Common Stock held directly or indirectly by each officer and director along with shares held by the Company ESOP have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of shares outstanding of the Registrant's Common Stock, $1 par value, on February 27, 1998 was 8,546,958. DOCUMENTS INCORPORATED BY REFERENCES. Portions of the Annual Report to Shareholders for the past year ended December 31, 1997, are incorporated by reference into Parts I and II of this document. Portions of the Registrant's definitive Proxy Statement for the 1998 annual meeting of security holders to be held May 7, 1998, are incorporated herein by reference into Part III of this document. Exhibit index is located on pages 33-34 of this document.
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PART I Item 1. BUSINESS (a) General Development of Business As used in this Form 10-K, the term "Company" refers to RLI Corp. and its subsidiaries and affiliates, unless the context otherwise indicates. RLI Corp., which was incorporated in Illinois in 1965, merged into and became a Delaware corporation in 1984. In May of 1993, RLI Corp. changed its state of incorporation back to Illinois through a merger. RLI Corp. is a holding company, which, through its subsidiaries, underwrites selected property and casualty insurance. (b) Financial Information about Industry Segments Selected information about industry segments is included herein as Item 8. (c) Narrative Description of Business RLI INSURANCE GROUP RLI Insurance Group is composed primarily of two main insurance companies. RLI Insurance Company, the principal subsidiary, writes multiple lines of insurance on an admitted basis in all 50 states, the District of Columbia and Puerto Rico. Mt. Hawley Insurance Company, a subsidiary of RLI Insurance Company, writes multiple lines of insurance on an admitted basis in Kansas and surplus lines insurance in the remaining 49 states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam. Other companies in the RLI Insurance Group include: Replacement Lens Inc., RLI Aviation, Inc., RLI Insurance Agency, Ltd., and RLI Insurance Ltd. Since 1977, when the Company first began underwriting specialty property and casualty coverages for commercial risks, highly cyclical market conditions and a number of other factors have influenced the Company's growth and underwriting profits. The Company, as a "niche" company rather than an "all lines" company, seeks to develop expertise and large homogeneous books of business in areas generally overlooked by traditional markets. In response to the soft market conditions of the early 1980's, which were characterized by severe rate competition and excess underwriting capacity, the Company limited its writings in specialty property and casualty lines and terminated certain lines and sources of production. Significant rate increases resulted when the insurance market hardened in late 1984. The Company responded by expanding its premium volume in targeted lines. Since 1987, the industry has experienced generally soft market conditions featuring intensified competition for admitted and surplus lines insurers, resulting in rate decreases. The Company has continually monitored its rates and controlled its costs in an effort to maximize profits during this entrenched soft market condition. As a result of Hurricane Andrew and other catastrophic losses, especially the Northridge Earthquake of January 17, 1994, property rates hardened in California, Florida and the wind belt, but remain soft in other areas of the country. During 1994, the Company secured rate increases of over 30% on the commercial property book of business, while the casualty book of business incurred flat to moderate decreases. During 1995, rates for catastrophic driven property business, especially in California, continued to remain hard. Since 1996, as expected, competition has reappeared for this type of business and the Company has reduced rates somewhat. The Company's casualty book has continued to incur flat to moderate rate decreases. 2
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The Company initially began to write specialty property and casualty insurance primarily through independent underwriting agents. However, with the opening of its first branch office in 1984, the Company began to shift its marketing efforts from independent underwriting agents to wholly-owned branch offices which market to wholesale producers. The Company also markets certain products to retail producers from its Specialty Marketing Division located at the home office. The Company produced business under agreements with four underwriting general agents in 1997. The majority of its specialty property and casualty business is marketed through its Specialty Markets and Surety divisions and eleven branch offices located in Los Angeles, California; San Diego, California; San Francisco, California; St. Paul, Minnesota; Overland Park, Kansas; Glastonbury, Connecticut; Atlanta, Georgia; Alpharetta, Georgia; Chicago, Illinois; Dallas, Texas; and Honolulu, Hawaii. The following table provides for the year ended December 31, 1997 the geographic distribution of the Company's risks insured as represented by direct premiums earned for all product lines. For the year ended December 31, 1997, no other state accounted for more than 2% of total direct premiums earned for all product lines. [Download Table] Direct Premiums State Earned Percent of Total ----- --------------- ---------------- California $105,546,214 39.3% Texas 31,148,921 11.6 Florida 21,068,919 7.8 New York 18,735,576 7.0 Ohio 6,746,665 2.5 Pennsylvania 6,058,952 2.3 New Jersey 5,965,523 2.2 Illinois 5,859,848 2.2 Michigan 5,858,720 2.2 All other 61,579,933 22.9 ----------- ------ Total direct premiums $268,569,271 100.00% ------------ ------- ------------ ------- The Company presently underwrites selected property and casualty insurance primarily in the following lines: COMMERCIAL PROPERTY. The Company's commercial property coverage consists primarily of excess and surplus lines and specialty insurance such as fire and difference in conditions which includes earthquake, flood and collapse coverages. The Company writes coverage for a wide range of commercial and industrial classes such as office buildings, apartments, condominiums, certain industrial and mercantile structures, and buildings under construction. The St. Paul, Los Angeles, Glastonbury, Overland Park, San Francisco, Chicago, Columbus and Alpharetta branch offices are responsible for underwriting this coverage. In 1997, 1996, and 1995, net earned premiums totaled $48,799,000, $47,822,000, and $49,430,000 or 29%, 31%, and 32% respectively, of the Company's consolidated revenues. GENERAL LIABILITY. The Company writes general liability coverages through its St. Paul, Glastonbury, Chicago, Alpharetta and Dallas branch offices. The Company's general liability business consists primarily of coverage for third party liability of commercial insureds including manufacturers, contractors, apartments and mercantile. Net earned premiums totaled $26,332,000, $34,834,000, and $36,499,000, or 16%, 22%, and 23% of the Company's consolidated revenues for the years 1997, 1996, and 1995, respectively. 3
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COMMERCIAL AND PERSONAL UMBRELLA LIABILITY. The Company's commercial umbrella coverage is produced through its Overland Park, St. Paul, Alpharetta, Glastonbury, and Dallas branch offices, and through an underwriting general agency in San Francisco. The coverage is principally written in excess of primary liability insurance provided by other carriers and, to a small degree, in excess of primary liability written by the Company. The personal umbrella coverage, which is produced through the Specialty Markets Division, is written in excess of the homeowners and automobile liability coverage provided by other carriers. Net earned premiums totaled $22,566,000, $21,282,000, and $18,092,000 or 12%, 14%, and 12% of the Company's consolidated revenues for the years 1997, 1996, and 1995, respectively. DIRECTORS' AND OFFICERS' LIABILITY/MISCELLANEOUS PROFESSIONAL LIABILITY. The Company produces Directors' and Officers' Liability through its underwriting facility in San Diego, California. In 1996, the facility expanded to offer Miscellaneous Professional Liability for a variety of low to moderate classes of risks. Net earned premiums totaled $4,430,000, $5,000,000, and $6,025,000, or 3%, 3%, and 4% of the Company's consolidated revenues for the years 1997, 1996, and 1995, respectively. EMPLOYER'S EXCESS INDEMNITY. Since 1993, the Company has written Employer's Excess Indemnity coverage for businesses which have opted out of the Workers' Compensation plan in the state of Texas. The coverage is similar to accident and health, in that it indemnifies the employer for expenses resulting from a work related injury or disease, excess of a self-insured retention (SIR). The SIR can range from $50,000 to $500,000. The product is underwritten out of the Overland Park branch office. A return to excessive competition for Texas workers' compensation business has reduced the market for this product since 1996. Net earned premiums totaled $5,130,000, $6,566,000, and $8,257,000, or 3%, 4%, and 5% of the Company's consolidated revenues for 1997, 1996, and 1995, respectively. SURETY. In 1993, the Company began writing surety business. This product line is underwritten from the Home Office in Peoria and through the Dallas, Texas branch office. The initial target market of the Surety Division was a wide range of commercial surety bonds written primarily through the independent agency system. In 1996, the Company expanded their product offering to include contract bonds for small size contractors. Net earned premiums totaled $$11,491,000, $4,407,000, and $2,956,000, or 8%, 3%, and 2% of the Company's consolidated revenues for 1997, 1996, and 1995, respectively. HOMEOWNERS/RESIDENTIAL PROPERTY. In 1997, the Company assumed a highly profitable book of homeowners and dwelling fire business for Hawaii homeowners from the Hawaii Property Insurance Association. In the aftermath of Hurricane Iniki in 1992, this business was available at reasonable rates and terms. Net earned premiums totalled $13,229,000 or 8% of the Company's consolidated revenues for the 1997 year. TRANSPORTATION. In 1997, the Company opened a transportation insurance facility in Atlanta to offer automobile liability and physical damage insurance to local, intermediate and long haul truckers, public transportation risks and equipment dealers. Incidental, related insurance coverages are also offered, including general liability, commercial umbrella and excess liability, and motor truck cargo. The facility is staffed by highly experienced transportation underwriters who will produce business through independent agents and brokers nationwide. The facility will begin generating premium income in 1998. OTHER. Smaller programs offered by the Company include: primary employer's indemnity, excess medical, commercial multi-peril, in-home business, and accident and health insurance. Net earned premiums from these lines totaled $9,907,000, $10,744,000, and $12,209,000 or 5%, 7%, and 8% of the Company's consolidated revenues for the years, 1997, 1996, and 1995, respectively. In June of 1995, a new facility was opened in Columbus, Ohio specializing in writing single interest inland marine property insurance for major lending institutions. This insurance covers the institution's interest in property used as collateral for loans, in the event of the borrower's default. This facility was closed October, 1997, and the coverage is currently underwritten with the Atlanta branch office. 4
