2018 RLI CORP. ANNUAL REPORT ON FORM 10K
A HIGHER STANDARD2018 YEAR IN REVIEW 1____As a leading provider of specializedinsurance, RLI is focused on developinginnovative solutions that meet customer needs and delivering results that surpass the expectations of shareholders.OUR VISION FINANCIAL HIGHLIGHTS
In thousands, except combined ratio, per-share data and return on equity
2018
2017
% Change
Gross premiums written
$ 983,216
$ 885,312
Net premiums written
Consolidated revenue
Net earnings
Operating earnings1
GAAP combined ratio
Total shareholders’ equity
Per-share data:
823,175
818,123
64,179
92,088
94.7
806,842
749,854
797,224
105,028
102,161
96.4
853,598
Net earnings (diluted)
$ 1.43
$ 2.36
Operating earnings (diluted)1
$ 2.05
$ 2.30
Cash dividends declared:
Regular
Special
Book value2
Year-end closing stock price
$ 0.87
$ 0.83
1.00
18.13
68.99
1.75
19.33
60.66
Return on equity
7.6%
12.3%
11.1%
9.8%
2.6%
-38.9%
-9.9%
-1.8%
-5.5%
-39.4%
-10.9%
4.8%
-42.9%
-6.2%
13.7%
-38.2%
1 See discussion of non-GAAP measures in note 1 of the SELECTED FINANCIAL DATA section on page 12 of the Year In Review wrap.
2 With the inclusion of dividends paid (regular and special), book value per share growth was 3% year over year.
2
3Dear Shareholders, Our story began in 1965, when RLI sold its first contact lens insurance policy in Peoria, IL. We’ve grown from these humble roots into a leading U.S. specialty insurer with a diverse product portfolio. Over time, we’ve made a difference for countless customers, shouldering risks in niche markets to provide our policyholders with the security to create, explore, grow and prosper. As RLI’s late founder Gerald D. Stephens once said, “We want to be known for excellence – a desire to bring an unprecedented standard of quality to our customers.” It is the continual pursuit of excellence that propels us to raise the bar across everything we do, year after year. We maintain an unwavering focus on providing best-in-class insurance products and exceptional service to our customers. We prudently manage our business through all market cycles and cultivate a company culture that encourages our employees to achieve more and do more for our customers and communities. At RLI, we hold ourselves to a higher standard.In 2018, we added another successful chapter to our story, delivering strong financial results amid highly competitive market conditions and another active year of catastrophic events in the United States. Through a combination of our superior service, hallmark underwriting discipline, diversified product portfolio and strong fiscal management, we helped our customers recover from unexpected events, while maintaining profitability and delivering value to shareholders. Highlights of our 2018 accomplishments include: • Achieving our 23rd consecutive year of underwriting profit, while sustaining our largest aggregate catastrophe loss in over two decades• Delivering broad-based growth across most of our product portfolio and ending the year with the highest gross and net premiums in our history and• Maintaining a strong balance sheet while returning capital to our shareholders through regular quarterly dividends and a $1.00 special dividend. A STANDARD OF UNDERWRITING DISCIPLINEHighly competitive market conditions continued in 2018 and extraordinary catastrophe activity in the U.S. — most notably the Kilauea volcano eruptions in Hawaii and hurricanes along the East Coast and Florida — impacted many RLI customers. Hurricane Michael, which was particularly destructive, resulted in the largest hurricane loss in RLI’s history and the largest single event loss our company has experienced since the Northridge earthquake struck the West Coast in 1994.Throughout the year, our team proactively responded to the needs of our policyholders with the highest levels of professionalism and provided the unparalleled claim service our producers and policyholders have come to expect from RLI. Despite the impact of catastrophe losses, RLI’s underwriting performance was strong and we posted underwriting income of $41.6 million, resulting in a 94.7 combined ratio. This marks our 23rd consecutive year of achieving a combined ratio below 100. JONATHAN E. MICHAELChairman & CEO STATUTORY COMBINED RATIO
Our average statutory combined ratio has outperformed the industry average
by 15 points over the last decade.
110
100
90
80
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
10-YEAR AVG.
RLI
P&C Industry*
83.9
100.5
81.4
102.5
79.1
108.2
88.0
103.1
82.2
95.8
84.1
97.2
83.9
97.9
89.0
100.7
96.2
103.9
94.0
99.4
86.2
100.9
*Sources: (1) A.M. Best (2018). Aggregate & Averages – Property/Casualty, United States & Canada. 2009 – 2017.
(2) Conning (2018). Property-Casualty Forecast & Analysis: By Line of Insurance, Fourth Quarter 2018. Estimated
for the year ended December 31, 2018.
P&C Industry*
RLI
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4
In addition to achieving profitability, we succeeded in significantly growing our top line. Gross premiums written increased by 11 percent in 2018, as mature products grew through enhanced marketing, product development and technology initiatives and as new products gained traction. RLI’s casualty segment grew its top-line results 12 percent during the year and posted a 98 combined ratio. Premium growth was largely driven by our mature casualty products, but was supplemented by growth within newer products added to the segment over the past few years.Property segment gross premiums were up 16 percent year over year and significant growth was experienced across all major products. Although segment profitability was negatively impacted by catastrophe activity during the year, especially within our non-admitted property lines, the business achieved a 99 combined ratio. Our surety segment gross premiums grew 1 percent in 2018, but the business delivered an exceptional 75 combined ratio. This segment continues to perform well despite intense competition. Maintaining discipline will continue to be critical for long-term success in this space. We uphold high underwriting standards across all of the markets we serve. Our strong culture of discipline and ownership requires us to constantly assess the performance of our product portfolio. We invest and nurture products that show promise and address those that are underperforming. At the end of the year, we repositioned our product portfolio and exited a few underperforming businesses to achieve better balance and profitability. Overall, our underwriting performance was strong and our customer service distinguished us during the year. We made many strategic investments in our business to enhance our product, distribution, service and technology capabilities. As we move forward, we will build on our successes and continue to execute our strategic plan. We will focus on further developing our talented team, elevating the customer experience, improving productivity through operational improvements and seeking new growth opportunities. We believe focused investments in these areas will help keep us at the forefront of the industry and differentiate us from the competition. 5 A STANDARD OF FINANCIAL STRENGTH AND STABILITY In 2018, market volatility experienced late in the year adversely impacted our investment portfolio performance. While the investment portfolio’s total return was down –0.2 percent overall, operating income benefited from investment income growth of 13 percent for the year. This growth was driven by an increased asset base as well as higher than average interest rates throughout the year. We remain steadfast in our long-term approach to our investments and maintain a well-diversified portfolio structured to maximize our total return.A STANDARD OF DELIVERING VALUE TO SHAREHOLDERSRLI’s operational and financial strategies are designed to create consistent value for you, our shareholders. While our top priority is to make strategic investments in our business that will support its growth and long-term success, when Over the past 10 years, RLI’s total return to shareholders has outpaced that of the S&P 500 and S&P 500 P&C Index.10-YEAR CUMULATIVE SHAREHOLDER RETURNAssumes $100 invested on December 31, 2008, in RLI, S&P 500 and S&P 500 P&C Index, with reinvestment of dividends. Comparison of 10-year annualized total return: RLI: 15.6% | S&P 500: 13.1% | S&P 500 P&C Index: 13.2%To update graph, go to Object > Graph > Data.The contents of the graph will pop up in a table. Edit the table and click the check mark to apply.Note: Some minor adjustments may be necessary after updating:• Update Values Below graph (these are not updated automatically) $100 89 102 154 150 236 259 340 363 364 425 $100 126 145 149 172 228 259 263 294 359 343 $100 112 122 122 147 203 235 257 297 364 347RLIS&P 500S&P 500 P&C Index$50$100$150$200$250$300$350$400S&P 500 P&C IndexS&P 500RLI201820172016201520142013201220112010200920086 A STANDARD OF EXCELLENCE
Our ability to grow over the past year and achieve an underwriting
profit in the face of significant catastrophe losses speaks volumes
about the quality of our people, the disciplined
underwriting standards we uphold and the
resilience of our unique business model.
While we lost our founder and friend, Jerry
Stephens, this past year, we remain faithful
to his uncompromising vision to serve our
customers well, further solidify our position as
a recognized performance leader of the U.S.
specialty insurance industry and deliver value to
shareholders.
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11%
Insiders &
ESOP
89%
Institutions &
other public
investors
• Update Values & Labels as necessary
To accomplish these objectives, we will continue
to execute on our strategies to grow, improve
productivity, provide great customer experiences
and empower our organization to deliver outstanding results. We will
strive to prove once again that Different Works.
On behalf of our Board of Directors, I would like to thank our
customers for their trust, our employees for their hard work and
you, our shareholders, for your support.
Jonathan E. Michael
Chairman & CEO
we generate capital faster than we can effectively deploy it, we
return it to shareholders. During the year, we paid regular quarterly
dividends and a $1.00 per share special dividend. RLI has paid
dividends for 170 consecutive quarters
and has increased regular dividends in
each of the last 43 years. Over the past
10 years, RLI has returned $1.2 billion to
shareholders in the form of dividends and
share repurchases.
STOCK OWNERSHIP
Insiders and employees own
11 percent of the company.
Our balance sheet remains strong, as
demonstrated by our A+ (Superior) financial
strength rating by A.M. Best. We are well-
positioned to continue pursuing profitable
opportunities in the year ahead.
A STANDARD OF SHARED REWARDS
RLI is proud to be a specialty insurance
performance leader. It’s an honor we’ve achieved with the help of our
talented associates. Our smart, empowered employees make RLI
different and serve as our greatest source of competitive advantage.
We believe exceptional service and integrity are as critical as
diligence and technical expertise in every interaction we have with
customers and distribution partners. Our employee stock ownership
plan is foundational for driving a higher standard of care and support
for our customers. This long-ingrained culture of ownership gives
employees a vested interest in our results and helps them see the
connection between their efforts and company profitability. It also
positions our company as a desirable destination for the best and
the brightest talent in the industry.
7
EARNINGS PER SHARE
Each share of our stock has generated $12.59
of diluted net earnings since 2013.
BOOK VALUE GROWTH with dividends
Over the past five years, RLI has returned nearly
$600 million in dividends to its shareholders.
$3.00
$3.00
$2.50
$2.50
$2.00
$2.00
$1.50
$1.50
$1.00
$1.00
$0.50
$0.50
$0.00
$0.00
$1,500
$1,500
$1,500
Operations ROE
Operations ROE
Net EPS
Net EPS
$1,200
$1,200
$1,200
9
0
.
9
0
.
3
3
1
6
.
2
1
6
.
2
2
1
.
3
2
1
.
3
3
5
.
2
3
5
.
2
9
5
.
2
9
5
.
2
8
0
.
2
8
0
.
2
6
3
.
2
6
0
3
3
.
2
2
.
0
3
.
2
5
0
.
2
5
0
.
2
3
4
.
1
3
4
.
1
2014
2015
2016
2017
2018
2
0
%
2
0
%
2014
2015
2016
2017
Diluted Net Earnings Per Share
Diluted Operating Earnings Per Share1
Diluted Net Earnings Per Share
Diluted Operating Earnings Per Share1
2018
1 See discussion of non-GAAP measures in note 1 of the SELECTED
FINANCIAL DATA section on page 12 of the Year In Review wrap.
$900
$900
$900
$600
$600
$600
$300
$300
$300
2
0
%
2
0
%
$0
$0
$0
2
0
%
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2
0
%
2013
2013
2013
2014
2014
2014
2015
2016
2017
2018
Cumulative Dividends
2015
2015
2016
2016
2017
2017
2018
2018
Reported Book Value
Cumulative Dividends
Cumulative Dividends
Reported Book Value
Reported Book Value
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Cumulative Dividends
Cumulative Dividends
Cumulative Dividends
Reported Book Value
Reported Book Value
Reported Book Value
8
BOARD OF
DIRECTORS
Kaj Ahlmann (2, 3)
Director since 2009
Retired Global Head of Strategic Services
and Chairman of the Advisory Board for
Deutsche Bank
Michael E. Angelina (2, 5)
Director since 2013
Executive Director of the Academy of
Risk Management and Insurance at
Saint Joseph’s University
John T. Baily (3, 4)
Director since 2003
Retired President of Swiss Re Capital
Partners
Calvin G. Butler, Jr. (2, 3)
Director since 2016
CEO of Baltimore Gas & Electric Company
David B. Duclos (1, 4)
Director since 2017
Retired CEO of QBE, North America
Susan S. Fleming (3, 4)
Director since 2018
Executive Educator, Speaker and Angel
Investor
Jordan W. Graham (1, 4)
Director since 2004
Managing Director for Quotient Partners
Jonathan E. Michael
Director since 1997
Chairman & CEO of RLI Corp.
Robert P. Restrepo, Jr. (1, 5)
Director since 2016
Retired Chairman, CEO & President of State
Auto Insurance Company
Debbie S. Roberts (2, 5)
Director since 2018
Retired President East Zone of McDonald’s
Corporation
James J. Scanlan (1, 2)
Director since 2015
Retired U.S. Insurance Industry Leader
of Pricewaterhouse Coopers LLP
Michael J. Stone (4, 5)
Director since 2012
Former President & COO of RLI Insurance
Company
1: Executive Resources Committee
2: Audit Committee
3: Nominating/Corporate Governance Committee
4: Finance and Investment Committee
5: Strategy Committee
EXECUTIVE
TEAM
Thomas L. Brown
Senior Vice President, Chief Financial Officer
Industry experience - 38 years
Todd W. Bryant
Vice President, Finance & Controller
Industry experience - 25 years
Seth A. Davis
Vice President, Corporate Services
Industry experience - 23 years
Aaron P. Diefenthaler
Vice President, Chief Investment Officer
& Treasurer
Industry experience - 17 years
Patrick D. Ferrell
Vice President, Internal Audit
Industry experience - 26 years
Jeffrey D. Fick
Senior Vice President, Chief Legal Officer
Industry experience - 14 years
Bryan T. Fowler
Vice President, Chief Information Officer
Industry experience - 21 years
Robert S. Handzel
Vice President, Chief Claim Officer
Industry experience - 41 years
Aaron H. Jacoby
Vice President, Corporate Development
Industry experience - 18 years
Jill C. Johnson
Vice President, Branch Operations
Industry experience - 35 years
Kathleen M. Kappes
Vice President, Human Resources
Industry experience - 16 years
Craig W. Kliethermes
President & COO
Industry experience - 34 years
EXECUTIVE TEAM (Cont.)
Jennifer L. Klobnak
Senior Vice President, Operations
Industry experience - 19 years
Elizabeth K. McLaughlin
Vice President, Chief Claim Counsel
Industry experience - 33 years
Jonathan E. Michael
Chairman & CEO
Industry experience - 42 years
Christopher D. Randall
Vice President, Risk Services
Industry experience - 24 years
Jean M. Stephenson
Vice President, Corporate Secretary
Industry experience - 24 years
FIELD
OFFICERS
CASUALTY
William R. Bell, III
Vice President, Environmental E&S
Industry experience - 31 years
Chad S. Berberich
Vice President, Executive Products Group
Industry experience - 22 years
Carol J. Denzer
Vice President, Small Commercial Lines
Industry experience - 33 years
Paul C. Dietrich
Vice President, Professional Services Group
Industry experience - 31 years
Dennis H. Drees
Vice President, Casualty Brokerage
Industry experience - 37 years
Jeffrey D. Foering
Vice President, Energy Casualty
Industry experience - 35 years
Daniel N. Meyer
President, RLI Transportation
Industry experience - 18 years
Richard D. Nesbitt
Vice President, General Binding Authority
Industry experience - 41 years
Richard W. Quehl
Senior Vice President, Commercial P&C
Industry experience - 49 years
Eric J. Raudins
Vice President, Specialty Personal Lines
Industry experience - 28 years
Paul J. Simoneau
Senior Vice President, E&S Lines
Industry experience - 41 years
CONTRACTORS BONDING AND
INSURANCE COMPANY
Robert M. Ogle
Vice President, Contractors Bonding
and Insurance Company
Industry experience - 30 years
PROPERTY
Robert J. Schauer
President, RLI Marine
Industry experience - 31 years
John A. Stenhouse
Vice President, E&S Property
Industry experience - 30 years
SURETY
Greg E. Chilson
Vice President, Surety
Industry experience - 27 years
Barton W. Davis
Vice President, Surety Underwriting
Industry experience - 31 years
Robert G. Kirk
Vice President, Commercial Surety
Industry experience - 28 years
Brian A. Schick
Vice President, Contract Surety
Industry experience - 24 years
CLAIM
Matthew R. Campen
Vice President, Claim
Industry experience - 15 years
Donald J. Driscoll
Vice President, Claim
Industry experience - 33 years
Kevin S. Horwitz
Vice President, Claim
Industry experience - 18 years
William J. Irish
Vice President, Claim
Industry experience - 32 years
Nicolas C. Mesco
Vice President, Claim
Industry experience - 11 years
10
SELECTED FINANCIAL DATA
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
The following is
selected financial
data of RLI Corp. and
subsidiaries for the 10
years ended December
31, 2018.
Amounts in thousands,
except per share data
and combined ratios.
11
Operating Results
Gross premiums written
Consolidated revenue
Net earnings
Comprehensive earnings
Operating earnings(1)
Net cash provided from operating activities
Financial Condition
Total investments and cash
Total assets
Unpaid losses and settlement expenses
Total debt
Total shareholders’ equity
Statutory surplus(2)
Share Information(3)
Net earnings per share(1):
Basic
Diluted
Comprehensive earnings per share:
Basic
Diluted
Operating earnings per share (1):
Basic
Diluted
Cash dividends declared per share:
Regular
Special
Book value per share
Closing stock price
Stock split
Weighted average shares outstanding:
Basic
Diluted
Common shares outstanding
Other Non-GAAP Financial Information
Net premiums written to statutory surplus(2)
GAAP combined ratio(4)
Statutory combined ratio(2)(4)
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
983,216
818,123
64,179
30,182
92,088
217,102
2,194,230
3,105,065
1,461,348
149,115
806,842
829,775
885,312
797,224
105,028
140,337
102,161
197,525
2,140,790
2,947,244
1,271,503
148,928
853,598
864,554
874,864
816,328
114,920
113,756
92,401
174,463
2,021,827
2,777,633
1,139,337
148,741
823,572
859,976
853,586
794,634
137,544
89,935
111,654
152,586
1,951,543
2,735,465
1,103,785
148,554
823,469
865,268
863,848
775,165
135,445
170,801
114,526
123,085
1,964,285
2,774,284
1,121,040
148,367
845,062
849,297
1.45
1.43
0.68
0.67
2.08
2.05
0.87
1.00
18.13
68.99
2.39
2.36
3.19
3.15
2.32
2.30
0.83
1.75
19.33
60.66
2.63
2.59
2.60
2.56
2.11
2.08
0.79
2.00
18.74
63.13
3.18
3.12
2.08
2.04
2.58
2.53
0.75
2.00
18.91
61.75
44,358
44,835
44,504
44,033
44,500
44,148
99%
94.7
94.0
87%
96.4
96.2
43,772
44,432
43,945
86%
89.5
89.0
43,299
44,131
43,544
83%
84.5
83.9
3.15
3.09
3.97
3.90
2.66
2.61
0.71
3.00
19.61
49.40
43,020
43,819
43,103
83%
84.5
84.1
134,966
36,240(5)
117,991(5)
843,195
705,601
126,255
119,112
111,932
1,922,058
2,738,912
1,129,433
148,184
828,966
859,221
784,799
660,774
103,346
129,191
86,854
702,107
619,169
126,598
147,931
115,525
1,840,881
2,644,520
1,158,483
99,888
796,363
684,072
1,900,288
2,654,615
1,150,714
99,781
792,634
710,186
636,316
583,424
128,197
146,778
113,089
100,235
1,803,021
2,480,073
1,173,943
99,674
769,151
732,379
631,200
546,552
92,431
154,712
100,722
127,759
1,852,502
2,502,850
1,146,460
99,567
809,260
784,161
2.95
2.90
2.79
2.74
2.62
2.57
0.67
1.50
19.29
48.69
200%(3)
42,744
43,514
42,982
78%
83.1
82.2
2.44
2.39
3.04
2.99
2.05
2.01
0.63
2.50
18.73
32.22
3.00
2.95
3.51
3.45
2.74
2.69
0.60
2.50
18.73
36.43
3.05
3.02
3.49
3.46
2.69
2.66
0.58
3.50
18.34
26.29
2.14
2.13
3.59
3.56
2.34
2.32
0.54
–
19.03
26.63
42,431
43,160
42,525
42,156
42,869
42,324
42,040
42,482
41,929
43,123
43,461
42,259
87%
89.0
88.0
77%
79.6
79.1(6)
66%
80.4
81.4
60%
82.8
83.9
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
Operating Results
Gross premiums written
Consolidated revenue
Net earnings
Comprehensive earnings
Operating earnings(1)
Net cash provided from operating activities
Financial Condition
Total investments and cash
Total assets
Total debt
Unpaid losses and settlement expenses
Total shareholders’ equity
Statutory surplus(2)
Share Information(3)
Net earnings per share(1):
Comprehensive earnings per share:
Operating earnings per share (1):
Cash dividends declared per share:
Regular
Special
Book value per share
Closing stock price
Stock split
Weighted average shares outstanding:
Basic
Diluted
Basic
Diluted
Basic
Diluted
Basic
Diluted
Common shares outstanding
Other Non-GAAP Financial Information
Net premiums written to statutory surplus(2)
GAAP combined ratio(4)
Statutory combined ratio(2)(4)
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
983,216
818,123
64,179
30,182
92,088
217,102
2,194,230
3,105,065
1,461,348
149,115
806,842
829,775
885,312
797,224
105,028
140,337
102,161
197,525
2,140,790
2,947,244
1,271,503
148,928
853,598
864,554
874,864
816,328
114,920
113,756
92,401
174,463
2,021,827
2,777,633
1,139,337
148,741
823,572
859,976
853,586
794,634
137,544
89,935
111,654
152,586
1,951,543
2,735,465
1,103,785
148,554
823,469
865,268
863,848
775,165
135,445
170,801
114,526
123,085
1,964,285
2,774,284
1,121,040
148,367
845,062
849,297
1.45
1.43
0.68
0.67
2.08
2.05
0.87
1.00
18.13
68.99
2.39
2.36
3.19
3.15
2.32
2.30
0.83
1.75
19.33
60.66
2.63
2.59
2.60
2.56
2.11
2.08
0.79
2.00
18.74
63.13
3.18
3.12
2.08
2.04
2.58
2.53
0.75
2.00
18.91
61.75
44,358
44,835
44,504
44,033
44,500
44,148
99%
94.7
94.0
87%
96.4
96.2
43,772
44,432
43,945
86%
89.5
89.0
43,299
44,131
43,544
83%
84.5
83.9
3.15
3.09
3.97
3.90
2.66
2.61
0.71
3.00
19.61
49.40
43,020
43,819
43,103
83%
84.5
84.1
843,195
705,601
126,255
119,112
111,932
134,966
1,922,058
2,738,912
1,129,433
148,184
828,966
859,221
784,799
660,774
103,346
129,191
86,854
36,240(5)
702,107
619,169
126,598
147,931
115,525
117,991(5)
1,840,881
2,644,520
1,158,483
99,888
796,363
684,072
1,900,288
2,654,615
1,150,714
99,781
792,634
710,186
636,316
583,424
128,197
146,778
113,089
100,235
1,803,021
2,480,073
1,173,943
99,674
769,151
732,379
631,200
546,552
92,431
154,712
100,722
127,759
1,852,502
2,502,850
1,146,460
99,567
809,260
784,161
2.95
2.90
2.79
2.74
2.62
2.57
0.67
1.50
19.29
48.69
200%(3)
42,744
43,514
42,982
78%
83.1
82.2
2.44
2.39
3.04
2.99
2.05
2.01
0.63
2.50
18.73
32.22
3.00
2.95
3.51
3.45
2.74
2.69
0.60
2.50
18.73
36.43
3.05
3.02
3.49
3.46
2.69
2.66
0.58
3.50
18.34
26.29
2.14
2.13
3.59
3.56
2.34
2.32
0.54
–
19.03
26.63
42,431
43,160
42,525
42,156
42,869
42,324
42,040
42,482
41,929
43,123
43,461
42,259
87%
89.0
88.0
77%
79.6
79.1(6)
66%
80.4
81.4
60%
82.8
83.9
(1) Operating earnings and operating earnings per share are non-GAAP financial
measures and consist of our GAAP net earnings adjusted by net realized gains/
(losses), net unrealized gains/(losses) on equity securities that are recognized
through net earnings in 2018 and forward and taxes related thereto. Net earnings
and net earnings per share are the GAAP financial measures that are most
directly comparable to operating earnings and operating earnings per share.
(2) Ratios and surplus information are presented on a statutory basis. As discussed
in Item 7, Management’s Discussion and Analysis of Financial Condition and
Results of Operations, statutory accounting principles differ from GAAP and are
generally based on a solvency concept. Further discussion is included in note 9
to the consolidated financial statements within Item 8, Financial Statements and
Supplementary Data. Reporting of statutory surplus is a required disclosure under
GAAP.
(3) On January 15, 2014, our stock split on a 2-for-1 basis. All share and per share
data has been retroactively stated to reflect this split.
(4) See page 35 for information regarding non-GAAP financial measures.
(5) Operating cash flow for 2011 includes a $50.0 million cash deposit that we
received from a commercial surety customer in lieu of credit. The return of this
$50.0 million deposit is reflected in operating cash flow for 2012.
(6) Includes statutory results of CBIC post-acquisition.
12
INVESTOR INFORMATION
RLI STOCK
RLI Corp. common stock trades on the New York Stock Exchange
under the symbol RLI.
COMPANY FINANCIAL STRENGTH RATINGS
A.M. Best:
A+ (Superior) RLI Group
Standard & Poor’s: A+ (Strong)
RLI Insurance Company
SHAREHOLDER INQUIRIES
Shareholders of record with requests concerning individual account
balances, stock certificates, dividends, stock transfers, tax
information or address corrections should contact the transfer
agent and registrar:
Moody’s:
A+ (Strong) Mt. Hawley Insurance
Company
A2 (Good)
A2 (Good)
RLI Insurance Company
Mt. Hawley Insurance
Company
Our financial strength ratings reflect each rating agency’s opinion of
our financial strength, operating performance and ability to meet our
obligations to policyholders and are not evaluations directed toward
the protection of investors.
CONTACTING RLI
For investor relations requests and management’s perspective on
specific issues, contact Aaron Jacoby, Vice President, Corporate
Development, at 309-693-5880 or at aaron.jacoby@rlicorp.com.
RLI Corp.
9025 N. Lindbergh Drive
Peoria, Illinois 61615-1431
Phone: 309-692-1000 or
800-331-4929
Fax: 309-692-1068
Find comprehensive
investor information
at rlicorp.com.
EQ Shareholder Services
P.O. Box 64856
St. Paul, MN 55164-0854
Phone: 800-468-9716 or 651-450-4064
Fax: 651-450-4085
shareowneronline.com
DIVIDEND REINVESTMENT PLANS
If you wish to sign up for an automatic dividend reinvestment and
stock purchase plan or to have your dividends deposited directly
into your checking, savings or money market accounts, send your
request to the transfer agent and registrar.
REQUESTS FOR ADDITIONAL INFORMATION
Electronic versions of the following documents are or will be
made available on our website: 2018 annual report on form 10-K;
2019 proxy statement; code of conduct; corporate governance
guidelines; and charters of the executive resources, audit, finance
and investment, strategy and nominating/corporate governance
committees of our board. Printed copies of these documents are
available without charge to any shareholder. To be placed on a
mailing list to receive shareholder materials, contact our corporate
headquarters.
13
OUR MISSION• We provide our customers with outstanding service through innovative risk management products and solutions.• We are dedicated to carefully chosen niche markets.• We attract outstanding talent and continuously develop our expertise.• We constantly re-evaluate, enhance and reinvigorate our business model to create new products, services and delivery systems.• We create long-term shareholder value by pursuing profitable growth, underwriting for a profit and earning returns that significantly exceed our cost of capital.OUR VALUESWe are talented.We are innovative.We are customer focused.We are driven.We are people of integrity.We are respectful.We are owners. 15A HIGHER STANDARD2018 YEAR IN REVIEW9025 N. LINDBERGH DRIVEPEORIA, IL 61615-1431P: 309.692.1000 | RLICORP.COM©2018 RLI CORP.1.0M UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the transition period from to
Commission File Number 001-09463
RLI CORP.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
37-0889946
(I.R.S. Employer Identification No.)
9025 North Lindbergh Drive, Peoria, Illinois
(Address of principal executive offices)
61615
(Zip Code)
Securities registered pursuant to Section 12(b) of the Act:
Registrant’s telephone number, including area code (309) 692-1000
Title of each class
Name of each exchange on which registered
Common Stock $0.01 par value
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to
Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required
to submit such files). Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting
company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and
“emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No
The aggregate market value of the registrant’s common stock held by non-affiliates of the Registrant as of June 30, 2018, based upon the closing
sale price of the Common Stock on June 30, 2018 as reported on the New York Stock Exchange, was $2,616,706,281. Shares of Common Stock
held directly or indirectly by each reporting officer and director along with shares held by the Company ESOP have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
The number of shares outstanding of the Registrant’s Common Stock, $0.01 par value, on February 7, 2019 was 44,512,543.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the Registrant’s definitive Proxy Statement for the 2019 annual meeting of shareholders to be held May 2, 2019, are
incorporated herein by reference into Part III of this document, including: “Share Ownership of Certain Beneficial Owners,”
“Board Meetings and Compensation,” “Compensation Discussion & Analysis,” “Executive Compensation,” “Equity
Compensation Plan Information,” “Executive Management,” “Corporate Governance and Board Matters,” “Audit Committee
Report” and “Proposal three: Ratification of Selection of Independent Registered Public Accounting Firm.”
Exhibit index is located on pages 121-122 of this document, which lists documents filed as exhibits or incorporated by
reference herein.
2
RLI Corp.
Index to Annual Report on Form 10-K
Part I
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Part II
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
Part III
Items 10-14.
Part IV
Item 15.
Exhibits and Financial Statement Schedules
Page
4
23
30
30
30
30
31
33
34
60
63
110
110
110
110
110
3
Item 1. Business
PART I
RLI Corp. (the “Company”) was founded in 1965. We underwrite select property and casualty insurance through major
subsidiaries collectively known as RLI Insurance Group. We conduct operations principally through three insurance
companies. RLI Insurance Company (RLI Ins.), a subsidiary of RLI Corp. and our principal insurance subsidiary, writes
multiple lines of insurance on an admitted basis in all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands and
Guam. Mt. Hawley Insurance Company (Mt. Hawley), a subsidiary of RLI Ins., writes excess and surplus lines insurance on a
non-admitted basis in all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam. Contractors Bonding
and Insurance Company (CBIC), a subsidiary of RLI Ins., writes multiple lines of insurance on an admitted basis in all 50
states and the District of Columbia. Each of our insurance companies is domiciled in Illinois. We have no material foreign
operations.
As a specialty insurance company with a niche focus, we offer insurance coverages in the specialty admitted and excess
and surplus markets. We distribute our property and casualty insurance through our branch offices that market to wholesale and
retail producers. We offer limited coverages on a direct basis to select insureds, as well as various reinsurance coverages. In
addition, from time to time, we produce a limited amount of business under agreements with managing general agents under
the direction of our product vice presidents.
We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments
to those reports filed with or furnished to the Securities and Exchange Commission (SEC) available free of charge on our
website (rlicorp.com). Information contained on our website is not intended to be incorporated by reference in this annual
report and you should not consider that information a part of this annual report. The SEC also maintains a website
(http://www.sec.gov) that contains reports, proxy and information statements and other information regarding the Company.
For the year ended December 31, 2018, the following table provides the geographic distribution of our risks insured as
represented by direct premiums earned for all coverages:
State
California
New York
Florida
Texas
Washington
New Jersey
Illinois
Arizona
Louisiana
Georgia
Pennsylvania
Ohio
Hawaii
All Other
Total direct premiums earned
Direct Premiums Earned Percent of Total
(in thousands)
$
$
141,868
126,672
88,992
79,766
32,374
27,754
25,323
24,475
24,136
21,296
19,529
19,165
18,575
246,309
896,234
15.8 %
14.1 %
9.9 %
8.9 %
3.6 %
3.1 %
2.8 %
2.7 %
2.7 %
2.4 %
2.2 %
2.2 %
2.1 %
27.5 %
100.0 %
In the ordinary course of business, we rely on other insurance companies to share risks through reinsurance. A large
portion of the reinsurance is put into effect under contracts known as treaties and, in some instances, by negotiation on each
individual risk (known as facultative reinsurance). We have quota share, excess of loss and catastrophe (CAT) reinsurance
contracts that protect against losses over stipulated amounts arising from any one occurrence or event. These arrangements
allow the Company to pursue greater diversification of business and serve to limit the maximum net loss on catastrophes and
large risks. Reinsurance is subject to certain risks, specifically market risk, which affect the cost of and the ability to secure
these contracts, and credit risk, which is the risk that our reinsurers may not pay on losses in a timely fashion or at all. The
following table illustrates the degree to which we have utilized reinsurance during the past three years. For an expanded
discussion of the impact of reinsurance on our operations, see note 5 to the consolidated financial statements within Item 8,
Financial Statements and Supplementary Data.
4
(in thousands)
PREMIUMS WRITTEN
Direct & Assumed
Reinsurance ceded
Net
PREMIUMS EARNED
Direct & Assumed
Reinsurance ceded
Net
Year Ended December 31,
2017
2018
2016
$ 983,216
$ 874,864
$ 885,312
(160,041) (135,458) (133,912)
$ 740,952
$ 749,854
$ 823,175
$ 938,160
$ 863,180
$ 867,639
(146,794) (129,702) (134,572)
$ 728,608
$ 737,937
$ 791,366
SPECIALTY INSURANCE MARKET OVERVIEW
The specialty insurance market differs significantly from the standard market. In the standard market, products and
coverage are largely uniform with relatively predictable exposures and companies tend to compete for customers on the basis
of price. In contrast, the specialty market provides coverage for risks that do not fit the underwriting criteria of the standard
carriers. Competition tends to focus less on price and more on availability, coverage, service and other value-based
considerations. While specialty market exposures may have higher insurance risks than their standard admitted market
counterparts, we manage these risks to achieve higher financial returns. To reach our financial and operational goals, we must
have extensive knowledge of, and expertise in, our markets. Many of our risks are underwritten on an individual basis and
tailored coverages are employed in order to respond to distinctive risk characteristics. We operate in the specialty admitted
insurance market, the excess and surplus insurance market and the specialty reinsurance markets.
SPECIALTY ADMITTED INSURANCE MARKET
We write business in the specialty admitted market. Most of these risks are unique and hard to place in the standard
admitted market, but for marketing and regulatory reasons, they must remain with an admitted insurance company. The
specialty admitted market is subject to greater state regulation than the excess and surplus market, particularly with regard to
rate and form filing requirements, restrictions on the ability to exit lines of business, premium tax payments and membership in
various state associations, such as state guaranty funds and assigned risk plans. For 2018, our specialty admitted operations
produced gross premiums written of $619.6 million, representing approximately 63 percent of our total gross premiums for the
year.
EXCESS AND SURPLUS INSURANCE MARKET
The excess and surplus market focuses on hard-to-place risks. Participating in this market allows the Company to
underwrite non-standard risks with more flexible policy forms and unregulated premium rates. This typically results in
coverages that are more restrictive and more expensive than in the standard admitted market. The excess and surplus lines
regulatory environment and production model also effectively filter submission flow and match market opportunities to our
expertise and appetite. According to the 2018 edition of A.M. Best Aggregate & Averages – Property/Casualty, United States
& Canada, the excess and surplus market represented approximately $23 billion, or 4 percent, of the entire $642 billion
domestic property and casualty industry in 2017, as measured by direct premiums written. Our excess and surplus operations
wrote gross premiums of $316.9 million, or 32 percent, of our total gross premiums written in 2018.
SPECIALTY REINSURANCE MARKETS
We write business in the specialty reinsurance markets. This business is generally written on a portfolio (treaty) basis. We
write contracts on an excess of loss and a proportional basis. Contract provisions are written and agreed upon between the
company and its reinsurance clients. The business is typically more volatile as a result of unique underlying exposures and
excess and aggregate attachments. For 2018, our specialty reinsurance operations wrote gross premiums of $46.7 million,
representing approximately 5 percent of our total gross premiums written for the year.
BUSINESS SEGMENT OVERVIEW
The segments of our insurance operations are casualty, property and surety. For additional information, see note 11 to the
consolidated financial statements within Item 8, Financial Statements and Supplementary Data.
5
CASUALTY SEGMENT
Commercial Excess and Personal Umbrella
Our commercial excess coverage is written in excess of primary liability insurance provided by other carriers and in
excess of primary liability written by the Company. The personal umbrella coverage is written in excess of homeowners’ and
automobile liability coverage provided by other carriers, except in Hawaii, where some underlying homeowners’ coverage is
written by the Company. Net premiums earned from this business totaled $124.4 million, $115.5 million and $111.1 million, or
16 percent, 16 percent and 15 percent of total net premiums earned for 2018, 2017 and 2016, respectively.
General Liability
Our general liability business consists primarily of coverage for third-party liability of commercial insureds including
manufacturers, contractors, apartments and mercantile. We also offer coverages for security guards and in the specialized areas
of onshore energy-related businesses and environmental liability for underground storage tanks, contractors and asbestos and
environmental remediation specialists. Net premiums earned from our general liability business totaled $93.9 million, $90.3
million and $86.9 million, or 12 percent of total net premiums earned for 2018, 2017 and 2016, respectively.
Commercial Transportation
Our transportation insurance provides commercial automobile liability and physical damage insurance to local,
intermediate and long haul truckers, public transportation entities and equipment dealers, along with other types of specialty
commercial automobile risks. We also offer incidental, related insurance coverages including general liability, excess liability
and motor truck cargo. We produce business through independent agents and brokers nationwide. Net premiums earned from
this business totaled $81.1 million, $78.1 million and $81.4 million, or 10 percent, 11 percent and 11 percent of total net
premiums earned for 2018, 2017 and 2016, respectively.