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COMPETITION The Company's specialty property and casualty insurance subsidiaries are part of an extremely competitive industry which is cyclical and 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 3,500 companies, both stock and mutual, actively market property and casualty products. The combination of products, service, pricing and other methods of competition vary from line to line. The Company's principal methods of meeting this competition are innovative products, marketing structure and quality service to the agents and policyholders at a fair price. The Company competes favorably in part because of its sound financial base and reputation, as well as its broad geographic penetration into all 50 states, the District of Columbia and Puerto Rico. In the property and casualty area, the Company has acquired experienced underwriting specialists in its branch and home offices. In 1987, the insurance industry, in general, entered into a "soft" or highly competitive period during which insurance rates generally decreased. The specialty property and casualty market continues to be soft with some rate increases experienced in the property lines in California, Florida and the wind belt from 1993 through 1995. In 1996, and continuing through 1997, some rate softening occurred in these property lines as competition reappeared. As a result, the Company reduced rates somewhat. The Company has, however, continued to maintain its underwriting and marketing standards by not seeking market share at the expense of earnings. New products and new programs are offered where the opportunity exists to provide needed insurance coverage with exceptional service on a profitable basis. RATINGS During 1992, the A.M. Best rating for RLI Insurance Company, the principal subsidiary of the Company, was upgraded to "A" (Excellent). During 1993, Mt. Hawley Insurance Company's (an indirect subsidiary of the Company) A.M. Best rating was upgraded from "A-" (Excellent) to "A" (Excellent). During 1997, A.M. Best reaffirmed "A" (Excellent) ratings for both RLI Insurance Company and Mt. Hawley Insurance Company. Ratings for the industry range from "A++" (Superior) to "F" (In Liquidation) with some companies not being rated. Publications of A.M. Best indicate that the "A" and "A-" (Excellent) ratings are assigned to those companies that in A.M. Best's opinion have achieved excellent overall performance when compared to the standards established by A.M. Best 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, A.M. Best reviews the company's profitability leverage and liquidity as well as the company's spread of risk, the quality and appropriateness of its reinsurance, the quality and diversification of its assets, the adequacy of its policy or loss reserves, the adequacy of its surplus, its capital structure and the experience and objectives of its management. A.M. Best's ratings are based on factors relevant to policyholders, agents, insurance brokers and intermediaries and are not directed to the protection of investors. In conjunction with RLI Corp.'s July, 1993 issuance of $46 million of 6.00% Convertible Debentures due 2003, the Company applied for and received a debt rating from two major debt rating agencies. Both Standard & Poor's Ratings Group and Moody's Investor Service assigned investment grade ratings to the issue. In July, 1997, the Company called for redemption the entire $46 million issue. As of December 31, 1997, the Company had no public debt outstanding. REINSURANCE The Company reinsures a significant portion of its property and casualty insurance exposure, paying to the reinsurer a portion of the premiums received on such policies. Earned premiums ceded to non-affiliated reinsurers totaled $138,298,000, $140,928,000, and $131,772,000 in 1997, 1996, and 1995, respectively. Insurance is ceded principally to reduce net liability on individual risks and to protect against catastrophic losses. 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. 5
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During the period 1995 through 1997, certain of the Company's reinsurers were unable to meet their obligations to the Company under reinsurance treaties. As reserves were previously established for the uncollectible amounts, the effects of the insolvent reinsurers on net earnings for 1995 through 1997 were immaterial. The Company continually monitors the financial stability of its reinsurers and establishes reserves for uncollectible reinsurance balances on a regular basis. As a result of these reviews, the Company reevaluates its position with respect to its reinsurance. During 1995 and 1996, the Company provided $613,296 and $1,006,140 for uncollectible reinsurance balances. During 1997, no additional provision was made. The Company believes that current reserve levels for uncollectible reinsurance are sufficient to cover the related exposure. The Company attempts to purchase reinsurance from a limited number of financially strong reinsurers. Retention levels are adjusted each year to maintain a balance between the growth in surplus and the cost of reinsurance. At December 31, 1997, the Company had prepaid reinsurance premiums and reinsurance recoverables on paid and unpaid losses and settlement expenses with American Re-Insurance Company (rated A+ "superior" by A.M. Best Company) that amounted to $67,733,602. All other reinsurance balances recoverable, when considered by individual reinsurer, are less than 10% of shareholders' equity. The following table sets forth the largest reinsurers in terms of amounts recoverable, the total amounts recoverable net of reinsurance payables from such reinsurers as of December 31, 1997 and the amounts of written premium ceded by the Company to such reinsurers during 1997. [Download Table] Gross Reinsurer Ceded --------------- ----- Exposure as of Percent Premiums Percent -------------- ------- -------- ------- December 31, 1997 of Total Written of Total ----------------- -------- ------- -------- American Re-Insurance Co. $ 67,733,602 29.92% $ 21,862,933 16.30% General Reins Corp. 16,717,318 7.39 8,055,842 6.00 Transatlantic Reinsurance 12,610,119 5.57 11,973,090 8.92 Employer's Re 8,039,583 3.55 7,330,366 5.46 NAC Reinsurance Corporation 5,825,704 2.57 4,853,765 3.62 Lloyd's of London 5,737,797 2.53 14,257,401 10.63 Everest Re 5,648,534 2.50 4,603,867 3.43 Old Lyme Ins. Co. of RI 5,546,935 2.45 5,457,835 4.07 TIG Insurance Co. 4,989,331 2.20 834,632 0.62 Universal Bonding Ins. 4,830,367 2.13 8,160,494 6.08 All other reinsurers 88,667,959 39.19 46,779,323 34.87 ---------- ----- ---------- ----- Total ceded exposure $226,347,249 100.00% $134,169,548 100.00% ------------ ------- ------------ ------- ------------ ------- ------------ ------- As of December 31, 1997, the Company held $11,626,930 in irrevocable letters of credit, $7,282,657 under trust agreements and $1,412,968 in cash to collateralize a portion of the total amount recoverable. Since 1992, the Company has purchased non-proportional contracts. This allows the Company to retain a larger percentage of the premium and a larger portion of the initial loss risk. Under non-proportional reinsurance, the ceding company retains losses on a risk up to a specified amount and the reinsurers assume any losses above that amount. Since 1989, through its various reinsurance programs, the Company has generally limited its maximum retained exposure on any one risk to $1,000,000. The Company seeks to limit its net aggregate exposure to a single catastrophic event to less than 10% of shareholders' equity by purchasing various types of reinsurance. 6
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In 1997, the Company's underwriting was supported by up to $200,000,000 in traditional reinsurance protection. In 1998, the Company has enhanced this protection by adding an additional $20,000,000 in catastrophe reinsurance protection at improved terms and conditions. Using computer-assisted techniques, the Company quantifies and monitors its exposure to earthquake risk, the most significant catastrophe exposure to the Company. Detail is captured for each location covered for earthquake risk and the Probable Maximum Loss (PML) for each risk is determined. The PML calculation for each risk includes all faults to which the risk is exposed. Richter scale magnitudes used in the PML calculations are determined and applied separately for each fault. The Company uses the greater of the magnitude of an earthquake which only occurs every 100 years or 6.5 on the Richter scale in its PML calculations. Several widely accepted methods are used to estimate the magnitude of the 100 year event for each fault. Underwriting decisions are based on the PML as determined by the system, which calculates PML's on over 200 faults. Portfolio runs are made regularly to determine the Company's overall exposure on each fault from all risks covered. Total exposure after facultative reinsurance is managed by the Company to fall within the limits covered by the Company's chosen net retention, working layer treaty reinsurance and catastrophe reinsurance. In 1997, the Company continued its innovative catastrophe reinsurance and loss financing program with Centre Reinsurance (Centre Re). The program, called Catastrophe Equity Puts (CatEPuts)-SM-, augments the Company's traditional reinsurance by integrating its loss financing needs with a pre-negotiated sale of securities linked to exchange-traded shares. CatEPuts allows the Company to put up to $50.0 million of its convertible preferred shares to Centre Re at a pre-negotiated rate in the event of a catastrophic loss provided the loss does not reduce GAAP equity to less than $55.0 million. CatEPuts is intended to be a three-year program and is designed to enable the Company to continue operating after a loss