Professional Services
We offer professional liability coverages focused on providing errors and omission coverage to small to medium-sized
design, technical, computer and miscellaneous professionals. Our product suite for these customers also includes a full array of
multi-peril package products including general liability, property, automobile, excess liability and workers’ compensation
coverages. This business primarily markets its products through specialty retail agents nationwide. Net premiums earned from
the professional services group totaled $80.0 million, $78.5 million and $75.9 million, or 10 percent, 11 percent and 10 percent
of total net premiums earned for 2018, 2017 and 2016, respectively.
Small Commercial
Our small commercial business offers property and casualty insurance coverages to small contractors and other small to
medium-sized retail businesses. The coverages included in these packages are predominantly general liability, but also have
some inland marine coverages as well as commercial automobile, property and umbrella coverage. These products are
primarily marketed through retail agents. Net premiums earned from the small commercial business totaled $51.5 million,
$49.6 million and $45.7 million, or 6 percent, 7 percent and 6 percent of total net premiums earned for 2018, 2017 and 2016,
respectively.
Executive Products
We provide a suite of management liability coverages, such as directors and officers (D&O) liability insurance, fiduciary
liability and fidelity coverages, for a variety of risk classes, including both public and private businesses. Our publicly traded
D&O appetite generally focuses on offering excess “Side A” D&O coverage (where corporations cannot indemnify the
individual directors and officers) as well as excess full coverage D&O. Additionally, we offer representations and warranties
coverage for companies involved in mergers and acquisitions, tax liability representations and warranties coverage for
companies claiming certain tax credits and excess cyber liability coverage to medium to large size public and private
businesses. Net premiums earned from the executive products business totaled $21.3 million, $18.1 million and $18.8 million,
or 3 percent, 2 percent and 3 percent of total net premiums earned for 2018, 2017 and 2016, respectively.
6
Medical Professional Liability
We provide healthcare liability coverage focused on long-term care. In early 2019, we exited the long-term care business
on a runoff basis. We also offer medical professional liability insurance specializing in hard-to-place individuals and group
physicians. This business is marketed through wholesale brokers and retail agents. Net premiums earned from the medical
professional liability business totaled $16.0 million, $17.1 million and $17.4 million, or 2 percent of total net premiums earned
for 2018, 2017 and 2016, respectively.
Other Casualty
We offer a variety of other smaller products in our casualty segment, including home business insurance, which provides
limited liability and property coverage, on and off-site, for a variety of small business owners who work from their own home.
We have a quota share reinsurance agreement with Prime Insurance Company and Prime Property and Casualty Insurance Inc.,
the two insurance subsidiaries of Prime Holdings Insurance Services, Inc. (Prime). We assume general liability, excess,
commercial auto, property and professional liability coverages on hard-to-place risks that are written in the excess and surplus
and admitted insurance markets. Additionally, we write mortgage reinsurance, which provides credit risk transfer on pools of
mortgages, and offer general liability coverage through a general binding authority (GBA) group. Net premiums earned from
these lines totaled $55.3 million, $31.4 million and $17.8 million, or 7 percent, 4 percent and 2 percent of total net premiums
earned for 2018, 2017 and 2016, respectively.
PROPERTY SEGMENT
Commercial Property
Our commercial property coverage consists primarily of excess and surplus lines and specialty insurance such as fire,
earthquake and difference in conditions (DIC), which can include earthquake, wind, flood and collapse coverages. We provide
insurance for a wide range of commercial and industrial risks, such as office buildings, apartments, condominiums, builders’
risks and certain industrial and mercantile structures. Net premiums earned from the commercial property business totaled
$71.5 million, $63.1 million and $68.2 million, or 9 percent of total net premiums earned for 2018, 2017 and 2016,
respectively.
Marine
Our marine coverages include cargo, hull, protection and indemnity (P&I), marine liability, as well as inland marine
coverages including builders’ risks and contractors’ equipment. Although the predominant exposures are located within the
United States, there is some incidental international exposure written within these coverages. Net premiums earned from the
marine business totaled $59.8 million, $50.9 million and $48.3 million, or 8 percent, 7 percent and 7 percent of total net
premiums earned for 2018, 2017 and 2016, respectively.
Specialty Personal
We offer specialized homeowners’ insurance in select locations, including homeowners’ and dwelling fire insurance
through retail agents in Hawaii and a limited amount of homeowners’ insurance in Massachusetts and North Carolina. We also
offered recreational vehicle insurance, which we began phasing out towards the end of 2016. Net premiums earned from
specialty personal coverages totaled $16.9 million, $20.8 million and $25.0 million, or 2 percent, 3 percent and 3 percent of
total net premiums earned for 2018, 2017 and 2016, respectively.
Other Property
Our other property coverages consist of newer product offerings, such as general binding authority, and lines which we
have recently exited, including property reinsurance. Net premiums earned from these lines totaled $1.1 million, $3.5 million
and $10.7 million, or 1 percent or less of total net premiums earned for 2018, 2017 and 2016, respectively.
7
SURETY SEGMENT
Miscellaneous
Our miscellaneous surety coverage includes small bonds for businesses and individuals written through independent
insurance agencies throughout the United States. Examples of these types of bonds are license and permit, notary and court
bonds. These bonds are usually individually underwritten and utilize extensive automation tools for the underwriting and bond
delivery to our agents and principals. Net premiums earned from miscellaneous surety coverages totaled $47.0 million, $47.2
million and $46.2 million, or 6 percent of total net premiums earned for 2018, 2017 and 2016, respectively.
Contract
We offer bonds for small to medium-sized contractors throughout the United States, underwritten on an account basis.
Typically, these are performance and payment bonds for individual construction contracts. These bonds are marketed through a
select number of insurance agencies that have surety and construction expertise. We also offer bonds for small and emerging
contractors that are reinsured through the Federal Small Business Administration. Net premiums earned from contract surety
coverages totaled $28.2 million, $28.6 million and $28.2 million, or 4 percent of total net premiums earned for 2018, 2017 and
2016, respectively.
Commercial
We offer a large variety of commercial surety bonds for medium to large-sized businesses across a broad spectrum of
industries. These risks are underwritten on an account basis and coverage is marketed through a select number of regional and
national brokers with surety expertise. Net premiums earned from commercial surety coverages totaled $26.8 million, $27.6
million and $29.1 million, or 3 percent, 4 percent and 4 percent of total net premiums earned for 2018, 2017 and 2016,
respectively.
Energy
Our energy surety coverages provide commercial surety bonds for the energy, petrochemical and refining industries both
on and off shore. These risks are primarily underwritten on an account basis and are primarily marketed through insurance
producers with expertise in these industries. Net premiums earned from energy coverages totaled $16.7 million, $17.6 million
and $18.0 million, or 2 percent of total net premiums earned for 2018, 2017 and 2016, respectively.
MARKETING AND DISTRIBUTION
We distribute our coverages primarily through branch offices throughout the country that market to wholesale and retail
brokers and through independent agents.
BROKERS
The largest volume of broker-generated premium is in our commercial property, general liability, commercial surety,
commercial excess, commercial transportation and medical professional liability coverages. This business is produced through
independent wholesale and retail brokers.
INDEPENDENT AGENTS
We target classes of insurance, such as homeowners’ and dwelling fire, home business, surety and personal umbrella,
through independent agents. Several of these products involve detailed eligibility criteria, which are incorporated into strict
underwriting guidelines and prequalification of each risk using a system accessible by the independent agent. The independent
agent cannot bind the risk unless they receive approval from our underwriters or through our automated systems.
UNDERWRITING AGENTS
We contract with certain underwriting agencies, which have limited authority to bind or underwrite business on our
behalf. The underwriting agreements involve strict underwriting guidelines and the agents are subject to audits upon request.
These agencies may receive some compensation through contingent profit commission.
8
DIGITAL AND DIRECT
We utilize digital efforts to produce and efficiently process and service business including home businesses, high
performance drivers, small commercial and personal umbrella risks and surety bonding. On a direct basis, we also assume
premium on various reinsurance treaties.
COMPETITION
Our specialty property and casualty insurance subsidiaries are part of a very competitive industry that is cyclical and
historically characterized by periods of high premium rates and shortages of underwriting capacity followed by periods of
severe competition and excess underwriting capacity. Within the United States alone, approximately 2,600 companies actively
market property and casualty coverages. Our primary competitors in the casualty segment include Arch, Aspen, Chubb, CNA,
Great American, Great West, Hartford, Lancer, Markel, Navigators, Protective, RSUI, Sompo, USLI, Travelers and Zurich.
Primary competitors in the property segment include Arch, Aspen, Chubb, CNA, Crum & Forster, Great American, Lexington,
Sompo and Travelers. Primary competitors in the surety segment are AIG, Arch, Chubb, CNA, Great American, HCC,
Navigators, Sompo, Travelers and XL. The combination of coverages, service, pricing and other methods of competition vary
from line to line. Our principal methods of meeting this competition are innovative coverages, marketing structure and quality
service to the agents and policyholders at a fair price. We compete favorably, in part, because of our sound financial base and
reputation, as well as our broad, geographic footprint in all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands
and Guam. In the casualty, property and surety areas, we have experienced underwriting specialists in our branch and home
offices. We continue to maintain our underwriting and marketing standards by not seeking market share at the expense of
earnings. We have a track record of withdrawing from markets when conditions become overly adverse, and offering new
coverages and programs where the opportunity exists to provide needed insurance coverage with exceptional service on a
profitable basis.
FINANCIAL STRENGTH RATINGS
A.M. Best financial strength ratings for the industry range from ‘‘A++’’ (Superior) to ‘‘F’’ (In liquidation) with some
companies not being rated. Standard & Poor’s financial strength ratings for the industry range from ‘‘AAA’’ (Extremely
strong) to ‘‘R’’ (Regulatory action). Moody’s financial strength ratings for the industry range from “Aaa” (Exceptional) to “C”
(Lowest). The following table illustrates the range of ratings assigned by each of the three major rating companies that has
issued a financial strength rating on our insurance companies:
A.M. Best
SECURE
Superior
Excellent
Very good
A++, A+
A, A-
B++, B+
B, B-
C++, C+
C, C-
D
E
F
S
VULNERABLE
Fair
Marginal
Weak
Poor
Under regulatory
supervision
In liquidation
Rating suspended
Standard & Poor’s
SECURE
Extremely strong
Very strong
Strong
Good
VULNERABLE
Marginal
Weak
Very weak
Extremely weak
Regulatory action
AAA
AA
A
BBB
BB
B
CCC
CC
R
Aaa
Aa
A
Baa
Ba
B
Caa
Ca
C
Moody’s
STRONG
Exceptional
Excellent
Good
Adequate
WEAK
Questionable
Poor
Very poor
Extremely poor
Lowest
Within-category modifiers
+,-
1,2,3 (1 high, 3 low)
Publications of A.M. Best, Standard & Poor’s and Moody’s indicate that ‘‘A’’ and ‘‘A+’’ ratings are assigned to those
companies that, in their opinion, have achieved exceptional overall performance compared to the standards they have
established and have a strong ability to meet their obligations to policyholders over a long period of time. In evaluating a
company’s financial and operating performance, each of the firms review the company’s profitability, leverage and liquidity, as
well as the company’s spread of risk, the quality and appropriateness of its reinsurance, the quality and diversification of its
9
assets, the adequacy of its policy and loss reserves, the adequacy of its surplus, its capital structure, its risk management
practices and the experience and objectives of its management. These ratings are based on factors relevant to policyholders,
agents, insurance brokers and intermediaries and are not specifically related to securities issued by the company.
At December 31, 2018, the following ratings were assigned to our insurance companies:
A.M. Best
RLI Ins., Mt. Hawley and CBIC* (group-rated)
A+, Superior
Standard & Poor’s
RLI Ins. and Mt. Hawley
Moody’s
RLI Ins. and Mt. Hawley
* CBIC is only rated by A.M. Best
A+, Strong
A2, Good
For A.M. Best, Standard & Poor’s and Moody’s, the financial strength ratings represented above are affirmations of
previously assigned ratings. A.M. Best, in addition to assigning a financial strength rating, also assigns financial size
categories. In October 2018, RLI Ins., Mt. Hawley and CBIC, which are collectively rated as a group, were assigned a financial
size category of “XI” (adjusted policyholders’ surplus of between $750 million and $1 billion). As of December 31, 2018, the
policyholders’ statutory surplus of RLI Insurance Group totaled $829.8 million, which continues to result in A.M. Best’s
financial size category “XI”.
REINSURANCE
We reinsure a portion of our insurance exposure, paying or ceding to the reinsurer a portion of the premiums received on
such policies. Earned premiums ceded to non-affiliated reinsurers totaled $146.8 million, $129.7 million and $134.6 million in
2018, 2017 and 2016, respectively. Insurance is ceded principally to reduce net liability on individual risks and to protect
against catastrophic losses. We use reinsurance as an alternative to using our own capital to take risks and reduce volatility.
Retention levels are evaluated each year to maintain a balance between the growth in surplus and the cost of reinsurance.
Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does
make the assuming reinsurer liable to the insurer to the extent of the insurance ceded.
Reinsurance is subject to certain risks, specifically market risk (which affects the cost and ability to secure reinsurance
contracts) and credit risk (which relates to the ability to collect from the reinsurer on our claims). We purchase reinsurance
from financially strong reinsurers. We evaluate reinsurers’ ability to pay based on their financial results, level of surplus,
financial strength ratings and other risk characteristics. A reinsurance committee, comprised of senior management, reviews
and approves our security guidelines and reinsurer usage. More than 93 percent of our reinsurance recoverables are due from
companies with financial strength ratings of “A” or better by A.M. Best and Standard & Poor’s rating services. For more
information regarding our largest reinsurers, see note 5 to the consolidated financial statements within Item 8, Financial
Statements and Supplementary Data.
We utilize both treaty and facultative reinsurance coverage for our risks. Treaty coverage refers to a reinsurance contract
under which the company agrees to cede all risks within a defined class of business to the reinsurer, who agrees to provide
coverage on all risks ceded without individual underwriting. Facultative coverage is applied to individual risks at the
company’s discretion and is subject to underwriting by the reinsurer. It is used for a variety of reasons, including
supplementing the limits provided by the treaty coverage or covering risks or perils excluded from treaty reinsurance.
Much of our reinsurance is purchased on an excess of loss basis. Under an excess of loss arrangement, we retain losses on
a risk up to a specified amount and the reinsurers assume any losses above that amount. We may choose to participate in the
reinsurance layers purchased by retaining a percentage of the layer. It is common to find conditions in excess of loss covers
such as occurrence limits, aggregate limits and reinstatement premium charges. Occurrence limits cap our recovery for multiple
losses caused by the same event. Aggregate limits cap our recovery for all losses ceded during the contract term. We may be
required to pay additional premium to reinstate or have access to use the reinsurance limits for potential future recoveries
during the same contract year. Some property and surety treaties include reinstatement provisions which require the Company,
in certain circumstances, to pay reinstatement premiums after a loss has occurred in order to preserve coverage.
10
Excluding CAT reinsurance, the table below summarizes the reinsurance treaty coverage currently in effect. We may
purchase facultative coverage in excess of the per risk limits shown.
(in millions)
Product Line(s) Covered
General liability
Commercial excess
Personal umbrella and eXS
Commercial transportation
Package - liability and workers' comp
Workers' compensation catastrophe
Medical professional liability
Professional services - professional liability
Executive products
Property - risk cover
Marine
Surety
Contract Type
Date
Renewal
Attachment
Point
Per Risk
Limit
Maximum
Purchased Retention *
Excess of Loss
Excess of Loss
Excess of Loss
Excess of Loss
Excess of Loss
Excess of Loss
Excess of Loss
Excess of Loss
Quota Share
Excess of Loss
Excess of Loss
Excess of Loss
$
1/1 $
1/1
1/1
1/1
1/1
1/1
1/1
4/1
7/1
1.0 $
1.0
1.0
0.5
1.0
11.0
1.0
1.0
N/A
1/1
6/1
4/1
1.0
2.0
2.0
9.0
9.0
9.0
4.5
10.0
14.0
9.0
9.0
25.0
24.0
28.0
73.0
1.9
1.9
1.9
1.1
1.9
— **
1.9
3.3
8.8
1.2
2.0
9.7 ***
*
**
Maximum retention includes first-dollar retention plus any co-participation we retain through the reinsurance tower.
The workers’ compensation catastrophe treaty responds after our package liability and workers’ compensation excess of
loss treaty with no additional retention.
*** A limited number of commercial and energy surety accounts are permitted to exceed the $75.0 million limit. These
accounts are subject to additional levels of review and are monitored on a monthly basis.
At each renewal, we consider any plans to change the underlying insurance coverage we offer, as well as updated loss
activity, the level of RLI Insurance Group’s surplus, changes in our risk appetite and the cost and availability of reinsurance
treaties. In the last renewal cycle, we maintained similar retentions on most lines of business.
PROPERTY REINSURANCE — CATASTROPHE COVERAGE
Our property CAT reinsurance reduces the financial impact of a CAT event involving multiple claims and policyholders.
Reinsurance limits purchased fluctuate due to changes in the amount of exposure we insure, reinsurance costs, insurance
company surplus levels and our risk appetite. In addition, we monitor the expected rate of return for each of our CAT lines of
business. At high rates of return, we grow the book of business and may purchase additional reinsurance to increase our
capacity. As the rate of return decreases, we shrink the book and may purchase less reinsurance as this capacity becomes
unnecessary. Our reinsurance coverage for the last three years and for 2019 are shown in the following table:
Catastrophe Coverages
(in millions)
2019
2018
2017
2016
First- Dollar
Retention
Limit
First- Dollar
Retention
Limit
First- Dollar
Retention
Limit
First- Dollar
Retention
Limit
California Earthquake
Non-California Earthquake
Other Perils
$
25
25
25
400 $
425
275
25
25
25
300 $
325
225
25
25
25
300 $
325
225
25
25
25
300
325
225
These CAT limits are in addition to the per-occurrence coverage provided by facultative and other treaty coverages. We
have participated in the CAT layers purchased by retaining a percentage of each layer throughout this period. Our participation
has varied based on price and the amount of risk transferred by each layer. Since 2014, all layers of the treaty have included
one prepaid reinstatement.
Our property CAT program continues to be applied on an excess of loss basis. It attaches after all other reinsurance has
been considered. Although covered in one program, limits and attachment points differ for California earthquakes and all other
11
perils. The following charts use information from our CAT modeling software to illustrate our pre-tax net retention resulting
from particular events that would generate the gross losses.
Catastrophe - California Earthquake
(in millions)
Projected
Gross Loss
Ceded
Losses
Net
Losses
Ceded
Losses
Net
Losses
Ceded
Losses
Net
Losses
2019
2018
2017
$
$
50
100
200
300
450
$
29
73
163
257
396
$
21
27
37
43
54
$
29
72
163
256
391
$
21
28
37
44
59
$
29
73
163
256
395
21
27
37
44
55
Catastrophe - Other (Earthquake outside of California, Wind, Other)
(in millions)
Projected
Gross Loss
Ceded
Losses
Net
Losses
Ceded
Losses
Net
Losses
Ceded
Losses
Net
Losses
2019
2018
2017
$
$
$
25
50
100
200
300
7
24
63
144
226
$
18
26
37
56
74
$
6
24
64
143
224
$
19
26
36
57
76
$
5
20
59
146
231
20
30
41
54
69
In the above table, projected losses for 2019 were estimated based on our exposure as of December 31, 2018, utilizing the
treaty structure in place as of January 1, 2019. All previous years were estimated similarly by utilizing the treaty structure in
place at the start of the listed year and the exposure at the end of the previous year.