of such magnitude that its reinsurance capacity is exhausted. If the Company exercises its option to put preferred shares to Centre Re, then Centre Re, in turn, has the option to reinsure certain business written by the Company on a prospective basis. FACTORS AFFECTING SPECIALTY PROPERTY AND CASUALTY PROFITABILITY The profitability of the specialty property and casualty insurance business is generally subject to many factors, including rate competition, the severity and frequency of claims, natural disasters, state regulation of premium rates, default of reinsurers, interest rates, general business conditions, regulatory measures and court decisions that define and expand the extent of coverage and the amount of compensation due for injuries or losses. One of the distinguishing features of the property and casualty insurance business is that its product must be priced before the ultimate claims costs can be known. In addition, underwriting profitability has tended to fluctuate over cycles of several years' duration. Insurers generally had profitable underwriting results in the late 1970's, substantial underwriting losses in the early 1980's and somewhat smaller underwriting losses in 1986 and 1987. During the years 1988 through 1992, underwriting losses increased due to increased rate competition and the frequency and severity of catastrophic losses, although pre-tax operating income remained profitable due to investment income gains. During 1993 through 1996, the industry experienced improvement in underwriting losses. The trends experienced during the late 1980s, however, have continued, and companies continue to post underwriting losses but remain profitable through investment income gains. As well, ongoing rate cuts are of concern to financial analysts. For 1997, the industry's statutory combined ratio is estimated to be 102.0. The Company believes that certain other factors affect its ability to underwrite specialty lines successfully, including: SPECIALIZED UNDERWRITING EXPERTISE. The Company employs experienced professionals in its branch offices. Each office restricts its production and underwriting of business to certain classes of insurance reflecting the particular areas of expertise of its key underwriters. In accepting risks, all independent and affiliated underwriters are required to comply with risk parameters, retention limits and rates prescribed by the Company's home office underwriting group, which reviews submissions and periodically audits and monitors underwriting files and reports on losses over $100,000. Compensation of senior underwriters is substantially dependent on the profitability of the business for which they are responsible. The loss of any of these professionals could have an adverse effect on the Company's underwriting abilities and earnings in these lines. The Company's Underwriting Policy limits extension of binding authority to independent agents. The Company's product distribution falls into distinct categories, with binding authority following the categorization. 7
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BROKER BUSINESS. The largest volume of broker generated premium is Commercial Property, General Liability, Commercial Umbrella and Employer's Excess Indemnity. This business is produced through wholesale brokers who are not affiliated with the Company. Only a Company underwriter has the authority to bind the Company on such risks. INDEPENDENT AGENT BUSINESS. The Surety Division offers its business through a variety of independent agents. Additionally, the Specialty Markets Division writes program business, such as Personal Umbrella and the In-Home Business Policy, through independent agents. Each of these programs involves detailed eligibility criteria which are incorporated into strict underwriting guidelines. The programs involve prequalification of each risk using the "smart" system accessible by the independent agent. The independent agent cannot bind the risk unless they receive approval through the Company's "smart" system. UNDERWRITING AGENTS. The Surety Division has authorized two underwriting general agencies to underwrite and bind contract surety business on behalf of RLI, primarily in the East and Southeast. One underwriting general agency in San Francisco has been authorized to underwrite commercial umbrella business in select Western states. Another underwriting agent in New York has been authorized to underwrite and handle claims for low limit deductible buy-backs on program business, primarily in the East. These underwriting general agencies receive some compensation through contingent profit commission. Otherwise, producers of business who are not Company employees are generally compensated on the basis of direct commissions with no provision for any contingent profit commission. There are a few volume incentives for producers handling association business, with the increased commission involved being tied to the program's underwriting profit. This represents less than 5% of the business. RETENTION LIMITS. The Company limits its net retention of single and aggregate risks through the purchase of reinsurance. See "Business -- Specialty Property and Casualty Insurance Segment -- Reinsurance." The amount of reinsurance available fluctuates according to market conditions. Reinsurance arrangements are subject to annual renewal. Any significant reduction in the availability of reinsurance or increase in the cost of reinsurance could adversely affect the Company's ability to insure specialty property and casualty risks at current levels or to add to the amount thereof. CLAIMS ADJUSTMENT ABILITY. The Company has a professional claims management team with proven experience in all areas of multi-line claims work. This team supervises and administers all claims and directs all outside legal and adjustment specialists. Whether a claim is being handled by the Company's claim specialist or has been assigned to a local attorney or adjuster, detailed attention is given to each claim to minimize loss expenses while providing for loss payments in a fair and equitable manner. EXPENSE CONTROL. Management continues to review all areas of the Company's operations to streamline the organization, emphasizing quality and customer service, while minimizing expenses. These strategies will help to contain the growth of future costs. Maintaining and improving underwriting and other key organizational systems continues to be paramount as a means of supporting the Company's orderly growth in anticipation of a market rebound, as it is the Company's philosophy to retain its talented insurance professionals and to build infrastructure in spite of the soft market. Other insurance operating expenses as a percent of gross written premiums for the years 1997, 1996, and 1995 were 7%, 6%, and 5%, respectively. ENVIRONMENTAL EXPOSURES. The Company is subject to environmental claims and exposures through its commercial umbrella, general liability, and discontinued assumed reinsurance lines of business. Within these lines, the Company's environmental exposures include environmental site cleanup, asbestos removal, and mass tort liability. The majority of the exposure is in the excess layers of the Company's commercial umbrella and assumed reinsurance books of business. 8
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The following table represents inception-to-date paid and unpaid environmental exposure data (including incurred but not reported losses) for the periods ended 1997, 1996, and 1995: [Download Table] -------------------------------------------------------------------------------- Inception-to-date December 31 (in thousands) 1997 1996 1995 -------------------------------------------------------------------------------- Loss and Loss Adjustment Expense (LAE) payments Gross $ 11,570 $ 8,267 $ 5,117 Ceded (7,646) (5,761) ($ 3,842) --------------------------------------------------------------------------------- Net $ 3,924 $ 2,506 $ 1,275 --------------------------------------------------------------------------------- --------------------------------------------------------------------------------- Unpaid losses and LAE at end of year Gross $ 14,880 $17,596 $20,154 Ceded (8,842) (11,150) ($13,398) --------------------------------------------------------------------------------- Net $ 6,038 $ 6,446 $ 6,756 --------------------------------------------------------------------------------- --------------------------------------------------------------------------------- Although the Company's environmental exposure is limited as a result of entering the liability lines after the industry had already recognized it as a problem, Management cannot determine the Company's ultimate liability within any reasonable degree of certainty. This ultimate liability is difficult to assess due to evolving legislation on such issues as joint and several liability, retroactive liability, and standards of cleanup. Additionally, the Company participates primarily in the excess layers, making it even more difficult to assess the ultimate impact. LOSSES AND SETTLEMENT EXPENSES Many years may elapse between the occurrence of an insured loss, the reporting of the loss to the insurer and the insurer's payment of that loss. To recognize liabilities for unpaid losses, insurers establish reserves, which are balance sheet liabilities. The reserves represent estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred. When a claim is reported, the claims department establishes a "case reserve" for the estimated amount of the ultimate payment. The estimate reflects the informed judgment of professional claims personnel, based on the Company's reserving practices and the experience and knowledge of such personnel regarding the nature and value of the specific type of claim. Estimates for losses incurred but not yet reported are determined on the basis of statistical information, including the Company's past experience. The Company does not use discounting (recognition of the time value of money) in reporting its estimated reserves for losses and settlement expenses. The reserves are closely monitored and reviewed by management, with changes reflected as a component of earnings in the current accounting period. For lines of business without sufficiently large numbers of policies or that have not accumulated sufficient development statistics, industry average development patterns are used. To the extent that the industry average development experience improves or deteriorates, the Company adjusts prior accident years' reserves for the change in development patterns. Additionally, there may be future adjustments to reserves should the Company's actual experience prove to be better or worse than industry averages. 9
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As part of the reserving process, historical data is reviewed and consideration is given to the anticipated impact of various factors such as legal developments and economic conditions, including the effects of inflation. The reserving process provides implicit recognition of the impact of inflation and other factors affecting claims payments by taking into account changes in historic payment patterns and perceived probable trends. Changes in reserves from the prior years' estimates are calculated based on experience as of the end of each succeeding year (loss and settlement expense development). The estimate is increased or decreased as more information becomes known about the frequency and severity of losses for individual years. A redundancy means the original estimate was higher than the current estimate; a deficiency means that the current estimate is higher than the original estimate. Due to the inherent uncertainty in estimating reserves for losses and loss adjustment expenses, there can be no assurance that the ultimate liability will not exceed amounts reserved, with a resulting adverse effect on the Company. Based on the current assumptions used in calculating reserves, Management believes the Company's overall reserve levels at December 31, 1997 are adequate to meet its future obligations. The table which follows is a reconciliation of the Company's unpaid losses and settlement expenses for the years 1997, 1996, and 1995. [Download Table] Year Ended December 31, ------------------------------- (Dollars in thousands) 1997 1996 1995 ---- ---- ---- Unpaid losses and settlement expenses at beginning of year: Gross $405,801 $418,986 $394,966 Ceded (165,017) (197,338) (199,737) ------- ------- ------- Net 240,784 221,648 195,229 ------- ------- ------- Increase (decrease) in incurred losses and settlement expenses: Current accident year 61,771 69,724 62,619 Prior accident years (520) (1,463) 23,271 ------- ------- ------- Total incurred 61,251 68,261 85,890 ------- ------- ------- ------- ------- ------- Loss and settlement expense payments for claims incurred: Current accident year (11,284) (11,026) (10,586) Prior accident years (47,999) (37,505) (48,023) ------- ------- ------- Total paid (59,283) (48,531) (58,609) ------- ------- ------- ------- ------- ------- Insolvent reinsurer charged off (recovered) (627) 607 514 Loss reserves commuted 429 (1,201) (1,376) ------- ------- ------- Unpaid losses and settlement expenses at end of year $242,554 $240,784 $221,648 ------- ------- ------- ------- ------- ------- Unpaid losses and settlement expenses at end of year: Gross 404,264 $405,801 $418,986 Ceded (161,710) (165,017) (197,338) ------- ------- ------- Net $242,554 $240,784 $221,648 ------- ------- ------- ------- ------- ------- 10
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Explanation of significant components of reserve development by calendar year are as follows: [Download Table] 1995 During 1995, the Company experienced approximately $23,300,000 of adverse development on loss reserves. This development resulted from approximately $27,300,000 of adverse development in the property line due to the 1994 Northridge earthquake. Excluding the earthquake development, the Company experienced approximately $4,000,000 of favorable development. Approximately $1,000,000 of this favorable development occurred in the property line excluding the earthquake, with the remaining $3,000,000 occurring in the other liability and products liability lines. The liability development was the result of IBNR reserve decreases made possible by lower than expected tail development on two liability programs. 1996 During 1996, the Company experienced approximately $1,463,000 of favorable development on loss reserves. This development resulted from approximately $1,519,000 of favorable development in the property lines of business. Various property claims closed during the year were settled below recorded reserves. The remaining $56,000 of adverse development relates to the net effect of changes made to casualty loss reserves. This development is a result of reserve strengthening of $3,557,000 made in the General Liability and Miscellaneous Professional business on accident years 1987 through 1995. This increase was offset by favorable development and reserve decreases of $3,501,000 in the Umbrella and Excess Employer's Indemnity programs on accident years 1986 and 1993 through 1995. 1997 During 1997, the Company experienced approximately $520,000 of favorable development on loss reserves. The development results from loss reserve adjustments in various lines of business. Reserve strengthening was necessary on the Property line of business due to development on the Lender's Single Interest program. As a result, an increase of $1,465,000 was made to IBNR reserves. This increase, however, was offset by $1,985,000 of favorable development on the Company's other casualty, in-home business, and surety bonding programs. The table on the following page presents the development under generally accepted accounting principles of the Company's balance sheet reserves for 1988 through 1997. The top line of the table shows the reserves at the balance sheet date for each of the indicated periods. This represents the estimated amount of losses and settlement expenses arising in all prior years that are unpaid at the balance sheet date, including losses that had been incurred but not yet reported to the Company. The lower portion of the table shows the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual periods. 11
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[Enlarge/Download Table] Year Ended December 31, ------------------------------------------------------------------------------------------------ (Dollars in thousands) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 ------- ------- -------- -------- -------- -------- -------- -------- -------- -------- Net Liability for unpaid losses and settlement expenses at end of year $89,197 $95,953 $103,302 $110,844 $130,452 $165,559 $195,229 $221,648 $240,784 $242,554 Paid (cumulative) as of: One year later 17,312 14,302 19,297 23,561 24,725 36,026 48,023 37,505 47,999 Two years later 26,093 26,685 35,963 37,763 46,342 63,675 73,972 75,485 Three years later 37,137 40,341 44,088 49,462 64,364 84,614 100,936 Four years later 47,617 44,714 52,322 57,085 78,994 96,741 Five years later 48,937 51,153 56,413 65,318 85,746 Six years later 53,670 54,546 62,989 70,270 Seven years later 56,254 59,444 66,254 Eight years later 60,499 62,266 Nine years later 62,689 Liability re-estimated as of: One year later 86,230 91,646 101,251 108,249 128,600 166,666 218,499 220,185 240,264 Two years later 85,120 89,112 98,505 105,747 132,850 164,218 214,352 218,142 Three years later 84,426 87,981 95,690 107,777 132,377 157,286 211,451 Four years later 84,931 87,403 97,041 106,326 127,426 152,460 Five years later 84,217 90,030 96,490 100,968 122,789 Six years later 87,585 88,982 93,159 97,101 Seven years later 86,593 85,381 89,692 Eight years later 83,306 83,344 Nine years later 81,964 Net cumulative redundancy (deficiency) $7,233 $12,609 $13,610 $13,743 $7,663 $13,099 $(16,222) $3,506 $520 Gross liability $268,043 $310,767 $394,966 $418,986 $405,801 $404,264 Reinsurance recoverable (137,591) (145,208) (199,737) (197,338) (165,017) (161,710) -------- -------- -------- -------- -------- -------- Net liability $130,452 $165,559 $195,229 $221,648 $240,784 $242,554 Gross re-estimated liability $249,557 $284,294 $414,669 $403,825 $409,839 Re-estimated recoverable (126,768) (131,834) (203,218) (185,683) (169,575) -------- -------- -------- -------- -------- Net re-estimated liability $122,789 $152,460 $211,451 $218,142 $240,264 Gross cumulative redundancy (deficiency) $ 18,486 $ 26,473 $(19,703) $15,161 $(4,038) 12
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OPERATING RATIO PREMIUMS TO SURPLUS RATIO The following table shows, for the periods indicated, the Company's insurance subsidiaries' statutory ratios of net premiums written to policyholders' surplus. While there is no statutory requirement applicable to the Company which establishes a permissible net premiums written to surplus ratio, guidelines established by the National Association of Insurance Commissioners provide that this ratio should generally be no greater than 3 to 1. [Enlarge/Download Table] Year Ended December 31, ----------------------------------------------------- (Dollars in thousands) 1997 1996 1995 1994 1993 --------- --------- --------- -------- --------- Statutory net premiums written $144,674 $130,908 $130,453 $131,164 $136,728 Policyholders' surplus $265,526 $207,787 $172,313 $136,125 $152,262 Ratio .5 to 1 .6 to 1 .8 to 1 1.0 to 1 .9 to 1 GAAP AND STATUTORY COMBINED RATIOS The underwriting experience of the Company is best indicated by its 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). [Download Table] Year Ended December 31, ------------------------------------------ GAAP 1997 1996 1995 1994 1993 ---- ----- ---- ---- ---- Loss ratio 43.2 52.2 64.4 72.5 63.3 Expense ratio 43.6 35.2 43.1 44.4 33.9 ---- ---- ----- ----- ---- Combined ratio 86.8 87.4 107.5 116.9 97.2 ---- ---- ----- ----- ---- ---- ---- ----- ----- ---- (1) Excluding the effects of the Northridge Earthquake, the GAAP combined ratio for the years ended 1995 and 1994 would have been 86.2 and 91.1, respectively. The Company also calculates the statutory combined ratio, which is not indicative of GAAP underwriting profits due to accounting for multiple-year retrospectively-rated reinsurance contracts and 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. [Download Table] Year Ended December 31, ------------------------------------------------- Statutory 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Loss ratio 43.0 52.3 63.6 73.4 65.8 Expense ratio 47.4 36.8 42.9 43.5 22.1 (4) ---- ---- ----- ----- ----- Combined ratio 90.4 89.1 106.5 (3) 116.9 (3) 87.9 (4) ---- ---- ----- ----- ----- ---- ---- ----- ----- ----- Industry combined ratio 102.0 (1) 105.8 (2) 106.4 (2) 108.4 (2) 106.9 (2) ---- ---- ----- ----- ----- ---- ---- ----- ----- ----- 13