The previous tables were generated using theoretical probabilities of events occurring in areas where our portfolio of
currently in-force policies could generate the level of loss illustrated. Actual results could vary significantly from these tables
as the actual nature or severity of a particular event cannot be predicted with any reasonable degree of accuracy. Reinsurance
limits are purchased based on the anticipated losses from large events. The largest losses shown above are possible, but have a
low probability of actually occurring. However, there is a remote chance that a larger event could occur. If the actual event
losses are larger than anticipated, we could retain additional losses above the limit of our CAT reinsurance.
We continuously monitor and quantify our exposure to catastrophes including earthquakes, hurricanes, floods, convective
storms, terrorist acts and other aggregating events. In the normal course of business, we manage our concentrations of
exposures to catastrophic events, primarily by limiting concentrations of locations insured to acceptable levels and by
purchasing reinsurance. Exposure and coverage detail is recorded for each risk location. We quantify and monitor the total
policy limit insured in each geographical region. In addition, we use third-party CAT exposure models and an internally
developed analysis to assess each risk to ensure we include an appropriate charge for assumed CAT risks. CAT exposure
modeling is inherently uncertain due to the model’s reliance on an infrequent observation of actual events and exposure data,
increasing the importance of capturing accurate policy coverage data. The model results are used both in the underwriting
analysis of individual risks and at a corporate level for the aggregate book of CAT-exposed business. From both perspectives,
we consider the potential loss produced by individual events that represent moderate-to-high loss potential at varying
probabilities and magnitudes. In calculating potential losses, we select appropriate assumptions including, but not limited to,
loss amplification and loss adjustment expense. We establish risk tolerances at the portfolio level based on market conditions,
the level of reinsurance available, changes to the assumptions in the CAT models, rating agency capital constraints,
underwriting guidelines and coverages and internal preferences. Our risk tolerances for each type of CAT, and for all perils in
aggregate, change over time as these internal and external conditions change. We are required to report to the rating agencies
estimated loss to a single event that could include all potential earthquakes and hurricanes contemplated by the CAT modeling
software. This reported loss includes the impact of insured losses based on the estimated frequency and severity of potential
events, loss adjustment expense, reinstatements paid after the loss, reinsurance recoveries and taxes. Based on the CAT
reinsurance treaty purchased on January 1, 2019, there is a 99.6 percent likelihood that the loss will be less than 16.2 percent of
policyholders’ surplus as of December 31, 2018. The exposure levels are within our tolerances for this risk.
12
LOSSES AND SETTLEMENT EXPENSES
OVERVIEW
Loss and loss adjustment expense (LAE) reserves represent our best estimate of ultimate payments for losses and related
settlement expenses from claims that have been reported but not paid and losses that have been incurred but not yet reported to
the Company (IBNR). Loss reserves do not represent an exact calculation of liability, but instead represent our estimates,
generally utilizing individual claim estimates, actuarial expertise and estimation techniques at a given accounting date. The loss
reserve estimates are expectations of what ultimate settlement and administration of claims will cost upon final resolution.
These estimates are based on facts and circumstances then known to the Company, review of historical settlement patterns,
estimates of trends in claims frequency and severity, projections of loss costs, expected interpretations of legal theories of
liability and many other factors. In establishing reserves, we also take into account estimated recoveries from reinsurance,
salvage and subrogation. The reserves are reviewed regularly by a team of actuaries we employ.
Net loss and loss adjustment reserves by product line at year-end 2018 and 2017 are illustrated in the following table.
LAE is classified in the table as either allocated loss adjustment expense (ALAE) or unallocated loss adjustment expense
(ULAE). ALAE refers to estimates of claim settlement expenses that can be identified with a specific claim or case, while
ULAE cannot be identified with a specific claim. For a detailed discussion of loss reserves, refer to our critical accounting
policy in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(as of December 31, in thousands)
Product Line
Casualty segment net loss and ALAE
reserves
Commercial excess
Personal umbrella
General liability
Commercial transportation
Professional services
Small commercial
Executive products
Medical professional liability
Other casualty
Property segment net loss and ALAE
reserves
Commercial property
Marine
Specialty personal
Other property
Surety segment net loss and ALAE
reserves
Miscellaneous
Contract
Commercial
Energy
Latent liability net loss and ALAE
reserves
Total net loss and ALAE reserves
ULAE reserves
Total net loss and LAE reserves
$
Case
8,172
21,208
68,295
87,544
35,127
19,351
21,617
19,087
10,763
26,012
11,426
2,465
2,060
2,932
4,311
137
2,195
2018
IBNR
Total
Case
2017
IBNR
Total
$
$ 122,690
42,203
171,640
46,015
85,002
37,885
47,581
21,058
49,208
$
130,862
63,411
239,935
133,559
120,129
57,236
69,198
40,145
59,971
13,021
20,189
3,490
3,751
3,769
7,639
5,482
3,244
39,033
31,615
5,955
5,811
6,701
11,950
5,619
5,439
9,724
21,452
78,360
81,543
28,543
12,075
11,327
16,621
6,595
21,375
11,512
1,989
3,348
2,550
(1,939)
1,686
2,843
$ 99,745
39,395
149,102
38,161
81,558
34,344
44,484
10,526
31,302
$ 109,469
60,847
227,462
119,704
110,101
46,419
55,811
27,147
37,897
10,615
18,095
3,525
6,682
5,035
7,638
6,276
2,254
31,990
29,607
5,514
10,030
7,585
5,699
7,962
5,097
5,061
$ 347,763
—
$ 347,763
13,828
$ 697,695
50,891
$ 748,586
18,889
$ 1,045,458
50,891
$ 1,096,349
6,532
$ 316,136
—
$ 316,136
15,795
$ 604,532
48,844
$ 653,376
22,327
$ 920,668
48,844
$ 969,512
Following is a table of significant risk factors involved in estimating losses grouped by major product line. We distinguish
between loss ratio risk and reserve estimation risk. Loss ratio risk refers to the possible dispersion of loss ratios from year to year due
to inherent volatility in the business, such as high severity or aggregating exposures. Reserve estimation risk recognizes the difficulty
in estimating a given year’s ultimate loss liability. As an example, our property CAT business (included below in “other property”)
has significant variance in year over year results; however, its reserving estimation risk is relatively moderate.
13
Product line
Commercial excess
Significant Risk Factors
Length of
Reserve Tail
Long
Emergence
patterns relied
upon
Internal
Personal umbrella
Medium
Internal
General liability
Long
Internal
Commercial transportation
Medium
Internal
Expected loss Reserve
ratio
variability
High
estimation
variability
High
Other risk factors
Low frequency
High severity
Loss trend volatility
Exposure growth
Unforeseen tort potential
Exposure changes/mix
Medium
Low frequency
High severity
Loss trend volatility
Exposure growth
Unforeseen tort potential
Medium
Exposure changes/mix
Unforeseen tort potential
Medium
High
High severity
Exposure growth/mix
Loss trend volatility
Unforeseen tort potential
Medium
Medium
Professional services
Medium
Internal & external
Highly varied exposures Medium
Medium
Small commercial
Long
Internal
Loss trend volatility
Unforeseen tort potential
Exposure growth/mix
Unforeseen tort potential
Small volume
Medium
Medium
Executive products
Long
Internal & significant external
Low frequency
High severity
Loss trend volatility
Economic volatility
Unforeseen tort potential
Exposure growth/mix
Small volume
High
High
Medical professional liability
Long
External
High severity
Exposure changes/mix
Unforeseen tort potential
Small volume
Loss trend volatility
High
High
Other casualty
Marine
Other property
Medium
Internal & external
Small volume
Medium
Medium
Medium
Internal & external
Exposure growth/mix
High
High
Short
Internal
CAT aggregation exposure
Low frequency
High severity
High
Medium
Economic volatility
Uniqueness of exposure
Medium
Medium
Surety
Medium
Internal
Runoff including asbestos &
environmental
Long
Internal & external
Loss trend volatility
Mass tort/latent exposure
High
High
On a quarterly basis, actuaries perform a ground-up reserve study of the expected value of the unpaid loss and LAE
derived using multiple standard actuarial methodologies that are described below. In addition, an emergence analysis is
completed quarterly to determine if further adjustments are necessary. The purpose of this analysis is to provide validation of
our carried loss reserves. These estimates are then compared to the carried loss reserves to determine the appropriateness of the
current reserve balance.
The methodologies we have chosen to incorporate are a function of data availability and are reflective of our own book of
business. From time to time, we evaluate the need to add supplementary methodologies. New methods are incorporated if it is
14
believed they improve the estimate of our ultimate loss and LAE liability. All of the actuarial methods eventually converge to
the same estimate as an accident year matures. Our core methodologies are listed below with a short description and their
relative strengths and weaknesses:
Paid Loss Development — Historical payment patterns for prior claims are used to estimate future payment patterns for
current claims. These patterns are applied to current payments by accident year to yield an expected ultimate loss.
Strengths: The method reflects only the claim dollars that have been paid and is not subject to case-basis reserve changes
or changes in case reserve practices.
Weaknesses: External claims environment changes can impact the rate at which claims are settled and losses paid (e.g.
increase in attorney involvement or legal precedent). Adjustments to reflect changes in payment patterns on a prospective basis
are difficult to quantify. For losses that have occurred recently, payments can be minimal and thus early estimates are subject to
significant instability.
Incurred Loss Development — Historical case-incurred patterns (paid losses plus case reserves) for past claims are used
to estimate future case-incurred amounts for current claims. These patterns are applied to current case-incurred losses by
accident year to yield an expected ultimate loss.
Strengths: Losses are reported more quickly than paid, therefore, the estimates stabilize sooner. The method reflects
more information in the analysis than the paid loss development method.
Weaknesses: Method involves additional estimation risk if significant changes to case reserving practices have occurred.
Case Reserve Development — Patterns of historical development in reported losses relative to historical case reserves are
determined. These patterns are applied to current case reserves by accident year and the result is combined with paid losses to
yield an expected ultimate loss.
Strengths: Like the incurred development method, this method benefits from using the additional information available
in case reserves that is not available from paid losses only. It also can provide a more reasonable estimate than other methods
when the proportion of claims still open for an accident year is unusually high or low.
Weaknesses: It is subject to the risk of changes in case reserving practices or philosophy. It may provide unstable
estimates when an accident year is immature and more of the IBNR is expected to come from unreported claims rather than
development on reported claims and when accident years are very mature with infrequent case reserves.
Expected Loss Ratio — Historical loss ratios, in combination with projections of frequency and severity trends, as well as
estimates of price and exposure changes, are analyzed to produce an estimate of the expected loss ratio for each accident year.
The expected loss ratio is then applied to the earned premium for each year to estimate the expected ultimate losses. The
current accident year expected loss ratio is also the prospective loss and ALAE ratio used in our initial IBNR generation
process.
Strengths: Reflects an estimate independent of how losses are emerging on either a paid or a case reserve basis. This
method is particularly useful in the absence of historical development patterns or where losses take a long time to emerge.
Weaknesses: Ignores how losses are actually emerging and thus produces the same estimate of ultimate loss regardless of
favorable/unfavorable emergence.
Paid and Incurred Bornhuetter/Ferguson (BF) — This approach blends the expected loss ratio method with either the paid
or incurred loss development method. In effect, the BF methods produce weighted average indications for each accident year.
As an example, if the current accident year for commercial automobile liability is estimated to be 20 percent paid, then the paid
loss development method would receive a weight of 20 percent and the expected loss ratio method would receive an 80 percent
weight. Over time, this method will converge with the ultimate estimated by the respective loss development method.
Strengths: Reflects actual emergence that is favorable/unfavorable, but assumes remaining emergence will continue as
previously expected. Does not overreact to the early emergence (or lack of emergence) where patterns are most unstable.
15
Weaknesses: Could potentially understate favorable or unfavorable development by putting weight on the expected loss
ratio.
In most cases, multiple estimation methods will be valid for the particular facts and circumstances of the claim liabilities
being evaluated. Each estimation method has its own set of assumption variables and its own advantages and disadvantages,
with no single estimation method being better than the others in all situations, and no one set of assumption variables being
meaningful for all product line components. The relative strengths and weaknesses of the particular estimation methods, when
applied to a particular group of claims, can also change over time. Therefore, the weight given to each estimation method will
likely change by accident year and with each evaluation.
The actuarial central estimates typically follow a progression that places significant weight on the BF methods when
accident years are younger and claim emergence is immature. As accident years mature and claims emerge over time,
increasing weight is placed on the incurred development method, the paid development method and the case reserve
development method. For product lines with faster loss emergence, the progression to greater weight on the incurred and paid
development methods occurs more quickly.
For our long and medium-tail products, the BF methods are typically given the most weight for the first 36 months of
evaluation. These methods are also predominant for the first 12 months of evaluation for short-tail lines. Beyond these time
periods, our actuaries apply their professional judgment when weighting the estimates from the various methods deployed but
place significant reliance on the expected stage of development in normal circumstances.
Judgment can supersede this natural progression if risk factors and assumptions change, or if a situation occurs that
amplifies a particular strength or weakness of a methodology. Extreme projections are critically analyzed and may be adjusted,
given less credence or discarded altogether. Internal documentation is maintained that records any substantial changes in
methods or assumptions from one loss reserve study to another.
RESERVE SENSITIVITIES
There are three major parameters that have significant influence on our actuarial estimates of ultimate liabilities by
product. They are the actual losses that are reported, the expected loss emergence pattern and the expected loss ratios used in
the analyses. If the actual losses reported do not emerge as expected, it may cause the Company to challenge all or some of its
previous assumptions. We may change expected loss emergence patterns, the expected loss ratios used in our analysis and/or
the weights we place on a given actuarial method. The impact will be much greater and more leveraged for products with
longer emergence patterns. Our general liability product is an example of a product with a relatively long emergence pattern.
We have constructed a chart that illustrates the sensitivity of our general liability reserve estimates to these key parameters. We
believe the scenarios to be reasonable as similar favorable variations have occurred in recent years. For example, while our
general liability emergence has ranged from 8 percent to 18 percent favorable over the last three years, our emergence for all
products combined, excluding general liability, has ranged from 5 percent to 18 percent favorable. The numbers below are the
changes in estimated ultimate loss and ALAE in millions of dollars as of December 31, 2018, resulting from the change in the
parameters shown. These parameters were applied to a general liability net loss and LAE reserve balance of $239.9 million, in
addition to associated ULAE and latent liability reserves, at December 31, 2018.
(in millions)
Result from favorable Result from unfavorable
change in parameter
change in parameter
+/-5 point change in expected loss ratio for all
accident years
+/-10% change in expected emergence patterns
+/-30% change in actual loss emergence over a
calendar year
$
$
$
Simultaneous change in expected loss ratio (5pts),
expected emergence patterns (10%), and actual loss
emergence (30%).
$
(9.0) $
(6.5) $
9.0
6.2
(13.3) $
13.3
(28.1) $
29.1
16
There are often significant inter-relationships between our reserving assumptions that have offsetting or compounding
effects on the reserve estimate. Thus, in almost all cases, it is impossible to discretely measure the effect of a single assumption
or construct a meaningful sensitivity expectation that holds true in all cases. The scenario above is representative of general
liability, one of our largest and longest-tailed products. It is unlikely that all of our products would have variations as wide as
illustrated in the example. It is also unlikely that all of our products would simultaneously experience favorable or unfavorable
loss development in the same direction or at their extremes during a calendar year. Because our portfolio is made up of a
diversified mix of products, there would ordinarily be some offsetting favorable and unfavorable emergence by product as
actual losses start to emerge and our loss estimates become more reliable.
OPERATING RATIOS
PREMIUMS TO SURPLUS RATIO
The following table shows, for the periods indicated, our insurance subsidiaries’ statutory ratios of net premiums written
to policyholders’ surplus. While there is no statutory requirement applicable to the Company that establishes a permissible net
premiums written to surplus ratio, guidelines established by the National Association of Insurance Commissioners (NAIC)
provide that this ratio should generally be no greater than 3 to 1. While the NAIC provides this general guideline, rating
agencies often require a more conservative ratio to maintain strong or superior ratings.
(dollars in thousands)
Statutory net premiums written
Policyholders’ surplus
Ratio
$
2018
823,175
829,775
1.0 to 1
GAAP AND STATUTORY COMBINED RATIOS
$
2017
749,854
864,554
0.9 to 1
Year Ended December 31,
2016
740,952
859,976
0.9 to 1
$
2015
$
722,189
865,268
0.8 to 1
$
2014
703,152
849,297
0.8 to 1
Our underwriting experience is best indicated by our GAAP combined ratio, which is the sum of (a) the ratio of incurred
losses and settlement expenses to net premiums earned (loss ratio) and (b) the ratio of policy acquisition costs and other
operating expenses to net premiums earned (expense ratio). The difference between the combined ratio and 100 reflects the
per-dollar rate of underwriting income or loss, with ratios below 100 indicating underwriting profit and ratios above 100
indicating underwriting loss.
GAAP
Loss ratio
Expense ratio
Combined ratio
2018
2017
Year Ended December 31,
2016
2015
2014
54.1
40.6
94.7
54.4
42.0
96.4
48.0
41.5
89.5
42.7
41.8
84.5
43.2
41.3
84.5
We also calculate the statutory combined ratio, which is not indicative of GAAP underwriting income due to accounting
for policy acquisition costs differently for statutory accounting purposes compared to GAAP. The statutory combined ratio is
the sum of (a) the ratio of statutory loss and settlement expenses incurred to statutory net premiums earned (loss ratio) and
(b) the ratio of statutory policy acquisition costs and other underwriting expenses to statutory net premiums written (expense
ratio). The difference between the combined ratio and 100 reflects the per-dollar rate of underwriting income or loss.
Statutory
Loss ratio
Expense ratio
Combined ratio
2018
2017
Year Ended December 31,
2016
2015
2014
54.1
39.9
94.0
54.4
41.8
96.2
48.0
41.0
89.0
42.7
41.2
83.9
43.2
40.9
84.1
P&C industry combined ratio
99.4 *
103.9 **
100.7 **
97.9 **
97.2 **
* Source: Conning (2018). Property-Casualty Forecast & Analysis: By Line of Insurance, Fourth Quarter 2018. Estimated
for the year ended December 31, 2018.
** Source: A.M. Best (2018). Aggregate & Averages – Property/Casualty, United States & Canada. 2014 – 2017.
17
INVESTMENTS
Our investment portfolio serves as the primary resource for loss payments and secondly as a source of income to support
operations. Our investment strategy is based on preservation of capital as the first priority, with a secondary focus on growing
book value through total return. Investments of the highest quality and marketability are critical for preserving our claims-
paying ability. Our portfolio contains no derivatives or off-balance sheet structured investments. In addition, we have a
diversified investment portfolio that distributes credit risk across many issuers and a policy that limits aggregate credit
exposure. Despite periodic fluctuations in market value, our equity portfolio is part of a long-term asset allocation strategy and
has contributed significantly to our growth in book value.