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(1) Source: Insurance Information Institute. Estimated for the year ended December 31, 1997. (2) Source: A.M. Best Aggregate & Averages -- Property-Casualty (1997 Edition). (3) Excluding the effects of the Northridge Earthquake, the statutory combined ratio for the years ended 1995 and 1994 would have been 85.3 and 89.7, respectively. (4) Contingent commission income recorded during 1993, from the cancellation of a multiple-year retrospectively-rated reinsurance contract, reduced the statutory combined and expense ratio by 10.3 points. INVESTMENTS The investment portfolios of the Company are managed by an Investment Committee of the Board of Directors. The Company follows an investment policy that is reviewed quarterly and revised periodically. Investments of the highest quality and marketability are critical for preserving claims paying ability. Virtually all of RLI's fixed income investments are U.S. Government securities or AA rated or better taxable and tax exempt issues. Common stock portfolios are limited to securities listed on national exchanges and listed by the Securities Valuation Office of the National Association of Insurance Commissioners. The investment portfolio serves primarily as the funding source of loss reserves and secondly as a source of income. For these reasons, RLI's primary investment criteria are quality and liquidity, followed by yield. During 1997, operating cash flows were used to acquire fixed income instruments composed mainly of intermediate-term U.S. Government and Agency securities and municipal securities. Additionally, a small portion of the funds were allocated to an investment grade convertible debenture portfolio designed to provide diversification and yield enhancement to the portfolio. The tax-exempt component of the fixed maturity portfolio increased $25.1 million, to $139.8 million; and comprises 41.9% of the Company's total fixed maturity portfolio, up 4.7% from year end 1996. The taxable U.S. Government, Agency and Municipal portion of the fixed income portfolio declined by $3.3 million to $182.5 million, or 54.7% of the total versus 60.3% at year end 1996. Investment grade corporate securities totaled $4.9 million compared to $3.7 million at year end 1996, while convertible debenture securities totaled $6.5 million, or 1.9% of the fixed income portfolio. Equity securities increased $62.6 million from $188.9 million at the end of last year to $251.5 million at the end of 1997. During 1997, net common equity investments totaling $6.9 million were purchased and pretax unrealized appreciation of equity securities totaled $55.7 million. Equity securities as a percentage of cash and invested assets increased to 41.6% at the end of 1997 from 35.1% at year end 1996. Combined cash and short-term investments totaling $18.7 million at year end 1997 represented 3.1% of cash and invested assets versus 7.6% in 1996. The Company's short-term investments consist of U.S. Government and Agency backed money market funds and the highest rated commercial paper. RLI's mix of fixed income securities continues to be biased in favor of U.S. Government and Agency securities due to their high liquidity and almost risk-free nature. The mixture of tax-exempt and taxable instruments within the fixed income portfolios is decided at the time of purchase on the basis of available after-tax returns and overall taxability of all invested assets. The majority of securities reviewed for purchase are either U.S. Government, Agency, or high grade municipal debt instruments. As part of its investment philosophy, the Company attempts to avoid exposure to default risk by holding, almost exclusively, instruments ranked in the top two grades of investment security quality by Standard & Poor's and Moody's (i.e. AAA and AA). Interest rate risk is limited by restricting and managing acceptable call provisions among new security purchases. 14
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The Company follows a program of matching assets to anticipated liabilities to ensure its ability to hold securities until maturity. The Company's known debt and long-term accounts payable are added to the estimate of its unpaid losses and settlement expenses, by line of business. These anticipated liabilities are then factored against ultimate payout patterns and the resulting payout streams are fully funded with the purchase of fixed-income securities of like maturity. Management believes that interest rate risk can best be minimized by such asset/liability matching. Aggregate maturities for the fixed maturity securities are as follows: [Download Table] MATURITY PAR AMORTIZED FAIR CARRYING YEAR VALUE VALUE VALUE VALUE ---- ---------- ---------- ---------- ---------- 1998 25,865,000 25,981,122 26,130,321 25,981,088 1999 34,985,000 35,197,887 36,030,860 35,364,470 2000 30,420,000 30,893,131 31,756,488 31,051,729 2001 20,370,000 20,946,461 21,440,505 20,970,047 2002 24,080,000 24,929,360 25,382,405 24,957,602 2003 41,270,000 41,465,570 41,584,515 41,426,089 2004 20,445,000 20,600,945 21,069,790 20,607,290 2005 30,290,000 30,489,946 31,462,432 30,453,708 2006 21,965,000 22,074,075 22,917,607 22,197,060 2007 15,800,000 15,968,813 16,272,714 15,933,831 2008 13,090,000 12,979,536 13,661,432 13,068,111 2009 23,125,000 23,158,055 23,907,396 23,158,055 2010 16,535,000 16,935,113 17,161,419 16,935,113 2011 4,000,000 3,972,741 4,033,570 4,009,119 2012 5,095,000 5,116,372 5,201,898 5,116,372 2013 2,000,000 1,734,360 1,762,629 1,772,899 2014 0 0 0 0 2015 500,000 520,376 566,250 566,250 2016 0 0 0 0 2017 250,000 131,416 131,250 131,250 ------------ ------------ ------------ ------------ $330,085,000 $333,095,279 $340,473,481 $333,700,083 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ Under generally accepted accounting principles, equity and fixed income securities are carried at fair market value, except that a company that can demonstrate its ability to hold fixed income securities until their originally scheduled maturity is permitted to carry such securities at amortized cost. RLI Corp. has chosen to carry most of its fixed income securities at amortized cost as it believes it has constructed its fixed income portfolios to match expected liability payouts and thus has the ability and intention to hold such securities until originally scheduled maturity. Consequently, fluctuations in the market value of most bonds are not reflected in the financial statements and do not affect shareholders' equity. At December 31, 1997, the Company's equity securities valued at $251.5 million, accounted for 41.6% of total cash and invested assets and 94.7% of the combined statutory surplus of its insurance subsidiaries. At December 31, 1997, net pretax unrealized capital appreciation of equity securities was $132.8 million. 15
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The Company's investment results are summarized in the following table: [Download Table] Year ended December 31, ---------------------------------------------------- (Dollars in thousands) 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- Average invested assets (1) $570,971 $504,773 $442,717 $407,722 $341,361 Investment income (2)(3) 24,558 23,681 22,029 20,133 16,857 Realized gains (losses) (3) 2,982 1,018 457 (3,595) 254 Change in unreal- ized appreciation/ depreciation (3)(4) 55,760 25,033 36,037 (5,749) 7,945 Annualized return on average invested assets 14.6% 9.9% 13.2% 2.7% 7.3% (1) Average of amounts at beginning and end of each year. (2) Investment income, net of investment expenses, including non-debt interest expense. (3) Before income taxes. (4) Relates to available-for-sale fixed maturities and equity securities. REGULATION STATE REGULATION The Company's insurance subsidiaries are highly regulated by insurance regulators in their states of incorporation as well as the states in which they do business. Such regulations, among other things, limit the amount of dividends and other distributions the subsidiaries can pay without prior approval of the insurance department in the states in which they are physically and/or commercially domiciled, and impose restrictions on the amount and type of investments they may have. Certain states also regulate the rates insurers may charge for certain property/casualty products. These regulations are designed to ensure financial solvency of insurance companies and to require fair and adequate service and treatment for policyholders. They are enforced through the granting and revoking of licenses to do business, licensing of agents and brokers, monitoring of trade practices, policy form approval, fair and equitable premium and commission rates, and minimum reserve and capital requirements. The procedures are administered by the various state departments of insurance and are supplemented by periodic reporting procedures and periodic examinations. The quarterly and annual financial reports to the states utilize accounting principles which are different than the generally accepted accounting principles used in shareholders' reports. The statutory accounting principles, in keeping with the intent to assure policyholder protection, are based, in general, on a liquidation concept while generally accepted accounting principles are based on a going concern concept. Currently, the National Association of Insurance Commissioners (NAIC) has a project to codify statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. Accordingly, the project may result in changes to the accounting policies that insurance enterprises use to prepare their statutory financial statements. Under the laws of most states , regulatory authorities have relatively broad discretion with respect to granting, renewing and revoking brokers' and agents' licenses to transact business in the state. The manner of operating in particular states may vary according to the licensing requirements of the particular state, which may, among other things, require a firm operate in the state through a corporation. In a few states, licenses are issued only to individual residents or locally-owned business entities. In such cases, the Company has arrangements with residents or business entities licensed to act in the state. 16
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As an insurance holding company, RLI Corp. is subject to regulation by the states in which its insurance subsidiaries are domiciled or transact business. Most states have enacted legislation that requires each insurance company in a holding company system to register with the insurance regulatory authority of its state of domicile and furnish to it financial and other information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. All transactions within a holding company system affecting insurers must be fair, and the insurer's policyholder surplus following any transaction must be both reasonable in relation to its outstanding liabilities and adequate for its needs. Notice to applicable regulators is required prior to the consummation of certain transactions affecting insurance subsidiaries of the holding company system. PROPOSITION 103 (RATE ROLLBACK INITIATIVE)--In November 1988, California voters approved Proposition 103, which requires insurance rates for certain lines of business to be rolled back 20% from the rates in effect in November 1987. Beginning in 1989 and ending in 1994, the Company deferred premium revenue of $1,449,200 and accrued interest in the amount of $1,050,480 to cover the proposed rollback. No additional provision was made during 1995 and the total funds accrued for rollback remained $2,449,680 at December 31, 1995. During 1996, the Company reached a settlement with the California Department of Insurance resolving its total liability for refunds and interest under Proposition 103. The settlement requires the Company to pay $2,987,050 in refunds and interest. In the second quarter of 1996, the Company recorded a pretax charge of $487,370 to record the difference between the actual settlement and the amount previously accrued. During 1997, the Company issued refund checks to policyholders. As of December 31, 1997, the total unclaimed refund amount was $1,526,283. Any amounts unclaimed as of November 1, 1998 will escheat to the California Division of Unclaimed Property. ASSESSMENTS AGAINST INSURERS Under insurance insolvency or guaranty laws in most states in which the Company operates, insurers doing business therein can be assessed for policyholder losses covered by insolvent insurance companies. The amount and timing of any future assessments on the Company under these laws cannot be reasonably estimated and are beyond the control of the Company. Recent financial difficulties of insurance companies increase the probability of assessments under these laws. Most of these laws do provide, however, that an assessment may be excused or deferred if it would threaten an insurer's financial strength. The Company generally accrues the full amount of the assessment upon notification. LEGISLATION AT FEDERAL LEVEL Although the federal government generally does not directly regulate the insurance business, federal initiatives often have an impact on the business in a variety of ways. Current and proposed federal measures which may significantly affect the insurance business include employee benefits regulation, limitation on anti-trust immunity, minimum solvency requirements and removal of barriers preventing banks from engaging in the insurance business. The Company is monitoring the following federal proposals: NATURAL DISASTER ACT--Recent natural disasters such as Hurricane Andrew, the Midwestern floods and the Northridge Earthquake have sparked debate on the best way to provide affordable insurance coverage for such events. Previously the Company supported the proposed Natural Disaster Act as the most desirable alternative. A new congressional bill, "The Homeowners Insurance Availability Act of 1997" addresses issues of catastrophe insurance for homeowners through federal assistance to state guarantee funds. The Company is monitoring the bill's progress and has neither opposed nor supported the bill at this time. SUPERFUND REFORM (ENVIRONMENTAL LIABILITY)--The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), more commonly known as Superfund, remains in effect, but no reform legislation was passed in 1997. Insurance companies, other businesses, environmental groups and municipalities are advocating a variety of reform proposals to revise the cleanup and liability provisions of CERCLA. Any reform proposal could result in additional taxation to fund cleanup efforts. 17
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NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS The National Association of Insurance Commissioners (NAIC) facilitates the regulation of multi-state companies through uniform reporting requirements, standardized procedures for financial examinations, and uniform regulatory procedures embodied in model acts and regulations. Current developments address the reporting and regulation of the adequacy of capital and surplus. The NAIC has developed Property-Casualty Risk-Based Capital (RBC) standards that relate an insurer's reported statutory surplus to the risks inherent in its overall operations. The RBC formula uses the statutory annual statement to calculate the minimum indicated capital level to support asset (investment and credit) risk and underwriting (loss reserves, premiums written, and unearned premium) risk. The NAIC model law calls for various levels of regulatory action based on the magnitude of an indicated RBC capital deficiency, if any. The Company continues to monitor its subsidiaries' internal capital requirements and the NAIC's RBC developments. The Company has determined that its capital levels are well in excess of the minimum capital requirements for all RBC action levels. Management believes that its capital levels are sufficient to support the level of risk inherent in its operations. CORPORATE COMPLIANCE The Company has developed a Code of Conduct and Compliance Manual which provides employees with guidance on complying with a variety of federal and state laws. AGENCY LICENSES AND TRADEMARKS Replacement Lens Inc. or its designated employees, must be licensed to act as resident or non-resident brokers or agents by regulatory authorities in the states in which it operates. Replacement Lens Inc. obtained service mark registration of the letters "RLI" in 1978 and currently maintains such registration in 47 states. Such registration protects the mark from deceptively similar use by the Company's competitors. The duration of this registration is ten years for all states except three in which registration is limited to five years unless renewed. Duration of the registration in the State of Wisconsin is twenty years. CLIENTELE No significant part of the Company's or its subsidiaries' business is dependent upon a single client or upon a very few clients, the loss of any one of which would have a material adverse effect on the Company. EMPLOYEES The Company employs a total of 392 associates. Of the 392 total associates, 35 are part-time and 357 are full-time. (d) Financial Information about Foreign and Domestic Operations and Export Sales. For purposes of this discussion, foreign operations are not considered material to the Company's overall operations. 18
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Item 2. PROPERTIES The Company owns a two-story, 80,000 square foot building in Peoria, Illinois, which serves as the Corporate Headquarters for RLI Corp., RLI Insurance Company and Mt. Hawley Insurance Company. Two RLI Insurance Company Branch Offices also lease office space in this building. Located on the same 15.0 acre campus is a 12,800 square foot building. Nearly 9,800 square feet of this building are used as warehouse storage for records and equipment. The remaining 3,000 square feet is used as office space. Additionally, the Company owns two other buildings located near the headquarter building. One, a 19,000 square foot building, is leased to Maui Jim, Inc. and is used as their headquarters. The other, a 20,000 square foot building, was purchased in December of 1996. Currently, used for warehousing and record storage, this building will provide space for future office expansion. All other operations of RLI Corp. lease the office space which they need in various locations throughout the country. Item 3. LEGAL PROCEEDINGS The Company is involved in certain legal proceedings and disputes considered by management to be ordinary and incidental to the business or which have no foundation in fact. Management believes that valid defenses exist as to all such litigation and disputes, and is of the opinion that these will not have a material effect on the Company's consolidated financial statements. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted by the Company to a vote of security holders during the fourth quarter of the fiscal year covered by this report. PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Refer to the Corporate Data on page 53 of the Annual Report to Shareholders for the year ended December 31, 1997 attached in Exhibit 13. Item 6. SELECTED FINANCIAL DATA Refer to the Selected Financial Data on pages 20 through 21 of the Annual Report to Shareholders for the year ended December 31, 1997 attached in Exhibit 13. Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Refer to the Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 22 through 29 of the Annual Report to Shareholders for the year ended December 31, 1997 attached in Exhibit 13. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Refer to the consolidated financial statements and supplementary data included on pages 30 through 49 of the Annual Report to Shareholders for the year ended December 31, 1997 attached in Exhibit 13. (See Index to Financial Statements and Schedules attached on page 23.) 19
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Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There were no changes in accountants or disagreements with accountants on any matters of accounting principles or practices or financial statement disclosure. PART III Items 10 to 13. Pursuant to General Instructions G(3) of Form 10-K, Items 10 to 13, inclusive, have not been restated or answered since the Company intends to file within 120 days after the close of its fiscal year with the Securities and Exchange Commission a definitive proxy statement pursuant to Regulation 14A under the Securities Exchange Act of 1934, which proxy statement involves the election of directors. The information required in these items 10 to 13, inclusive, is incorporated by reference to that proxy statement. PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (l-2) Consolidated Financial Statements and Schedules. See Index to Financial Statements and Schedules attached. (3) Exhibits. See Exhibit Index on pages 33-34. (b) No reports on Form 8-K were filed during the last quarter of 1997. (c) Exhibits. See Exhibit Index on pages 33-34. (d) Financial Statement Schedules. The schedules included on attached pages 24 through 32 as required by Regulation S-X are excluded from the Company's Annual Report to Shareholders. See Index to Financial Statements and Schedules on page 23. There is no other financial information required by Regulation S-X which is excluded from the Company's Annual Report to Shareholders. 20