Investment portfolios are managed both internally and externally by experienced portfolio managers. We follow an
investment policy that is reviewed quarterly and revised periodically, with oversight conducted by our senior officers and board
of directors.
Our investments include fixed income debt securities, common stock equity securities, exchange traded funds (ETFs) and
a small number of limited partnership interests. The fixed income portfolio increased to 80 percent of the total portfolio, while
the equity allocation declined to 16 percent of the overall portfolio. Other invested assets represented 2 percent of the total
portfolio and include investments in low income housing tax credit partnerships, membership stock in the Federal Home Loan
Bank of Chicago and investments in private funds. The remaining 2 percent was made up of cash and cash equivalents. As of
December 31, 2018, 84 percent of the fixed income portfolio was rated A or better and 64 percent was rated AA or better.
We classify all of the securities in our fixed income portfolio as available-for-sale, which are carried at fair value. Beyond
available operating cash flow, the portfolio provides an additional source of liquidity and can be used to address potential
future changes in our asset/liability structure.
Aggregate maturities for the fixed-income portfolio as of December 31, 2018, are as follows:
(in thousands)
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034 and later
Total excluding
Mtge/ABS/CMBS*
Par
Value
Amortized
$
41,303 $
62,908
133,843
92,805
119,041
101,398
188,572
127,478
120,870
69,847
41,445
36,264
14,510
5,520
5,266
51,490
Cost
41,319 $
62,723
134,661
93,779
119,991
103,602
190,550
126,953
121,652
72,303
45,912
40,214
16,148
6,405
6,349
53,688
Fair
Value
Carrying
Value
41,333 $
62,382
134,556
93,421
120,321
102,314
189,259
125,060
119,678
71,804
47,244
40,595
16,299
6,496
6,314
51,464
41,333
62,382
134,556
93,421
120,321
102,314
189,259
125,060
119,678
71,804
47,244
40,595
16,299
6,496
6,314
51,464
$
1,212,560 $
1,236,249 $
1,228,540 $
1,228,540
Mtge/ABS/CMBS*
$
533,232 $
540,216 $
531,975 $
531,975
Grand Total
$
1,745,792 $
1,776,465 $
1,760,515 $
1,760,515
*Mortgage-backed, asset-backed & commercial mortgage-backed
We had cash, short-term investments and fixed income securities maturing within one year of $83.0 million at year-end
2018. This total represented 4 percent of cash and investments, compared to 2 percent at year-end 2017. Our short-term
investments consist of investments with original maturities of 90 days or less, primarily AAA-rated prime and government
money market funds.
18
REGULATION
STATE REGULATION
As an insurance holding company, we, as well as our insurance company subsidiaries, are subject to regulation by the
states and territories in which the insurance subsidiaries are domiciled or transact business. Registration in each insurer’s state
of domicile requires periodic reporting to such state’s insurance regulatory authority of the financial, operational and
management information regarding the insurers within the holding company system. All transactions within a holding company
system affecting insurers must have fair and reasonable terms, and the insurers’ policyholders’ surplus following any
transaction must be both reasonable in relation to its outstanding liabilities and adequate for its needs. Notice to and, in some
cases, consent from regulators is required prior to the consummation of certain transactions affecting insurance company
subsidiaries of the holding company system. Each state and territory individually regulates the insurance operations of both
insurance companies and insurance agents/brokers. Most insurance regulations are designed to protect the interests of
policyholders rather than shareholders and other investors.
Two primary focuses of state regulation of insurance companies are financial solvency and market conduct practices.
Regulations designed to ensure financial solvency of insurers are enforced by various filing, reporting and examination
requirements. Marketplace oversight is conducted by monitoring and periodically examining trade practices, approving policy
forms, licensing of agents and brokers and requiring the filing and, in some cases, approval of premiums and commission rates
to ensure they are fair and adequate.
Because our insurance company subsidiaries operate in all 50 states, the District of Columbia, Puerto Rico, the Virgin
Islands and Guam, we must comply with the individual insurance laws, regulations, rules and case law of each state and
territory, including those regulating the filing of insurance rates and forms. Each of our three insurance company subsidiaries is
domiciled in Illinois, with the Illinois Department of Insurance (IDOI) as its principal insurance regulator.
As a holding company, the amount of dividends we are able to pay depends upon the funds available for distribution,
including dividends or distributions from our subsidiaries. The insurance laws applicable to our insurance company
subsidiaries impose certain restrictions on their ability to pay dividends. The insurance holding company laws require that
ordinary dividends paid by an insurance company be reported to the insurer’s domiciliary regulator prior to payment of the
dividend and that extraordinary dividends may not be paid without such regulator’s prior approval (or non-disapproval). An
extraordinary dividend is generally defined under Illinois law as a dividend that, together with all other dividends made within
the past 12 months, exceeds the greater of 100 percent of the insurer’s statutory net income for the 12-month period ending as
of December 31 of the preceding year or 10 percent of the insurer’s statutory policyholders’ surplus as of the preceding year-
end. Insurance regulators have broad powers to prevent the reduction of statutory surplus to inadequate levels, and there is no
assurance that extraordinary dividend payments would be permitted.
In addition, changes to the state insurance regulatory requirements are frequent, including changes caused by state
legislation, regulations by the state insurance departments and court rulings. State insurance regulators are members of the
NAIC. The NAIC is a non-governmental regulatory support organization that seeks to promote uniformity and to enhance state
regulation of insurance through various activities, initiatives and programs. Among other regulatory and insurance company
support activities, the NAIC maintains a state insurance department accreditation program and proposes model laws,
regulations and guidelines for approval by state legislatures and insurance regulators. Such proposed laws and regulations
cover areas including risk assessments, corporate governance and financial and accounting rules. To the extent such proposed
model laws and regulations are adopted by states, they will apply to insurance carriers.
In December 2010, the NAIC adopted amendments to the Insurance Holding Company System Regulatory Act and
Model Regulation (Amended Holding Company Model Act). The Amended Holding Company Model Act introduces the
concept of “enterprise risk” within an insurance holding company system and imposes more extensive informational
requirements on parents and other affiliates of licensed insurers or reinsurers, with the purpose of protecting the licensed
companies from enterprise risk, including requiring an annual enterprise risk report by the ultimate controlling person
identifying the material risks within the insurance holding company system that could pose enterprise risk to the licensed
companies. An enterprise risk is generally defined as an activity or event involving affiliates of an insurer that could have a
material adverse effect on the insurer or the insurer’s holding company system. Illinois has adopted a version of the Amended
Holding Company Model Act. We are in compliance with the enterprise risk reporting requirements as adopted by Illinois.
The Own Risk and Solvency Assessment (ORSA) model act was developed by the NAIC and proposed for adoption by
each state insurance regulatory department. Illinois has adopted the Risk Management and ORSA Law, applicable to Illinois-
19
domiciled insurance companies meeting certain size requirements, including ours. The ORSA program is a key component of
an insurance company’s overall enterprise risk management (ERM) framework, which is the process by which organizations
identify, measure, monitor and manage key risks affecting the entire enterprise. An ORSA summary report, filed by the
Company with the IDOI each year, is an internal identification, description and assessment of the risks associated with our
business plan, and the sufficiency of capital resources to support those risks.
The NAIC uses a risk-based capital (RBC) model to monitor and regulate the solvency of licensed property and casualty
insurance companies. Illinois has adopted a version of the NAIC’s model law. The RBC calculation is used to measure an
insurer’s capital adequacy with respect to: the risk characteristics of the insurer’s premiums written and unpaid losses and loss
adjustment expenses, rate of growth and quality of assets, among other measures. Depending on the results of the RBC
calculation, insurers may be subject to varying degrees of regulatory action. RBC is calculated annually by insurers, as of
December 31 of each year. As of December 31, 2018, each of our insurance company subsidiaries had RBC levels significantly
in excess of the company action level RBC, defined as being 200 percent of the authorized control level RBC, which would
prompt corrective action under Illinois law. RLI Ins., our principal insurance company subsidiary, had an authorized control
level RBC of $170.9 million compared to actual statutory capital and surplus of $829.8 million as of December 31, 2018,
resulting in a statutory capital to authorized control level RBC ratio of 489 percent. The calculation of RBC requires certain
judgments to be made, and, accordingly, each of our insurance company subsidiaries’ current RBC may be greater or less than
the RBC calculated as of any date of determination.
Each of our insurance company subsidiaries is required to file detailed annual reports, including financial statements, in
accordance with prescribed statutory accounting rules, with regulatory officials in the jurisdictions in which they conduct
business. The quarterly and annual financial reports filed with the states utilize statutory accounting principles (SAP) that are
different from U.S. GAAP. As a basis of accounting, SAP was developed to monitor and regulate the solvency of insurance
companies. In developing SAP, insurance regulators were primarily concerned with assuring an insurer’s ability to pay all its
current and future obligations to policyholders. As a result, statutory accounting focuses on conservatively valuing the assets
and liabilities of insurers, generally in accordance with standards specified by the insurer’s domiciliary state. The values for
assets, liabilities and equity reflected in financial statements prepared in accordance with U.S. GAAP are usually different from
those reflected in financial statements prepared under SAP.
As part of their routine regulatory oversight process, state insurance departments conduct periodic detailed examinations,
generally once every three to five years, of the books, records, accounts and operations of insurance companies that are
domiciled in their states. Examinations are generally carried out in cooperation with the insurance departments of other, non-
domiciliary states under guidelines promulgated by the NAIC. The most recent examination report of our insurance company
subsidiaries completed by the IDOI was issued on November 27, 2018 for the five-year period ending December 31, 2017. The
examination report is available to the public.
Each of our insurance company subsidiaries is subject to Illinois laws and regulations that impose restrictions on the
amount and type of investments our insurance company subsidiaries may have. Such laws and regulations generally require
diversification of the insurer’s investment portfolio and limit the amounts of investments in certain asset categories, such as
below investment grade fixed income securities, real estate-related equity, other equity investments and derivatives. Failure to
comply with these laws and regulations would generally cause investments that exceed regulatory limitations to be treated as
non-admitted assets for measuring statutory surplus and, in some instances, could require the divestiture of such non-qualifying
investments.
Many jurisdictions have laws and regulations that limit an insurer’s ability to withdraw from a particular market. For
example, states may limit an insurer’s ability to cancel or non-renew policies. Furthermore, certain states prohibit an insurer
from withdrawing one or more lines of business from the state, except pursuant to a plan that is approved by the state insurance
department. The state insurance department may disapprove a withdrawal plan that may lead to marketplace disruption. Laws
and regulations that limit cancellation and non-renewal, and that subject program withdrawals to prior approval requirements,
may restrict our ability to exit unprofitable marketplaces in a timely manner.
Virtually all states require licensed insurers to participate in various forms of guaranty associations in order to bear a
portion of the loss suffered by qualified policyholders of insurance companies that become insolvent. Depending upon state
law, licensed insurers can be assessed a small percentage of the annual premiums written for the relevant lines of insurance in
that state to contribute to paying the claims of insolvent insurers. These assessments may increase or decrease in the future,
depending upon the rate of insurance company insolvencies. In some states, these assessments may be wholly or partially
recovered through policy fees paid by insureds. We cannot predict the amount and timing of future assessments. Therefore, the
20
liabilities we have currently established for these potential assessments may not be adequate and an assessment may materially
impact our financial condition.
In addition, the insurance holding company laws require advance approval by state insurance commissioners of any
change in control of an insurance company that is domiciled, or in some cases, having such substantial business that it is
deemed to be commercially domiciled in that state. “Control” is generally presumed to exist through the ownership of 10
percent or more of the voting securities of a domestic insurance company or of any company that controls a domestic insurance
company. In addition, insurance laws in many states contain provisions that require pre-notification to the insurance
commissioners of a change in control of a non-domestic insurance company licensed in those states. Any future transactions
that would constitute a change in control of our insurance company subsidiaries, including a change of control of RLI, would
generally require the party acquiring control to obtain the prior approval by the insurance departments of the insurance
company subsidiaries’ state of domicile (Illinois) or commercial domicile, if applicable. It may also require pre-acquisition
notification in applicable states that have adopted pre-acquisition notification provisions. Obtaining these approvals could
result in a material delay of, or deter, any such transaction.
In light of the number and severity of recent U.S. company data breaches, some states have recently enacted new
insurance laws that require certain regulated entities to implement and maintain comprehensive information security programs
to safeguard the personal information of insureds. In 2017, the New York State Department of Financial Services (NYDFS)
enacted a cybersecurity regulation. This regulation requires banks, insurance companies and other financial services institutions
regulated by the NYDFS to establish and maintain a cybersecurity program “designed to protect consumers and ensure the
safety and soundness of New York State’s financial services industry.” We are implementing the requirements of the regulation
and are in compliance with those phases already enacted. We anticipate that the NYDFS will examine the cybersecurity
programs of financial institutions in the future and that may result in additional regulatory scrutiny, expenditure of resources
and possible regulatory actions and reputational harm.
In October 2017, the NAIC adopted a new Insurance Data Security Model Law. The law is intended to establish the
standards for data security and standards for the investigation and notification of data breaches applicable to insurance
licensees in states adopting such law, with provisions that are generally consistent with the NYDFS cybersecurity regulation
discussed above. As with all NAIC model laws, this model law must be adopted by a state before becoming law in the state.
Currently, only South Carolina and Ohio have adopted this model law in some form. Illinois has not adopted a version of the
Insurance Data Security Model Law. The NAIC has also adopted a guidance document that sets forth 12 principles for
effective insurance regulation of cybersecurity risks. The document is based on similar regulatory guidance adopted by the
Securities Industry and Financial Markets Association and the “Roadmap for Cybersecurity Consumer Protections,” which
describes the protections to which the NAIC believes consumers should be entitled from their insurance companies, agents and
other businesses concerning the collection and maintenance of consumers’ personal information, as well as what consumers
should expect when such information has been involved in a data breach. We expect cybersecurity risk management,
prioritization and reporting to continue to be an area of significant regulatory focus by such regulatory bodies and self-
regulatory organizations.
The rates, policy terms and conditions of reinsurance agreements generally are not subject to regulation by any regulatory
authority. However, the ability of a ceding insurer to take credit for the reinsurance purchased from reinsurance companies is a
significant component of reinsurance regulation. Typically, a ceding insurer will only enter into a reinsurance agreement if it
can obtain credit against its reserves on its statutory basis financial statements for the reinsurance ceded to the reinsurer. With
respect to U.S.-domiciled ceding companies, credit is usually granted when the reinsurer is licensed or accredited in the state
where the ceding company is domiciled. States also generally permit ceding insurers to take credit for reinsurance if the
reinsurer is: (i) domiciled in a state with a credit for reinsurance law that is substantially similar to the credit for reinsurance
law in the primary insurer’s state of domicile, and (ii) meets certain financial requirements. Credit for reinsurance purchased
from a reinsurer that does not meet the foregoing conditions is generally allowed to the extent that such reinsurer secures its
obligations with qualified collateral.
FEDERAL LEGISLATION AND REGULATION
The U.S. insurance industry is not currently subject to any significant federal regulation and instead is regulated
principally at the state level. However, the federal Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley Act), the Dodd-Frank Wall
Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) and creation of the Federal Insurance Office
(summarized below) include elements that affect the insurance industry, insurance companies and public companies such as
ours.
21
The Sarbanes-Oxley Act established several significant corporate governance-related laws and SEC regulations
applicable to public companies. The Dodd-Frank Act created significant changes in regulatory structures of banking and other
financial institutions, created new governmental agencies (while merging and removing others), increased oversight of
financial institutions and enhanced regulation of capital markets. The legislation also mandates new rules affecting executive
compensation and corporate governance for public companies such as ours. Federal agencies have been given significant
discretion in drafting the rules and regulations that will implement the Dodd-Frank Act. We will continue to monitor,
implement and comply with all Dodd-Frank Act-related changes to our regulatory environment. Changes in general political,
economic or market conditions, including the latest U.S. presidential and congressional elections, could affect the scope, timing
and final implementation of the Dodd-Frank Act. We cannot predict if or when future legislation or administrative guidance
will be enacted or issued or what impact any changing regulation may have on our operations.
In addition, the Dodd-Frank Act contains insurance industry-specific provisions, including establishment of the Federal
Insurance Office (FIO) and streamlining the regulation and taxation of surplus lines insurance and reinsurance among the
states. The FIO, part of the U.S. Department of the Treasury, has limited authority and no direct regulatory authority over the
business of insurance. The FIO’s principal mandates include monitoring the insurance industry, collecting insurance industry
information and data and representing the U.S. with international insurance regulators. Although the FIO does not provide
substantive regulation of the insurance industry at this time, we will monitor its activities carefully for any regulatory impact on
our company.
Furthermore, the Dodd-Frank Act authorized the U.S. Treasury Secretary and the Office of the U.S. Trade Representative
to negotiate covered agreements. A covered agreement is an agreement between the U.S. and one or more foreign
governments, authorities or regulatory entities, regarding prudential measures with respect to insurance or reinsurance.
Pursuant to this authority, in September 2017, the U.S. and the European Union (EU) signed a covered agreement to address,
among other things, reinsurance collateral requirements (Covered Agreement). The Covered Agreement became provisionally
effective on November 7, 2017, following completion of the EU’s procedural requirements, but must be approved by the
European Parliament before treated as “fully” effective. We cannot predict with any certainty whether the Covered Agreement
will be implemented or what the impact of such implementation will be on our business.
As part of the passage of the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA) in January 2015, the
National Association of Registered Agents and Brokers (NARAB) was established by federal law, which is expected to
streamline insurance agent/broker licensing. There has been little progress in implementing the provisions of NARAB to date.
Other federal laws and regulations apply to many aspects of our company and its business operations. This federal
regulation includes, without limitation, laws affecting privacy and data security and credit reporting — examples of which
include the Gramm-Leach-Bliley Act, Fair Credit Reporting Act and Fair and Accurate Credit Transactions Act. It also
includes international economic and trade sanctions — examples of which include the Office of Foreign Asset Control
(OFAC), Foreign Account Tax Compliance Act and the Iran Threat Reduction and Syrian Human Rights Act (ITR/SHR).
ITR/SHR generally prohibits U.S. companies from engaging in certain transactions with the government of Iran or certain
Iranian businesses, including the provision of insurance or reinsurance. Under ITR/SHR, we must disclose whether RLI Corp.
or any of its affiliates knowingly engaged in certain specified activities identified in that law. For the year 2018, neither RLI
Corp. nor its affiliates have knowingly engaged in any transaction or dealing reportable under Section 13(r) of the Exchange
Act, as required by the ITR/SHR.
LICENSES AND TRADEMARKS
We hold a U.S. federal service mark registration of our corporate logo “RLI” and several other company service marks
and trademarks with the U.S. Patent and Trademark Office. Such registrations protect our intellectual property nationwide from
deceptively similar use. The duration of these registrations is 10 years, unless renewed. We monitor our trademarks and service
marks and protect them from unauthorized use as necessary.
EMPLOYEES
As of December 31, 2018, we employed a total of 912 associates. Of the 912 total associates, 25 were part-time and 887
were full-time.