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SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. RLI Corp. (Registrant) By: /s/Joseph E. Dondanville ------------------------------------------------- J. E. Dondanville Vice President, Chief Financial Officer (Principal Financial and Accounting Officer) Date: March 11, 1998 ----------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/Gerald D. Stephens ------------------------------------------------- G. D. Stephens, President (Principal Executive Officer) Date: March 11, 1998 ----------------------------------------------- * * * * * By: /s/Joseph E. Dondanville ------------------------------------------------- J. E. Dondanville, Vice President, Chief Financial Officer (Principal Financial and Accounting Officer) Date: March 11, 1998 ----------------------------------------------- * * * * * By: /s/Gerald D. Stephens ------------------------------------------------- G. D. Stephens, Director Date: March 11, 1998 ----------------------------------------------- * * * * * By: /s/Bernard J. Daenzer ------------------------------------------------- B. J. Daenzer, Director Date: March 11, 1998 ----------------------------------------------- * * * * * By: /s/Richard J. Haayen ------------------------------------------------- R. J. Haayen, Director Date: March 11, 1998 ----------------------------------------------- * * * * * By: /s/William R. Keane ------------------------------------------------- W. R. Keane, Director Date: March 11, 1998 ----------------------------------------------- * * * * * 21
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By: /s/Gerald I. Lenrow ------------------------------------------------- G. I. Lenrow, Director Date: March 11, 1998 ----------------------------------------------- * * * * * By: /s/Jonathan E. Michael ------------------------------------------------- J.E. Michael, Director Date: March 11, 1998 ----------------------------------------------- * * * * * By: /s/Edwin S. Overman ------------------------------------------------- E. S. Overman, Director Date: March 11, 1998 ----------------------------------------------- * * * * * By: /s/Edward F. Sutkowski ------------------------------------------------- E. F. Sutkowski, Director Date: March 11, 1998 ----------------------------------------------- * * * * * By: /s/Robert O. Viets ------------------------------------------------- R. O. Viets, Director Date: March 11, 1998 ----------------------------------------------- * * * * * 22
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INDEX TO FINANCIAL STATEMENTS AND SCHEDULES [Enlarge/Download Table] Reference (Page) DATA SUBMITTED HEREWITH: Report of Independent Auditors 24 Schedules: I. Summary of Investments - Other than Investments in Related Parties at December 31, 1997. 25 II. Condensed Financial Information of Registrant for the three years ended December 31, 1997. 26 - 28 III. Supplementary Insurance Information for the three years ended December 31, 1997. 29 - 30 IV. Reinsurance for the three years ended December 31, 1997. 31 V. Valuation and Qualifying Accounts 32 VI. Supplemental Information Concerning Property-Casualty Insurance Operations for the three years ended December 31, 1997. 29 - 30 Schedules other than those listed are omitted for the reason that they are not required, are not applicable or that equivalent information has been included in the financial statements, and notes thereto, or elsewhere herein. 23
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INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders RLI Corp.: Under date of January 21, 1998, we reported on the consolidated balance sheets of RLI Corp. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of earnings and comprehensive earnings, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997, as contained in the 1997 annual report to shareholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1997. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, the financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. KPMG Peat Marwick LLP Chicago, Illinois January 21, 1998 24
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RLI CORP. AND SUBSIDIARIES SCHEDULE I--SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1997 [Enlarge/Download Table] Column A Column B Column C Column D Amount at Which Shown in Fair the Balance Type of Investment Cost(1) Value Sheet ----------------------------------------------------------------------------------------------------------- Fixed maturities: Bonds: Held-to-maturity United States government and government agencies and authorities $153,767,160 $156,388,429 $153,767,160 States, political subdivisions, and revenues 136,267,149 140,419,278 136,267,149 ----------------------------------------------------------------------------------------------------------- Total held-to-maturity 290,034,309 296,807,707 290,034,309 ----------------------------------------------------------------------------------------------------------- Trading U.S. governments 3,655,128 3,712,755 3,712,755 Foreign governments 440,589 448,026 448,026 Corporate 4,919,479 4,977,849 4,977,849 States, political subdivisions & revenues 404,082 406,942 406,942 ----------------------------------------------------------------------------------------------------------- Total trading 9,419,278 9,545,572 9,545,572 ----------------------------------------------------------------------------------------------------------- Available-for-sale U.S. governments 20,248,316 20,464,950 20,464,950 Corporates 6,342,006 6,472,500 6,472,500 States, political subdivisions, and revenues 7,051,370 7,182,572 7,182,572 ----------------------------------------------------------------------------------------------------------- Total available-for-sale 33,641,692 34,120,202 34,120,202 ----------------------------------------------------------------------------------------------------------- Total fixed maturities 333,095,279 340,473,481 333,700,083 ----------------------------------------------------------------------------------------------------------- Equity securities, available-for-sale: Common stock: Public utilities 38,504,391 66,506,467 66,506,467 Banks, trusts and insurance companies 9,844,003 31,739,750 31,739,750 Industrial, miscellaneous and all other 70,287,038 153,212,226 153,212,226 Preferred stock 1,958 1,400 1,400 ----------------------------------------------------------------------------------------------------------- Total equity securities 118,637,390 251,459,843 251,459,843 ----------------------------------------------------------------------------------------------------------- Short-term investments 18,696,896 18,696,896 18,696,896 ----------------------------------------------------------------------------------------------------------- Total investments $470,429,565 $610,630,220 $603,856,822 ----------------------------------------------------------------------------------------------------------- Note: See notes 1D and 2 of Notes to Consolidated Financial Statements, as attached in Exhibit 13. (1) Original cost of equity securities and, as to fixed maturities, original cost reduced by repayments and adjusted for amortization of premiums or accrual of discounts. 25
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RLI CORP. AND SUBSIDIARIES SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) CONDENSED BALANCE SHEETS DECEMBER 31, 1997 AND 1996 [Enlarge/Download Table] 1997 1996 ------------------------------------------------------------------------------------------- ASSETS Cash $ 135,663 $ 9,597,834 Investments in subsidiaries, at equity 264,146,254 228,205,464 Equity securities available-for-sale, at fair value (Cost--$6,677,285 in 1997 and $6,800,912 in 1996) 12,288,528 9,676,285 Investment in Rabbi Trust 6,432,355 4,062,723 Deferred debt costs 805,701 Property and equipment 1,045,298 1,051,637 Other assets 418,040 898,113 ------------------------------------------------------------------------------------------- Total assets $284,466,138 $254,297,757 ------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Accounts payable, current $ 1,996,859 $ 1,283,960 Notes payable, short-term 7,500,000 Deferred compensation--Rabbi Trust 6,432,355 4,062,723 Interest payable--Convertible debentures 1,265,000 Income taxes payable--current 332,621 10,878 Income taxes payable--deferred 1,523,663 805,121 Long-term debt--Convertible debentures 46,000,000 Other liabilities 128,200 830,714 ------------------------------------------------------------------------------------------- Total liabilities 17,913,698 54,258,396 ------------------------------------------------------------------------------------------- Shareholders' equity: Common stock ($1 par value, authorized 50,000,000 shares, issued 10,229,673 in 1997 and 8,453,449 shares in 1996) 10,229,673 8,453,449 Other shareholders' equity 301,872,049 197,464,904 Treasury shares at cost (1,595,419 shares in 1997 and 631,719 shares in 1996) (45,549,282) (5,878,992) ------------------------------------------------------------------------------------------- Total shareholders' equity 266,552,440 200,039,361 ------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $284,466,138 $254,297,757 ------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------- See Notes to Consolidated Financial Statements, as attached in Exhibit 13. 26
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RLI CORP. AND SUBSIDIARIES SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)--(CONTINUED) CONDENSED STATEMENTS OF EARNINGS AND COMPREHENSIVE EARNINGS YEARS ENDED DECEMBER 31, [Enlarge/Download Table] 1997 1996 1995 -------------------------------------------------------------------------------------------------------------------------------- Net investment income (expense) $ 454,906 $ 164,181 $ (100,881) Selling, general, and administrative expenses 4,118,010 3,559,113 2,093,019 Interest expense on debt 1,547,542 2,808,470 3,347,378 -------------------------------------------------------------------------------------------------------------------------------- (5,210,646) (6,203,402) (5,541,278) Income tax benefit (1,675,135) (2,186,013) (2,147,995) -------------------------------------------------------------------------------------------------------------------------------- Net loss before equity in net earnings of subsidiaries (3,535,511) (4,017,389) (3,393,283) Equity in net earnings of subsidiaries 33,706,994 29,713,110 11,342,824 -------------------------------------------------------------------------------------------------------------------------------- Net earnings $30,171,483 $25,695,721 $ 7,949,541 -------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------- Other Comprehensive Earnings, net of tax Unrealized gains on securities: Unrealized holding gains arising during the period $1,859,712 $901,569 $1,245,523 Less: Reclassification adjustment for (gains) losses included in Net Earnings (81,383) 1,778,329 10,846 912,415 54,384 1,299,907 -------------------------------------------------------------------------------------------------------------------------------- Other Comprehensive Earnings--parent only 1,778,329 912,415 1,299,907 Equity in Other Comprehensive Earnings of Subsidiaries 34,465,638 15,361,757 22,124,323 -------------------------------------------------------------------------------------------------------------------------------- Other Comprehensive Earnings 36,243,967 16,274,172 23,424,230 -------------------------------------------------------------------------------------------------------------------------------- Comprehensive Earnings $66,415,450 $41,969,893 $31,373,771 -------------------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------------------- See Notes to Consolidated Financial Statements, as attached in Exhibit 13. 27