22
FORWARD LOOKING STATEMENTS
Forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 appear throughout this report. These statements relate to our current expectations, beliefs,
intentions, goals or strategies regarding the future and are based on certain underlying assumptions by the Company. These
forward looking statements generally include words such as “expect,” “predict,” “estimate,” “will,” “should,” “anticipate,”
“believe” and similar expressions. Such assumptions are, in turn, based on information available and internal estimates and
analyses of general economic conditions, competitive factors, conditions specific to the property and casualty insurance and
reinsurance industries, claims development and the impact thereof on our loss reserves, the adequacy and financial security of
our reinsurance programs, developments in the securities market and the impact on our investment portfolio, regulatory
changes and conditions and other factors and are subject to various risks, uncertainties and other factors, including, without
limitation those set forth below in “Item 1A Risk Factors.” Actual results could differ materially from those expressed in, or
implied by, these forward looking statements. We assume no obligation to update any such statements. You should review the
various risks, uncertainties and other factors listed from time to time in our Securities and Exchange Commission filings.
Item 1A. Risk Factors
Our results of operations and revenues may fluctuate as a result of many factors, including cyclical changes in the
insurance industry, which may cause the price of our securities to be volatile.
The results of operations of companies in the property and casualty insurance industry historically have been subject to
significant fluctuations and uncertainties. Our profitability can be affected significantly by:
Competitive pressures impacting our ability to write new business or retain existing business at an adequate rate,
Rising levels of loss costs that we cannot anticipate at the time we price our coverages,
Volatile and unpredictable developments, including man-made, weather-related and other natural CATs, terrorist
attacks or significant price changes of the commodities we insure,
Changes in the level of reinsurance capacity,
Changes in the amount of losses resulting from new types of claims and new or changing judicial interpretations
relating to the scope of insurers’ liabilities and
The ability of our underwriters to accurately select and price risk and our claim personnel to appropriately deliver
fair outcomes.
In addition, the demand for property and casualty insurance, both admitted and excess and surplus lines, can vary
significantly, rising as the overall level of economic activity increases and falling as that activity decreases, causing our
revenues to fluctuate. These fluctuations in results of operations and revenues may not reflect long-term results and may cause
the price of our securities to be volatile.
Adverse changes in the economy could lower the demand for our insurance products and could have an adverse effect
on the revenue and profitability of our operations.
Factors such as business revenue, construction spending, government spending, the volatility and strength of the capital
markets and inflation can all affect the business and economic environment. These same factors affect our ability to generate
revenue and profits. Insurance premiums in our markets are heavily dependent on our customer revenues, values transported,
miles traveled and number of new projects initiated. In an economic downturn characterized by higher unemployment, declines
in construction spending and reduced corporate revenues, the demand for insurance products is adversely affected. Adverse
changes in the economy may lead our customers to have less need for insurance coverage, to cancel existing insurance policies,
to modify coverage or to not renew with the Company, all of which affect our ability to generate revenue.
Catastrophic losses, including those caused by natural disasters, such as earthquakes and hurricanes, or man-made
events such as terrorist attacks, are inherently unpredictable and could cause the Company to suffer material financial
losses.
We face the risk of property damage resulting from catastrophic events, particularly earthquakes on the West Coast and
hurricanes and tropical storms affecting the continental U.S. or Hawaii. We also face risk from lava flows in Hawaii impacting
23
our homeowners business and from wildfires, particularly on the West Coast. Since the Northridge, California earthquake in
1994, most of our catastrophe-related claims have resulted from hurricanes and other seasonal storms such as tornadoes and
hail storms.
The incidence and severity of CATs are inherently unpredictable. The extent of losses from a CAT is a function of both
the total amount of insured values in the area affected by the event and the severity of the event. Most CATs are restricted to
fairly specific geographic areas. However, hurricanes and earthquakes may produce significant damage in large, heavily
populated areas. In addition to hurricanes and earthquakes, CAT losses can be due to windstorms, severe winter weather and
fires and may include terrorist events. In addition, climate change could have an impact on longer-term natural CAT trends.
Extreme weather events that are linked to rising temperatures, changing global weather patterns, sea, land and air temperatures,
as well as sea levels, rain and snow could result in increased occurrence and severity of CATs. CATs can cause losses in a
variety of our property and casualty segments, and it is possible that a catastrophic event or multiple catastrophic events could
cause the Company to suffer material financial losses. In addition, CAT claim costs may be higher than we originally estimate
and could cause substantial volatility in our financial results for any fiscal quarter or year. Our ability to write new business
could also be affected. We believe that increases in the value and geographic concentration of insured property, the effects of
inflation and the growth of our workers’ compensation business could also increase the severity of claims from CAT events in
the future.
For information on our approaches to catastrophe risk mitigation, including reinsurance and catastrophe modeling, see the
Property Reinsurance – Catastrophe Coverage section within “Item 1. Business” and Note 1.S to the consolidated financial
statements within Item 8, Financial Statements and Supplementary Data. However, since our CAT models cannot contemplate
all possible CAT scenarios and includes underlying assumptions based on a limited set of actual events, the losses we might
incur from an actual catastrophe could be higher than our expectation of losses generated from modeled catastrophe scenarios
and our results of operations and financial condition could be materially and adversely affected.
Our loss reserves are based on estimates and may be inadequate to cover our actual insured losses, which would
negatively impact our profitability.
Significant periods of time often elapse between the occurrence of an insured loss, the reporting of the loss to the
Company and the payment of that loss. To recognize liabilities for unpaid losses, we establish reserves as balance sheet
liabilities representing estimates of amounts needed to pay reported and unreported losses and the related loss adjustment
expenses. Loss reserves are estimates of the ultimate cost of claims and do not represent an exact calculation of liability. These
estimates are based on historical information and on estimates of future trends that may affect the frequency and severity of
claims that may be reported in the future. Estimating loss reserves is a difficult, complex and inherently uncertain process
involving many variables and subjective judgments. As part of the reserving process, we review historical data and consider the
impact of various factors such as:
Loss emergence and cedant reporting patterns,
Underlying policy terms and conditions,
Business and exposure mix,
Trends in claim frequency and severity,
Changes in operations,
Emerging economic and social trends,
Inflation and
Changes in the regulatory and litigation environments.
This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an
appropriate basis for predicting future events. It also assumes adequate historical or other data exists upon which to make these
judgments. For more information on the estimates used in the establishment of loss reserves, see the loss and settlement
expenses section of our critical accounting policies contained within Item 7, Management’s Discussion and Analysis of
Financial Condition and Results of Operations. However, there is no precise method for evaluating the impact of any specific
factor on the adequacy of reserves and actual results are likely to differ from original estimates. If the actual amount of insured
losses is greater than the amount we have reserved for these losses, our profitability could suffer.
24
We may suffer losses from litigation, which could materially and adversely affect our financial condition and business
operations.
As is typical in our industry, we continually face risks associated with litigation of various types, including general
commercial and corporate litigation, and disputes relating to bad faith allegations that could result in the Company incurring
losses in excess of policy limits. We are party to a variety of litigation matters throughout the year. Litigation is subject to
inherent uncertainties, and if there were an outcome unfavorable to the Company, there exists the possibility of a material
adverse impact on our results of operations and financial position in the period in which the outcome occurs. Even if an
unfavorable outcome does not materialize, we still may face substantial expense and disruption associated with the litigation.
Our reinsurers may not pay on losses in a timely fashion, or at all, which may increase our costs.
We purchase reinsurance to transfer part of the risk we have assumed (known as ceding) to a reinsurance company in
exchange for part of the premium we receive in connection with the risk. Although reinsurance makes the reinsurer liable to the
Company to the extent the risk is transferred or ceded to the reinsurer, it does not relieve the Company (the reinsured) of its
liability to its policyholders. Accordingly, we bear credit risk with respect to our reinsurers. That is, our reinsurers may not pay
claims made by the Company on a timely basis, or they may not pay some or all of these claims for a variety of reasons. Either
of these events would increase our costs and could have a materially adverse effect on our business.
If we cannot obtain adequate reinsurance protection for the risks we have underwritten, we may be exposed to greater
losses from these risks or we may reduce the amount of business we underwrite, which will reduce our revenues.
Market conditions beyond our control determine the availability and cost of the reinsurance protection that we purchase.
In addition, the historical results of reinsurance programs and the availability of capital also affect the availability of
reinsurance. Our reinsurance agreements are generally subject to annual renewal. We cannot be sure that we can maintain our
current reinsurance protection, obtain other reinsurance facilities in adequate amounts and at favorable rates or diversify our
exposure among an adequate number of high quality reinsurance partners. If we are unable to renew our expiring facilities or to
obtain new reinsurance facilities on terms we deem acceptable, either our net exposures would increase—which could increase
the volatility of our results—or, if we were unwilling to bear an increase in net exposures, we would have to reduce the level of
our underwriting commitments, which would reduce our revenues.
Our investment results and, therefore, our financial condition may be impacted by changes in the business, financial
condition or operating results of the entities in which we invest, as well as changes in interest rates, government monetary
policies, general economic conditions, liquidity and overall market conditions.
We invest the premiums we receive from customers until they are needed to pay expenses or policyholder claims. Funds
remaining after paying expenses and claims remain invested and are included in retained earnings. The value of our investment
portfolio can fluctuate as a result of changes in the business, financial condition or operating results of the entities in which we
invest. In addition, fluctuations can result from changes in interest rates, credit risk, government monetary policies, liquidity of
holdings and general economic conditions. The equity portfolio will fluctuate with movements in the overall stock market.
While the equity portfolio has been constructed to have lower downside risk than the market, the portfolio is positively
correlated with movements in domestic stocks. The bond portfolio is affected by interest rate changes and movement in credit
spreads. We attempt to mitigate our interest rate and credit risks by constructing a well-diversified portfolio of high-quality
securities with varied maturities. These fluctuations may negatively impact our financial condition. However, we attempt to
manage this risk through asset allocation, duration and security selection.
We compete with a large number of companies in the insurance industry for underwriting revenues.
We compete with a large number of other companies in our selected lines of business. During periods of intense
competition for premium (soft markets), we are vulnerable to the actions of other companies who may seek to write business
without the appropriate regard for risk and profitability. During these times, it is very difficult to grow or maintain premium
volume without sacrificing underwriting discipline and income.
We face competition from specialty insurance companies, underwriting agencies and intermediaries, as well as
diversified financial services companies that are significantly larger than we are and that have significantly greater financial,
marketing, management and other resources. We may also face competition from new sources of capital such as institutional
investors seeking access to the insurance market, sometimes referred to as alternative capital, which may depress pricing or
limit our opportunities to write business. Some of these competitors also have greater experience and market recognition than
25
we do. We may incur increased costs in competing for underwriting revenues. If we are unable to compete effectively in the
markets in which we operate or expand our operations into new markets, our underwriting revenues may decline, as well as
overall business results.
A number of new, proposed or potential legislative or industry developments could further increase competition in our
industry. These developments include:
An increase in capital-raising by companies in our lines of business, which could result in new entrants to our
markets and an excess of capital in the industry,
The deregulation of commercial insurance lines in certain states and the possibility of federal regulatory reform of
the insurance industry, which could increase competition from standard carriers for our excess and surplus lines
of insurance business,
Programs in which state-sponsored entities provide property insurance in CAT-prone areas or other “alternative
markets” types of coverage,
Changing practices, which may lead to greater competition in the insurance business and
The emergence of insurtech companies and the development of new technologies, which may lead to disruption
of current business models and the insurance value chain.
New competition from these developments could cause the supply and/or demand for insurance or reinsurance to change,
which could affect our ability to price our coverages at attractive rates and thereby adversely affect our underwriting results.
A downgrade in our ratings from A.M. Best, Standard & Poor’s or Moody’s could negatively affect our business.
Financial strength ratings are a critical factor in establishing the competitive position of insurance companies. Our
insurance companies are rated for overall financial strength by A.M. Best, Standard & Poor’s and Moody’s. A.M. Best,
Standard & Poor’s and Moody’s ratings reflect their opinions of our financial strength, operating performance, strategic
position and ability to meet our obligations to policyholders, and are not evaluations directed to investors. Our ratings are
subject to periodic review by such firms, and the criteria used in the rating methodologies is subject to change; as such, we
cannot assure the continued maintenance of our current ratings. All of our ratings were reviewed during 2018. A.M. Best
reaffirmed its “A+, Superior” rating for the combined entity of RLI Ins., Mt. Hawley and CBIC (group-rated). Standard &
Poor’s reaffirmed our “A+, Strong” rating for the group of RLI Ins. and Mt. Hawley. Moody’s reaffirmed our group rating of
“A2, Good” for RLI Ins. and Mt. Hawley. Because these ratings have become an increasingly important factor in establishing
the competitive position of insurance companies, if our ratings are reduced from their current levels by A.M. Best, Standard &
Poor’s or Moody’s, our competitive position in the industry, and therefore our business, could be adversely affected. A
significant downgrade could result in a substantial loss of business, as policyholders might move to other companies with
higher claims-paying and financial strength ratings.
We are subject to extensive governmental regulation, which may adversely affect our ability to achieve our business
objectives. Moreover, if we fail to comply with these regulations, we may be subject to penalties, including fines and
suspensions, which may adversely affect our financial condition, results of operations and reputation.
Most insurance regulations are designed to protect the interests of policyholders rather than shareholders and other
investors. These regulations, generally administered by a department of insurance in each state and territory in which we do
business, relate to, among other things:
Approval of policy forms and premium rates,
Standards of solvency, including risk-based capital measurements,
Licensing of insurers and their producers,
Restrictions on agreements with our large revenue-producing agents,
Cancellation and non-renewal of policies,
Restrictions on the nature, quality and concentration of investments,
26
Restrictions on the ability of our insurance company subsidiaries to pay dividends to the Company,
Restrictions on transactions between insurance company subsidiaries and their affiliates,
Restrictions on the size of risks insurable under a single policy,
Requiring deposits for the benefit of policyholders,
Requiring certain methods of accounting,
Periodic examinations of our operations and finances,
Prescribing the form and content of records of financial condition required to be filed and
Requiring reserves for unearned premium, losses and other purposes.
State insurance departments also conduct periodic examinations of the conduct and affairs of insurance companies and
require the filing of annual, quarterly and other reports relating to financial condition, holding company issues and other
matters. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business
objectives.
In addition, regulatory authorities have relatively broad discretion to deny or revoke licenses for various reasons,
including the violation of regulations. In some instances, we follow practices based on our interpretations of regulations or
practices that we believe may be generally followed by the industry. These practices may turn out to be different from the
interpretations of regulatory authorities. If we do not have the requisite licenses and approvals or do not comply with applicable
regulatory requirements, insurance regulatory authorities could fine the Company, preclude or temporarily suspend the
Company from carrying on some or all of its activities or otherwise penalize the Company. This could adversely affect our
ability to operate our business. Further, changes in the level of regulation of the insurance industry or changes in laws or
regulations themselves or interpretations by regulatory authorities could adversely affect our ability to operate our business as
currently conducted.
In addition to regulations specific to the insurance industry, including the insurance laws of our principal state regulator
(Illinois), as a public company we are also subject to the rules and regulations of the U.S. Securities and Exchange Commission
and the New York Stock Exchange (NYSE), each of which regulate many areas such as financial and business disclosures,
corporate governance and shareholder matters. We are also subject to the corporation laws of Delaware, where we are
incorporated. At the federal level, among other laws, we are subject to the Sarbanes-Oxley Act and the Dodd-Frank Act, each
of which regulate corporate governance, executive compensation and other areas, as well as laws relating to federal trade
restrictions, privacy/data security and terrorism risk insurance laws. We monitor these laws, regulations and rules on an
ongoing basis to ensure compliance and make appropriate changes as necessary. Implementing such changes may require
adjustments to our business methods, increases to our costs and other changes that could cause the Company to be less
competitive in the industry.
We may be unable to attract and retain qualified key employees.
We depend on our ability to attract and retain qualified executive officers, experienced underwriting talent and other
skilled employees who are knowledgeable about our business. Providing suitable succession planning for such positions is also
important. If we cannot attract or retain top-performing executive officers, underwriters and other employees, if the quality of
their performance decreases or if we fail to implement succession plans for our key staff, we may be unable to maintain our
current competitive position in the markets in which we operate or expand our operations into new markets.
We are an insurance holding company and therefore may not be able to receive adequate or timely dividends from our
insurance subsidiaries.
RLI Corp. is the holding company for our three insurance operating companies. At the holding company level, our
principal assets are the shares of capital stock of our insurance company subsidiaries. We rely largely on dividends from our
insurance company subsidiaries to meet our obligations for paying principal and interest on outstanding debt, corporate
expenses and dividends to RLI Corp. shareholders. Dividend payments to RLI Corp. from our principal insurance subsidiary
are restricted by state insurance laws as to the amount that may be paid without prior approval of the insurance regulatory
authorities of Illinois. As a result, we may not be able to receive dividends from such subsidiary at times and in amounts
necessary to pay RLI Corp. obligations and desired dividends to shareholders. Ordinary dividends, which may be paid by our
principal insurance subsidiary without prior regulatory approval, are subject to certain limitations based upon income, surplus
27
and earned surplus. The maximum ordinary dividend distribution from our principal insurance subsidiary in a rolling 12-month
period is limited by Illinois law to the greater of 10 percent of RLI Ins. policyholder surplus as of December 31 of the
preceding year, or the net income of RLI Ins. for the 12-month period ending December 31 of the preceding year. Ordinary
dividends are further restricted by the requirement that they be paid from earned surplus. Any dividend distribution in excess of
the ordinary dividend limits is deemed extraordinary and requires prior approval (or non-disapproval) from the IDOI. Because
the limitations are based upon a rolling 12-month period, the presence, amount and impact of these restrictions vary over time.
Anti-takeover provisions affecting the Company could prevent or delay a change of control that is beneficial to you.
Provisions of our certificate of incorporation and by-laws, as well as applicable Delaware law, federal and state
regulations and insurance company regulations may discourage, delay or prevent a merger, tender offer or other change of
control that holders of our securities may consider favorable. Some of these provisions impose various procedural and other
requirements that could make it more difficult for shareholders to effect certain corporate actions. These provisions could:
Have the effect of delaying, deferring or preventing a change in control of the Company,
Discourage bids for our securities at a premium over the market price,
Adversely affect the market price, the voting and other rights of the holders of our securities or
Impede the ability of the holders of our securities to change our management.
In particular, we are subject to Section 203 of the Delaware General Corporation Law which, under certain circumstances,
restricts our ability to engage in a business combination, such as a merger or sale of assets, with any stockholder that, together
with affiliates, owns 15 percent or more of our common stock, which similarly could prohibit or delay the accomplishment of a
change of control transaction.
Any significant interruption in the operation of our facilities, systems and business functions could adversely affect
our financial condition and results of operations.
We rely on multiple computer systems to interact with producers and customers, issue policies, pay claims, run modeling
functions, assess insurance risks and complete various important internal processes including accounting and bookkeeping. Our
business is highly dependent on our ability to access these systems to perform necessary business functions. Additionally, some
of these systems may include or rely upon third-party systems not located on our premises. Any of these systems may be
exposed to unplanned interruption, unreliability or intrusion from a variety of causes, including among others, storms and other
natural disasters, terrorist attacks, utility outages or complications encountered as existing systems are replaced or upgraded.