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RLI CORP. AND SUBSIDIARIES SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)--(CONTINUED) CONDENSED STATEMENTS OF CASH FLOWS [Enlarge/Download Table] YEARS ENDED DECEMBER 31, 1997 1996 1995 ---------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities Losses before equity in net earnings of subsidiaries $ (3,535,511) $(4,017,389) $(3,393,283) Adjustments to reconcile net losses to net cash provided by operating activities: Other items, net (1,792,215) (55,262) (399,566) Change in: Affiliate balances payable 451,029 (207,668) 135,916 Interest Payable (1,265,000) Federal income taxes 140,485 437,303 1,658,597 Deferred debt costs 805,701 123,164 123,165 ---------------------------------------------------------------------------------------------------- Net cash used in operating activities (5,195,511) (3,719,852) (1,875,171) ---------------------------------------------------------------------------------------------------- Cash Flows from Investing Activities Purchase of: Equity securities, available-for-sale (135,001) (387,395) (857,883) Property and equipment (37,210) (9,600) Unconsolidated investee ownership interest (3,694,118) Sale of: Equity securities, available-for-sale 383,838 236,986 1,004,380 Cash dividends received-subsidiaries 16,998,248 21,125,783 7,823,965 ---------------------------------------------------------------------------------------------------- Net cash provided by investing activities 13,515,757 20,975,374 7,960,862 ---------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities Proceeds from issuance of debt 7,500,000 2,800,000 Payments on debt (2,800,000) (6,255,000) Fractional share paid (1,211) (4,010) Shares issued under stock option plan 161,356 Treasury shares reissued 2,207,526 33,667 Treasury shares purchased (20,738,547) (3,040,671) Cash dividends paid (4,704,015) (4,261,445) (3,849,521) ---------------------------------------------------------------------------------------------------- Net cash used in financing activities (17,782,417) (7,894,590) (7,274,864) ---------------------------------------------------------------------------------------------------- Net increase (decrease) in cash (9,462,171) 9,360,932 (1,189,173) Cash at beginning of year 9,597,834 236,902 1,426,075 ---------------------------------------------------------------------------------------------------- Cash at end of year $ 135,663 $ 9,597,834 $ 236,902 ---------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------- Interest paid on outstanding debt for 1997, 1996, and 1995 amounted to $2,809,903, $2,834,192, and $3,372,479, respectively. See Notes to Consolidated Financial Statements, as attached in Exhibit 13. 28
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RLI CORP. AND SUBSIDIARIES SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION SCHEDULE VI--SUPPLEMENTARY INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS [Enlarge/Download Table] YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995 Column A Column B Column C (1) Column E (1) Column F Column H Incurred Deferred Unpaid Losses and policy losses and settlement acquisition settlement Unearned Premiums expenses Segment costs expenses, net premiums, net earned Current year ------------------------------------------------------------------------------------------------------ Year ended December 31, 1997 RLI Insurance Group $ 21,984,585 $242,554,249 $ 78,865,812 $141,884,445 $ 61,771,256 ----------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------- Year ended December 31, 1996 RLI Insurance Group $ 16,663,603 $240,784,071 $ 76,076,561 $130,656,095 $ 69,724,730 ----------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------- Year ended December 31, 1995 RLI Insurance Group $ 15,806,911 $221,648,494 $ 75,824,217 $133,468,133 $ 62,618,745 ----------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------- NOTE 1: Investment income is not allocated to the segments, therefore net investment income (column G) has not been provided. 29
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RLI CORP. AND SUBSIDIARIES SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION SCHEDULE VI--SUPPLEMENTARY INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS (CONTINUED) YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995 [Download Table] Column A Column H Column I Column J Column K Incurred Losses and settlement Policy Other Net expenses acquisition operating Premiums Segment Prior year costs expenses written ---------------------------------------------------------------------------------- Year ended December 31, 1997 RLI Insurance Group $ (519,822) $43,140,381 $18,741,377 $144,673,696 ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- Year ended December 31, 1996 RLI Insurance Group $ (1,463,423) $29,556,390 $16,441,332 $132,357,640 ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- Year ended December 31, 1995 RLI Insurance Group $ 23,271,250 $43,042,045 $14,470,053 $130,452,895 ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- 30
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RLI CORP. AND SUBSIDIARIES SCHEDULE IV--REINSURANCE FOR THE YEARS 1997, 1996, AND 1995 [Enlarge/Download Table] Column A Column B Column C Column D Column E Column F Percentage Ceded to Assumed of Amount Gross Other From Other Net Assumed to Amount Companies Companies Amount Net ---------------------------------------------------------------------------------------------------- 1997 ---------------------------------------------------------------------------------------------------- RLI Insurance Group premiums earned $268,569,271 $138,197,583 $11,512,757 $141,884,445 8.1% ---------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------- 1996 ---------------------------------------------------------------------------------------------------- RLI Insurance Group premiums earned $271,551,708 $140,928,326 $ 32,713 $130,656,095 .02% ---------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------- 1995 RLI Insurance Group premiums earned $264,651,370 $131,771,599 $ 588,362 $133,468,133 .4% ---------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------- NOTES: Column B, "Gross Amount" includes only direct premiums earned. 31
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RLI CORP. AND SUBSIDIARIES SCHEDULE V--VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995 [Enlarge/Download Table] Column A Column B Column C Column D Column E Balance at Amounts Amounts Balance beginning of charged to recovered Amounts at end period expense (written-off) commuted of period --------------------------------------------------------------------------------------------------------------- 1997 Allowance for insolvent reinsurers $16,897,798 -- $ 159,396 -- $17,057,194 1996 Allowance for insolvent reinsurers $16,336,146 $1,006,140 $(444,488) -- $16,897,798 1995 Allowance for insolvent reinsurers $15,547,400 $ 613,296 $ 261,373 $(85,923) $16,336,146 32
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[Enlarge/Download Table] EXHIBIT INDEX Exhibit No. Description of Document Reference (page) ----------- ----------------------- ---------------- 2.1 Plan of Reorganization and Agreement Incorporated by reference to the Company's Quarterly of Merger Form 10-Q for the First Quarter ended March 31, 1993. 2.2 Articles of Merger Incorporated by reference to the Company's Quarterly Form 10-Q for the Second Quarter ended June 30, 1993. 3.1 Articles of incorporation Incorporated by reference to the Company's Quarterly Form 10-Q for the Second Quarter ended June 30, 1997. 3.2 By-Laws Incorporated by reference to the Company's Quarterly Form 10-Q for the Second Quarter ended June 30, 1997. 4.1 Indenture dated July 28, 1993 between Incorporated by reference to the Company's Registration the Company and Norwest Bank Statement on Form S-3 filed on July 21, 1993. Minnesota, National Association as Trustee 10.1 Market Value Potential Plan Incorporated by reference to the Company's Quarterly Form 10-Q for the Second Quarter ended June 30, 1997. 10.2 RLI Corp. Director Deferred Incorporated by reference to the Company's Registration Compensation Plan Statement on Form 10-Q for the Second Quarter ended June 30, 1993. 10.3 The RLI Corp. Directors' Irrevocable Incorporated by reference to the Company's Registration Trust Agreement Statement on Form 10-Q for the Second Quarter ended June 30, 1993. 10.4 Key Employee Excess Benefit Plan Incorporated by reference to the Company's Annual Form 10-K/A for the year ended December 31, 1992. 10.5 RLI Corp. Incentive Stock Incorporated by reference to Company's Registration Statement Option Plan on Form S-8 filed on March 11, 1996, File No. 333-01637 10.6 Directors' Stock Option Plan Incorporated by reference to the Company's Quarterly Form 10-Q for the Second Quarter ended June 30, 1997. 10.9 Reinsurance Agreements between the Incorporated by reference to the Company's Annual Form 10-K/A Company and American Re-Insurance for the year ended December 31, 1992. Company 10.10 Reinsurance Agreements between the Incorporated by reference to the Company's Annual Form 10-K/A Company and Lloyds of London for the year ended December 31, 1992. 10.11 Reinsurance Agreements between the Incorporated by reference to the Company's Annual Form 10-K/A Company and NAC Reinsurance Corp. for the year ended December 31, 1992. 11.0 Statement re computation of per Refer to the Notes to Consolidated Financial Statements--Note 1K share earnings "Earnings per share", on page 36 of the Annual Report to Shareholders attached in Exhibit 13. 33
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Exhibit No. Description of Document Reference (page) ----------- ----------------------- ---------------- 13.1 Refer to the Annual Report to Share- Attached Exhibit 13. holders for the year ended December 31, 1997, pages 20-49 and 53. 21.1 Subsidiaries of the Registrant Attached page 35. 23.1 Consent of KPMG Peat Marwick LLP Attached page 36. 23.2 Consent of Kirkland & Ellis Incorporated by reference to the Company's Registration Statement on Form S-3 filed July 21, 1993. 24.1 Powers of Attorney Incorporated by reference to the Company's Registration Statement on Form S-3 filed on July 21, 1993. 27 Financial Data Schedule Attached Exhibit 27. 28.1 Information from reports furnished to Attached page 37. state insurance regulatory authorities

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