Any such issues could materially impact our company including the impairment of information availability, compromise
of system integrity/accuracy, misappropriation of confidential information, reduction of our volume of transactions and
interruption of our general business. Although we believe our computer systems are securely protected and continue to take
steps to ensure they are protected against such risks, we cannot guarantee such problems will not occur. If they do, interruption
to our business and damage to our reputation, and related costs, could be significant, which could impair our profitability.
Technology breaches or failures, including but not limited to cyber security incidents, could disrupt our operations
and result in the loss of critical and confidential information, which could adversely impact our reputation and results of
operations.
Global cyber security threats can range from uncoordinated individual attempts to gain unauthorized access to our
information technology systems and those of our business partners or service providers to sophisticated and targeted measures
known as advanced persistent threats. While we, our business partners and service providers employ measures to prevent,
detect, address and mitigate these threats (including access controls, data encryption, vulnerability assessments, continuous
monitoring of information technology networks and systems and maintenance of backup and protective systems), cyber
security incidents, depending on their nature and scope, could potentially result in the misappropriation, destruction, corruption
or unavailability of critical data and confidential or proprietary information (our own or that of third parties) and the disruption
of business operations. Security breaches could expose the Company to a risk of loss or misuse of our or our customers’
information, litigation and potential liability. In addition, cyber incidents that impact the availability, reliability, speed,
accuracy or other proper functioning of our technology systems could impact our operations. We may not have the resources or
technical sophistication to anticipate or prevent every type of cyber attack. A significant cyber incident, including system
failure, security breach, disruption by malware or other damage could interrupt or delay our operations, result in a violation of
28
applicable privacy and other laws, damage our reputation, cause a loss of customers or give rise to remediation costs, monetary
fines and other penalties, which could be significant. It is possible that insurance coverage we have in place would not entirely
protect the Company in the event that we experienced a cyber security incident, interruption or widespread failure of our
information technology systems.
We rely on third party vendors for a number of key components of our business.
We contract with a number of third party vendors to support our business. For example, we have license agreements for
services that include natural catastrophe modeling, policy management, claims processing, producer management and
accounting and financial management. The vendors range from large national companies, who are dominant in their area of
expertise and would be difficult to quickly replace, to smaller or start-up vendors with leading technology, but with shorter
operating histories and fewer financial resources. Failures of certain vendors to provide services could adversely affect our
ability to deliver products and services to our customers, disrupting our business and causing the Company to incur significant
expense. If one or more of our vendors fail to protect personal information of our customers, claimants or employees, we may
incur operational impairments, or could be exposed to litigation, compliance costs or reputation damage. We maintain a vendor
management program to establish procurement policies and to monitor vendor risk, including the financial stability of our
critical vendors.
If we are unable to keep pace with the technological advancements in the insurance industry, our ability to compete
effectively could be impaired.
Our operations rely upon complex and expensive information technology systems for interacting with policyholders,
brokers and other business partners. The pace at which information systems must be upgraded is continually increasing,
requiring an ongoing commitment of significant resources to maintain or upgrade to current standards. We are committed to
developing and maintaining information technology systems that will allow our insurance subsidiaries to compete effectively.
There can be no assurance that the development of current technology will not result in our being competitively disadvantaged,
especially with those companies that have greater resources. If we are unable to keep pace with the advancements being made
in technology, our ability to compete with other insurance companies who have advanced technological capabilities will be
negatively affected. Further, if we are unable to effectively update or replace our key legacy technology systems as they
become obsolete or as emerging technology renders them competitively inefficient, our competitive position and our cost
structure could be adversely affected.
We may not be able to effectively start up or integrate new product opportunities.
Our ability to grow our business depends, in part, on our creation, implementation or acquisition of new insurance
products that are profitable and fit within our business model. Our ability to grow profitably requires that we identify market
opportunities, which may include acquisitions, and that we attract and retain underwriting and claims expertise to support that
growth. New product launches as well as resources to integrate business acquisitions are subject to many obstacles, including
ensuring we have sufficient business and systems processes, determining appropriate pricing, obtaining reinsurance, assessing
opportunity costs and regulatory burdens and planning for internal infrastructure needs. If we cannot effectively or accurately
assess and overcome these obstacles or we improperly implement new insurance products, our ability to grow profitably could
be impaired.
Access to capital and market liquidity may adversely affect our ability to take advantage of business opportunities as
they arise.
Our ability to grow our business depends in part on our ability to access capital when needed. We cannot predict capital
market liquidity or the availability of capital. We also cannot predict the extent and duration of future economic and market
disruptions, the impact of government interventions into the market to address these disruptions and their combined impact on
our industry, business and investment portfolios. If our company needs capital but cannot raise it, our business and future
growth could be adversely affected.
Our success will depend on our ability to maintain and enhance effective operating procedures and manage risks on
an enterprise wide basis.
Operational risk and losses can result from, among other things, fraud, errors, failure to document transactions properly,
failure to obtain proper internal authorization, failure to comply with regulatory requirements, information technology failures
or external events. We continue to enhance our operating procedures and internal controls to effectively support our business
29
and our regulatory and reporting requirements. The NAIC and state legislatures have increased their focus on risks within an
insurer’s holding company system that may pose enterprise risk to insurers. The Illinois legislature has adopted the Risk
Management and ORSA Law, which requires domestic insurers to maintain a risk management framework and establishes a
legal requirement for domestic insurers to conduct an ORSA in accordance with the NAIC’s ORSA Guidance Manual. The
ORSA Law also provides that, no less than annually, an insurer must submit an ORSA summary report. Under the Illinois
insurance holding company laws, on an annual basis, we are also required to file with the IDOI an enterprise risk report, which
is intended to identify the material risks within our insurance holding company system that could pose enterprise risk to our
insurance company subsidiaries. We operate within an ERM framework designed to assess and monitor our risks. However,
assurance that we can effectively review and monitor all risks or that all of our employees will operate within the ERM
framework cannot be guaranteed. Assurances that our ERM framework will result in the Company accurately identifying all
risks and accurately limiting our exposures based on our assessments also cannot be guaranteed.
We may not be able to, or might not choose to, continue paying dividends on our common stock.
We have a history of paying regular, quarterly dividends and in recent years have paid special dividends. Any
determination to pay either type of dividend to our stockholders in the future will be at the discretion of our board of directors
and will depend on our results of operations, financial condition and other factors deemed relevant by our board of directors.
Our ability to pay dividends depends largely on our subsidiaries’ earnings and operating capital requirements and is subject to
the regulatory, contractual and other constraints of our subsidiaries, including the effect of any such dividends or distributions
on the A.M. Best rating or other ratings of our insurance subsidiaries. In addition, we may choose to retain capital to support
growth or further mitigate risk, as opposed to returning excess capital to our shareholders.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We own five commercial buildings totaling 173,000 square feet on our 23-acre campus that serves as our corporate
headquarters in Peoria, Illinois. All of our branch offices and other company operations lease office space throughout the
country. Management considers our office facilities suitable and adequate for our current levels of operations.
Item 3. Legal Proceedings
We are party to numerous claims, losses and litigation matters that arise in the normal course of our business. Many of
such claims, losses or litigation matters involve claims under policies that we underwrite as an insurer. We believe that the
resolution of these claims, losses and litigation matters will not have a material adverse effect on our financial condition,
results of operations or cash flows.
We are also involved in various other legal proceedings and litigation unrelated to our insurance business from time to
time that arise in the ordinary course of business operations. Management believes that any liabilities that may arise as a result
of these legal matters will not have a material adverse effect on our financial condition, results of operations or cash flows.
Item 4. Mine Safety Disclosures
Not applicable.
30
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
PART II
Market Information; Holders; Dividends
Closing Stock Price
2018
1st Quarter
2nd Quarter
3rd Quarter
4th Quarter
2017
1st Quarter
2nd Quarter
3rd Quarter
4th Quarter
Low
Ending
High
$ 64.47 $ 58.71 $ 63.39 $
61.74
66.53
64.57
69.71
79.86
76.82
66.19
78.58
68.99
Dividends
Declared
0.21
0.22
0.22
1.22
Closing Stock Price
Low
Ending
High
$ 61.61 $ 57.15 $ 60.02 $
53.01
51.02
56.99
58.67
58.68
60.93
54.62
57.36
60.66
Dividends
Declared
0.20
0.21
0.21
1.96
RLI Corp. common stock trades on the New York Stock Exchange under the symbol RLI. RLI Corp. has paid dividends
for 170 consecutive quarters and increased quarterly dividends in each of the last 43 years. In December 2018 and 2017, RLI
Corp. paid special cash dividends of $1.00 and $1.75 per share, respectively, to shareholders. As of February 7, 2019, there
were 765 registered holders of the Company’s common stock.
Performance
The following graph provides a five-year comparison of RLI’s total return to shareholders compared to that of the S&P
500 and S&P 500 P&C Index:
2013
2014
2015
2016
2017
2018
--------------
RLI
S&P 500
••••••••••••••••
S&P 500 P&C Index — — —
$
$
$
100
100
100
110
114
116
144
115
127
154
129
147
154
157
180
180
150
171
Assumes $100 invested on December 31, 2013, in RLI, S&P 500 and S&P 500 P&C Index, with reinvestment of dividends.
Comparison of five-year annualized total return — RLI: 12.4%, S&P 500: 8.5%, and S&P 500 P&C Index: 11.3%.
31
Securities Authorized for Issuance under Equity Compensation Plans
Refer to Part III, Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters,” of this document for information on securities authorized for issuance under our equity compensation plan.
Recent Sales of Unregistered Securities; Uses of Proceeds from Registered Securities
Not applicable.
Equity Repurchases
In 2010, our Board of Directors implemented a $100 million share repurchase program. We last repurchased shares in
2011. We have $87.5 million of remaining capacity from the repurchase program. The repurchase program may be suspended
or discontinued at any time without prior notice.
32
Item 6. Selected Financial Data
The following is selected financial data of RLI Corp. and Subsidiaries for the five years ended December 31, 2018:
(amounts in thousands, except per share data and ratios)
2018
2017
2016
2015
2014
OPERATING RESULTS
Gross premiums written
Consolidated revenue (1)
Net earnings (1)
Comprehensive earnings
Net cash provided from operating activities
$
$
$
$
$
983,216
818,123
64,179
30,182
217,102
885,312
797,224
105,028
140,337
197,525
874,864
816,328
114,920
113,756
174,463
853,586
794,634
137,544
89,935
152,586
863,848
775,165
135,445
170,801
123,085
FINANCIAL CONDITION
Total investments and cash
Total assets
Unpaid losses and settlement expenses
Total debt
Total shareholders’ equity
Statutory surplus (2)
SHARE INFORMATION
Net earnings per share (1):
Basic
Diluted
Comprehensive earnings per share:
Basic
Diluted
Cash dividends declared per share:
Regular
Special
Book value per share
Closing stock price
Weighted average shares outstanding:
Basic
Diluted
Common shares outstanding
OTHER NON-GAAP FINANCIAL
INFORMATION
Net premiums written to statutory surplus (2)
GAAP combined ratio (3)
Statutory combined ratio (2)(3)
$ 2,194,230
$ 3,105,065
$ 1,461,348
149,115
$
806,842
$
829,775
$
2,140,790
2,947,244
1,271,503
148,928
853,598
864,554
2,021,827 1,951,543 1,964,285
2,777,633 2,735,465 2,774,284
1,139,337 1,103,785 1,121,040
148,367
845,062
849,297
148,741
823,572
859,976
148,554
823,469
865,268
$
$
$
$
$
$
$
$
1.45
1.43
0.68
0.67
0.87
1.00
18.13
68.99
2.39
2.36
3.19
3.15
0.83
1.75
19.33
60.66
2.63
2.59
2.60
2.56
0.79
2.00
18.74
63.13
3.18
3.12
2.08
2.04
0.75
2.00
18.91
61.75
3.15
3.09
3.97
3.90
0.71
3.00
19.61
49.40
44,358
44,835
44,504
44,033
44,500
44,148
43,772
44,432
43,945
43,299
44,131
43,544
43,020
43,819
43,103
99 %
87 %
94.7
94.0
96.4
96.2
86 %
89.5
89.0
83 %
84.5
83.9
83 %
84.5
84.1
(1) Unrealized gains and losses on equity securities were included in consolidated revenue and net earnings in 2018 and
flowed through comprehensive earnings in prior years.
(2) Ratios and surplus information are presented on a statutory basis. As discussed in Item 7, Management’s Discussion and
Analysis of Financial Condition and Results of Operations, statutory accounting principles differ from GAAP and are
generally based on a solvency concept. Further discussion is included in note 9 to the consolidated financial statements
within Item 8, Financial Statements and Supplementary Data. Reporting of statutory surplus is a required disclosure under
GAAP.
(3) See page 35 for information regarding non-GAAP financial measures.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
RLI Corp. is a U.S.-based, specialty insurance company that underwrites select property and casualty insurance through
major subsidiaries collectively known as RLI Insurance Group. As a specialty insurance company with a niche focus, we offer
insurance coverages in the specialty admitted and excess and surplus markets. Coverages in the specialty admitted market, such
as our energy surety bonds, are for risks that are unique or hard-to-place in the standard market, but must remain with an
admitted insurance company for regulatory or marketing reasons. In addition, our coverages in the specialty admitted market
may be designed to meet specific insurance needs of targeted insured groups, such as our professional liability and package
coverages for design professionals and our stand-alone personal umbrella policy. The specialty admitted market is subject to
more state regulation than the excess and surplus market, particularly with regard to rate and form filing requirements,
restrictions on the ability to exit lines of business, premium tax payments and membership in various state associations, such as
state guaranty funds and assigned risk plans. We also underwrite coverages in the excess and surplus market. The excess and
surplus market, unlike the admitted market, is less regulated and more flexible in terms of policy forms and premium rates.
This market provides an alternative for customers with risks or loss exposures that generally cannot be written in the standard
market. This typically results in coverages that are more restrictive and more expensive than coverages in the admitted market.
When we underwrite within the excess and surplus market, we are selective in the lines of business and type of risks we choose
to write. Using our non-admitted status in this market allows the Company to tailor terms and conditions to manage these
exposures effectively. Often, the development of these coverages is generated through proposals brought to the Company by an
agent or broker seeking coverage for a specific group of clients or loss exposures. Once a proposal is submitted, our
underwriters determine whether it would be a viable product based on our business objectives.
We focus on niche markets and developing unique products that are tailored to customers’ needs. We hire underwriters
with deep expertise and provide exceptional customer service and support. We maintain a highly diverse product portfolio and
underwrite for profit in all market conditions. In 2018, we achieved our 23rd consecutive year of profitability, averaging an
88.1 combined ratio over that period. This drives our ability to provide shareholder returns in three different ways: the
underwriting income itself, net investment income from our investment portfolio and long-term appreciation in our equity
portfolio. Our investment strategy is based on preservation of capital as the first priority, with a secondary focus on generating
total return. The fixed income portfolio consists primarily of highly-rated, diversified, liquid, investment-grade securities.
Consistent underwriting income allows a portion of our investment portfolio to be invested in equity securities and other risk
asset classes. Our equity portfolio consists of a core stock portfolio weighted toward dividend-paying stocks, as well as
exchange traded funds (ETFs). Our minority equity ownership interests in Maui Jim, Inc. (Maui Jim), a manufacturer of high-
quality sunglasses, and Prime Holdings Insurance Services, Inc. (Prime), a specialty insurance company, have also enhanced
financial results. We have a diversified investment portfolio and closely monitor our investment risks. Despite periodic
fluctuations in market value, our equity portfolio is part of a long-term asset allocation strategy and has contributed
significantly to our historic growth in book value.
We measure the results of our insurance operations by monitoring growth and profitability across three distinct business
segments: casualty, property and surety. Growth is measured in terms of gross premiums written, and profitability is analyzed
through combined ratios, which are further subdivided into their respective loss and expense components.
The casualty portion of our business consists largely of commercial excess, personal umbrella, general liability,
transportation and executive products coverages, as well as package business and other specialty coverages, such as professional
liability and workers’ compensation for office-based professionals. We also offer fidelity and crime coverage for commercial
insureds and select financial institutions and medical and healthcare professional liability coverage. The casualty business is
subject to the risk of estimating losses and related loss reserves because the ultimate settlement of a casualty claim may take
several years to fully develop. The casualty segment is also subject to inflation risk and may be affected by evolving legislation
and court decisions that define the extent of coverage and the amount of compensation due for injuries or losses.
Our property segment is comprised primarily of commercial fire, earthquake, difference in conditions and marine
coverages. We also offer select personal lines policies, including homeowners’ coverages. Our property reinsurance and
recreational vehicle (RV) products are in runoff after we began curtailing offerings at the end of 2015 and 2016, respectively.
Property insurance results are subject to the variability introduced by perils such as earthquakes, fires and hurricanes. Our
major catastrophe exposure is to losses caused by earthquakes, primarily on the West Coast. Our second largest catastrophe
exposure is to losses caused by wind storms to commercial properties throughout the Gulf and East Coast, as well as to homes
we insure in Hawaii. We limit our net aggregate exposure to a catastrophic event by minimizing the total policy limits written
in a particular region, purchasing reinsurance and maintaining policy terms and conditions throughout market cycles. We also
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use computer-assisted modeling techniques to provide estimates that help the Company carefully manage the concentration of
risks exposed to catastrophic events.
The surety segment specializes in writing small to large-sized commercial and contract surety coverages, as well as those
for the energy, petrochemical and refining industries. We also offer miscellaneous bonds including license and permit, notary
and court bonds. Often, our surety coverages involve a statutory requirement for bonds. While these bonds typically maintain a
relatively low loss ratio, losses may fluctuate due to adverse economic conditions affecting the financial viability of our
principals. The contract surety product guarantees the construction work of a commercial contractor for a specific project.
Generally, losses occur due to the deterioration of a contractor’s financial condition. This line has historically produced
marginally higher loss ratios than other surety lines during economic downturns.
GAAP, NON-GAAP AND PERFORMANCE MEASURES
Throughout this annual report, we include certain non-generally accepted accounting principles (“non-GAAP”) financial
measures. Management believes that these non-GAAP measures better explain the Company’s results of operations and allow
for a more complete understanding of the underlying trends in the Company’s business. These measures should not be viewed
as a substitute for those determined in accordance with generally accepted accounting principles in the United States of
America (GAAP). In addition, our definitions of these items may not be comparable to the definitions used by other
companies.
Following is a list of non-GAAP measures found throughout this report with their definitions, relationships to GAAP
measures and explanations of their importance to our operations.
Underwriting Income
Underwriting income or profit represents one measure of the pretax profitability of our insurance operations and is
derived by subtracting losses and settlement expenses, policy acquisition costs and insurance operating expenses from net
premiums earned, which are all GAAP financial measures. Each of these captions is presented in the statements of earnings but
is not subtotaled. However, this information is available in total and by segment in note 11 to the consolidated financial
statements within Item 8, Financial Statements and Supplementary Data. The nearest comparable GAAP measure is earnings
before income taxes which, in addition to underwriting income, includes net investment income, net realized gains or losses,
net unrealized gains or losses on equity securities in 2018, general corporate expenses, debt costs and our portion of earnings
from unconsolidated investees.
Combined Ratio
The combined ratio, which is derived from components of underwriting income, is a common industry performance
measure of profitability for underwriting operations and is calculated in two components. First, the loss ratio is losses and
settlement expenses divided by net premiums earned. The second component, the expense ratio, reflects the sum of policy
acquisition costs and insurance operating expenses divided by net premiums earned. All items included in these components of
the combined ratio are presented in our GAAP consolidated financial statements. The sum of the loss and expense ratios is the
combined ratio. The difference between the combined ratio and 100 reflects the per-dollar rate of underwriting income or loss.
For example, a combined ratio of 90 implies that for every $100 of premium we earn, we record $10 of underwriting income.
Net Unpaid Loss and Settlement Expenses
Unpaid losses and settlement expenses, as shown in the liabilities section of our balance sheets, represents the total
obligations to claimants for both estimates of known claims and estimates for incurred but not reported (IBNR) claims. The
related asset item, reinsurance balances recoverable on unpaid losses and settlement expense, is the estimate of known claims
and estimates of IBNR that we expect to recover from reinsurers. The net of these two items is generally referred to as net
unpaid loss and settlement expenses and is commonly used in our disclosures regarding the process of establishing these
various estimated amounts.
CRITICAL ACCOUNTING POLICIES
In preparing the consolidated financial statements, we are required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the
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consolidated financial statements and the reported amounts of revenues and expenses for the reporting period. Actual results
could differ significantly from those estimates.
The most critical accounting policies involve significant estimates and include those used in determining the liability for
unpaid losses and settlement expenses, investment valuation and other-than-temporary impairment (OTTI), recoverability of
reinsurance balances, deferred policy acquisition costs and deferred taxes.
LOSSES AND SETTLEMENT EXPENSES
Overview
Loss and loss adjustment expense (LAE) reserves represent our best estimate of ultimate payments for losses and related
settlement expenses from claims that have been reported but not paid and those losses that have occurred but have not yet been
reported to the Company. Loss reserves do not represent an exact calculation of liability, but instead represent our estimates,
generally utilizing individual claim estimates, actuarial expertise and estimation techniques at a given accounting date. The loss
reserve estimates are expectations of what ultimate settlement and administration of claims will cost upon final resolution.
These estimates are based on facts and circumstances then known to the Company, review of historical settlement patterns,
estimates of trends in claims frequency and severity, projections of loss costs, expected interpretations of legal theories of
liability and many other factors. In establishing reserves, we also take into account estimated recoveries from reinsurance,
salvage and subrogation. The reserves are reviewed regularly by a team of actuaries we employ.
The process of estimating loss reserves involves a high degree of judgment and is subject to a number of variables. These
variables can be affected by both internal and external events, such as changes in claims handling procedures, claim personnel,
economic inflation, legal trends and legislative changes, among others. The impact of many of these items on ultimate costs for
loss and LAE is difficult to estimate. Loss reserve estimations also differ significantly by coverage due to differences in claim
complexity, the volume of claims, the policy limits written, the terms and conditions of the underlying policies, the potential
severity of individual claims, the determination of occurrence date for a claim and reporting lags (the time between the
occurrence of the policyholder event and when it is actually reported to the insurer). Informed judgment is applied throughout
the process. We continually refine our loss reserve estimates as historical loss experience develops and additional claims are
reported and settled. We rigorously attempt to consider all significant facts and circumstances known at the time loss reserves
are established.
Due to inherent uncertainty underlying loss reserve estimates, including, but not limited to, the future settlement
environment, final resolution of the estimated liability may be different from that anticipated at the reporting date. Therefore,
actual paid losses in the future may yield a significantly different amount than currently reserved — favorable or unfavorable.
The amount by which estimated losses differ from those originally reported for a period is known as “development.”
Development is unfavorable when the losses ultimately settle for more than the levels at which they were reserved or
subsequent estimates indicate a basis for reserve increases on unresolved claims. Development is favorable when losses
ultimately settle for less than the amount reserved or subsequent estimates indicate a basis for reducing loss reserves on
unresolved claims. We reflect favorable or unfavorable developments of loss reserves in the results of operations in the period
the estimates are changed.
We record two categories of loss and LAE reserves: case-specific reserves and IBNR reserves.
Within a reasonable period of time after a claim is reported, our claim department completes an initial investigation and
establishes a case reserve. This case-specific reserve is an estimate of the ultimate amount we will have to pay for the claim,
including related legal expenses and other costs associated with resolving and settling it. The estimate reflects all of the current
information available regarding the claim, the informed judgment of our professional claim personnel regarding the nature and
value of the specific type of claim and our reserving practices. During the life cycle of a particular claim, as more information
becomes available, we may revise the estimate of the ultimate value of the claim either upward or downward. We may
determine that it is appropriate to pay portions of the reserve to the claimant or related settlement expenses before final
resolution of the claim. The amount of the individual claim reserve will be adjusted accordingly and is based on the most recent
information available.
We establish IBNR reserves to estimate the amount we will have to pay for claims that have occurred, but have not yet
been reported to the Company, claims that have been reported to the Company that may ultimately be paid out differently than
reflected in our case-specific reserves and claims that have been closed but may reopen and require future payment.
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Our IBNR reserving process involves three steps: (1) an initial IBNR generation process that is prospective in nature,
(2) a loss and LAE reserve estimation process that occurs retrospectively and (3) a subsequent discussion and reconciliation
between our prospective and retrospective IBNR estimates, which includes changes in our provisions for IBNR where deemed
appropriate. These three processes are discussed in more detail in the following sections.
LAE represents the cost involved in adjusting and administering losses from policies we issued. The LAE reserves are
frequently separated into two components: allocated and unallocated. Allocated loss adjustment expense (ALAE) reserves
represent an estimate of claims settlement expenses that can be identified with a specific claim or case. Examples of ALAE
would be the hiring of an outside adjuster to investigate a claim or an outside attorney to defend our insured. The claim adjuster
typically estimates this cost separately from the loss component in the case reserve. Unallocated loss adjustment expense
(ULAE) reserves represent an estimate of claims settlement expenses that cannot be identified with a specific claim. An
example of ULAE would be the cost of an internal claim examiner to manage or investigate claims.
Our best estimate of ultimate loss and LAE reserves are proposed by our lead reserving actuary and approved by our Loss
Reserve Committee (LRC). The LRC is made up of various members of the management team including the lead reserving
actuary, chief executive officer, chief operating officer, chief financial officer, general counsel and other selected executives.
We do not use discounting (recognition of the time value of money) in reporting our estimated reserves for losses and
settlement expenses. Based on current assumptions used in calculating reserves, we believe that our reserve levels at
December 31, 2018, make a reasonable provision to meet our future obligations.
Initial IBNR Generation Process
Initial carried IBNR reserves are determined through a reserve generation process. The intent of this process is to
establish an initial total reserve that will provide a reasonable provision for the ultimate value of all unpaid loss and ALAE
liabilities. For most casualty and surety products, this process involves the use of an initial loss and ALAE ratio that is applied
to the earned premium for a given period. The result is our best initial estimate of the expected amount of ultimate loss and
ALAE for the period by product. Payments and case reserves are subtracted from this initial estimate of ultimate loss and
ALAE to determine a carried IBNR reserve.
For most property products, we use an alternative method of determining an appropriate provision for initial IBNR. Since
this segment is characterized by a shorter period of time between claim occurrence and claim settlement, the IBNR reserves are
determined by IBNR percentages applied to premium earned. The percentages are determined based on expected loss ratios
and loss development assumptions. The loss development assumptions are typically based on historical reporting patterns but
could consider alternative sources of information. The IBNR percentages are reviewed and updated periodically. No
deductions for paid or case reserves are made. This alternative method of determining initial IBNR allows incurred losses and
ALAE to react more rapidly to the actual emergence and is more appropriate for our property products where final claim
resolution occurs over a shorter period of time.
We do not reserve for natural or man-made catastrophes until an event has occurred. Shortly after such occurrence, we
review insured locations exposed to the event and industry loss estimates of the event. We also consider our knowledge of
frequency and severity from early claim reports to determine an appropriate reserve for the catastrophe. These reserves are
reviewed frequently to consider actual losses reported and appropriate changes to our estimates are made to reflect the new
information.
The initial loss and ALAE ratios that are applied to earned premium are reviewed at least semi-annually. Prospective
estimates are made based on historical loss experience adjusted for exposure mix, price change and loss cost trends. The initial
loss and ALAE ratios also reflect our judgment as to estimation risk. We consider estimation risk by product and coverage
within product, if applicable. A product with greater volatility and uncertainty has greater estimation risk. Products or
coverages with higher estimation risk include, but are not limited to, the following characteristics:
Significant changes in underlying policy terms and conditions,
A new business or one experiencing significant growth and/or high turnover,
Small volume or lacking internal data requiring significant utilization of external data,
Unique reinsurance features including those with aggregate stop-loss, reinstatement clauses, commutation provisions
or clash protection,
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Longer emergence patterns with exposures to latent unforeseen mass tort,
Assumed reinsurance businesses where there is an extended reporting lag and/or a heavier utilization of ceding
company data and claims and product expertise,
High severity and/or low frequency,
Operational processes undergoing significant change and/or
High sensitivity to significant swings in loss trends, economic change or judicial change.
The historical and prospective loss and ALAE estimates, along with the risks listed, are the basis for determining our
initial and subsequent carried reserves. Adjustments in the initial loss ratio by product and segment are made where necessary
and reflect updated assumptions regarding loss experience, loss trends, price changes and prevailing risk factors. The LRC
approves all final decisions regarding changes in the initial loss and ALAE ratios.
Loss and LAE Reserve Estimation Process
Estimates of the expected value of the unpaid loss and LAE are derived using standard actuarial methodologies on a
quarterly basis. In addition, an emergence analysis is completed quarterly to determine if further adjustments are necessary.
These estimates are then compared to the carried loss reserves to determine the appropriateness of the current reserve balance.
The process of estimating ultimate payment for claims and claim expenses begins with the collection and analysis of
current and historical claim data. Data on individual reported claims, including paid amounts and individual claim adjuster
estimates, are grouped by common characteristics. There is judgment involved in this grouping. Considerations when grouping
data include the volume of the data available, the credibility of the data available, the homogeneity of the risks in each cohort
and both settlement and payment pattern consistency. We use this data to determine historical claim reporting and payment
patterns, which are used in the analysis of ultimate claim liabilities. In some analyses, including business without sufficiently
large numbers of policies or that have not accumulated sufficient historical statistics, our own data is supplemented with
external or industry average data as available and when appropriate. For our newer products such as medical professional
liability and workers’ compensation, as well as for executive products, we utilize external data extensively.
In addition to the review of historical claim reporting and payment patterns, we also incorporate estimated losses relative
to premium (loss ratios) by year into the analysis. The expected loss ratios are based on a review of historical loss performance,
trends in frequency and severity and price level changes. The estimates are subject to judgment including consideration given
to available internal and industry data, growth and policy turnover, changes in policy limits, changes in underlying policy
provisions, changes in legal and regulatory interpretations of policy provisions and changes in reinsurance structure. For the
most current year, these are equivalent with the ratios used in the initial IBNR generation process. Increased recognition is
given to actual emergence as the years age.
We use historical development patterns, expected loss ratios and standard actuarial methods to derive an estimate of the
ultimate level of loss and LAE payments necessary to settle all the claims occurring as of the end of the evaluation period.
Our reserve processes include multiple standard actuarial methods for determining estimates of IBNR reserves. Other
supplementary methodologies are incorporated as necessary. Mass tort and latent liabilities are examples of exposures for
which supplementary methodologies are used. Each method produces an estimate of ultimate loss by accident year. We review
all of these various estimates and assign weights to each based on the characteristics of the product being reviewed.
Our estimates of ultimate loss and LAE reserves are subject to change as additional data emerges. This could occur as a
result of change in loss development patterns, a revision in expected loss ratios, the emergence of exceptional loss activity, a
change in weightings between actuarial methods, the addition of new actuarial methodologies, new information that merits
inclusion or the emergence of internal variables or external factors that would alter our view.
There is uncertainty in the estimates of ultimate losses. Significant risk factors to the reserve estimate include, but are not
limited to, unforeseen or unquantifiable changes in:
Loss payment patterns,
Loss reporting patterns,
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Frequency and severity trends,
Underlying policy terms and conditions,
Business or exposure mix,
Operational or internal processes affecting the timing of loss and LAE transactions,
Regulatory and legal environment and/or
Economic environment.
Our actuaries engage in discussions with senior management, underwriting and the claim department on a regular basis to
ascertain any substantial changes in operations or other assumptions that are necessary to consider in the reserving analysis.
A considerable degree of judgment in the evaluation of all these factors is involved in the analysis of reserves. The human
element in the application of judgment is unavoidable when faced with uncertainty. Different experts will choose different
assumptions based on their individual backgrounds, professional experiences and areas of focus. Hence, the estimates selected
by various qualified experts may differ significantly from each other. We consider this uncertainty by examining our historic
reserve accuracy and through an internal peer review process.
Given the substantial impact of the reserve estimates on our financial statements, we subject the reserving process to
significant diagnostic testing and reasonability checks. In addition, there are data validity checks and balances in our front-end
processes. Data anomalies are researched and explained to reach a comfort level with the data and results. Leading indicators
such as actual versus expected emergence and other diagnostics are also incorporated into the reserving processes.
Determination of Our Best Estimate
Upon completion of our loss and LAE estimation analysis, the results are discussed with the LRC. As part of this
discussion, the analysis supporting the actuarial central estimate of the IBNR reserve by product is reviewed. The actuaries also
present explanations supporting any changes to the underlying assumptions used to calculate the indicated central estimate. A
review of the resulting variance between the indicated reserves and the carried reserves takes place. Our actuaries make a
recommendation to management in regards to booked reserves that reflect their analytical assessment and view of estimation
risk. After discussion of these analyses and all relevant risk factors, the LRC determines whether the reserve balances require
adjustment. Resulting reserve balances have always fallen within our actuaries’ reasonable range of estimates.
As a predominantly excess and surplus lines and specialty admitted insurer serving niche markets, we believe there are
several reasons to carry, on an overall basis, reserves above the actuarial central estimate. We believe we are subject to above-
average variation in estimates and that this variation is not symmetrical around the actuarial central estimate.
One reason for the variation is the above-average policyholder turnover and changes in the underlying mix of exposures
typical of an excess and surplus lines business. This constant change can cause estimates based on prior experience to be less
reliable than estimates for more stable, admitted books of business. Also, as a niche market insurer, there is little industry-level
information for direct comparisons of current and prior experience and other reserving parameters. These unknowns create
greater-than-average variation in the actuarial central estimates.
Actuarial methods attempt to quantify future outcomes. However, insurance companies are subject to unique exposures
that are difficult to foresee at the point coverage is initiated and, often, many years subsequent. Judicial and regulatory bodies
involved in interpretation of insurance contracts have increasingly found opportunities to expand coverage beyond that which
was intended or contemplated at the time the policy was issued. Many of these policies are issued on an “all risk” and
occurrence basis. Aggressive plaintiff attorneys have often sought coverage beyond the insurer’s original intent including court
interpretations of exclusionary language.
We believe that because of the inherent variation and the likelihood that there are unforeseen and under-quantified
liabilities absent from the actuarial estimate, it is prudent to carry loss reserves above the actuarial central estimate. Most of our
variance between the carried reserve and the actuarial central estimate is in the most recent accident years for our casualty
segment, where the most significant estimation risks reside. These estimation risks are considered when setting the initial loss
ratios. In the cases where these risks fail to materialize, favorable loss development will likely occur over subsequent
accounting periods. It is also possible that the risks materialize above the amount we considered when booking our initial loss
reserves. In this case, unfavorable loss development is likely to occur over subsequent accounting periods.
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Our best estimate of loss and LAE reserves may change as a result of a revision in the actuarial central estimate, the
actuary’s certainty in the estimates and processes and our overall view of the underlying risks. From time to time, we
benchmark our reserving policies and procedures and refine them by adopting industry best practices where appropriate. A
detailed, ground-up analysis of the actuarial estimation risks associated with each of our products and segments, including an
assessment of industry information, is performed annually. This information is used when determining management’s best
estimate of booked reserves.
Loss reserve estimates are subject to a high degree of variability due to the inherent uncertainty of ultimate settlement
values. Periodic adjustments to these estimates will likely occur as the actual loss emergence reveals itself over time. Our loss
reserving processes reflect accepted actuarial practices and our methodologies result in a reasonable provision for reserves as of
December 31, 2018.
INVESTMENT VALUATION AND OTTI
Throughout each year, we and our investment managers buy and sell securities to achieve investment objectives in
accordance with investment policies established and monitored by our board of directors and executive officers.
Equity securities are carried at fair value with unrealized gains and losses recorded within net earnings in 2018. Prior to
2018, unrealized gains and losses on equity securities were recognized through other comprehensive earnings. We classify our
investments in fixed income securities into one of three categories: trading, held-to-maturity or available-for-sale. We do not
hold any securities classified as trading or held-to-maturity. Available-for-sale securities are carried at fair value with
unrealized gains and losses recorded as a component of comprehensive earnings and shareholders’ equity, net of deferred
income taxes.
Fair value is defined as the price in the principal market that would be received for an asset to facilitate an orderly
transaction between market participants on the measurement date.
We determined the fair value of certain financial instruments based on their underlying characteristics and relevant
transactions in the marketplace. We maximize the use of observable inputs and minimize the use of unobservable inputs when
measuring fair value.
We regularly evaluate our fixed income securities using both quantitative and qualitative criteria to determine impairment
losses for other-than-temporary declines in the fair value of the investments. The following are some of the key factors we
consider for determining if a security is other-than-temporarily impaired:
The length of time and the extent to which the fair value has been less than amortized cost,
The probability of significant adverse changes to the cash flows,
The occurrence of a discrete credit event resulting in the issuer defaulting on a material obligation, the issuer
seeking protection from creditors under the bankruptcy laws, or the issuer proposing a voluntary reorganization
under which creditors are asked to exchange their claims for cash or securities having a fair value substantially
lower than par value of their claims or
The probability that we will recover the entire amortized cost basis of our fixed income securities prior to
maturity.
Quantitative criteria considered during this process include, but are not limited to: the degree and duration of current fair
value as compared to the amortized cost of the security, degree and duration of the security’s fair value being below cost and
whether the issuer is in compliance with the terms and covenants of the security. Qualitative criteria include the credit quality,
current economic conditions, the anticipated speed of cost recovery, the financial health of and specific prospects for the issuer,
as well as the absence of intent to sell or requirement to sell securities prior to recovery. In addition, we consider price declines
in our OTTI analysis when they provide evidence of declining credit quality, and we distinguish between price changes caused
by credit deterioration as opposed to rising interest rates.
Key factors that we consider in the evaluation of credit quality include:
Changes in technology that may impair the earnings potential of the investment,
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The discontinuance of a segment of business that may affect future earnings potential,
Reduction or elimination of dividends,
Specific concerns related to the issuer’s industry or geographic area of operation,
Significant or recurring operating losses, poor cash flows and/or deteriorating liquidity ratios and
A downgrade in credit quality by a major rating agency.
For mortgage-backed securities and asset-backed securities that have significant unrealized loss positions and major
rating agency downgrades, credit impairment is assessed using a cash flow model that estimates likely payments using
security-specific collateral and transaction structure. All of our mortgage-backed and asset-backed securities remain AAA-
rated by one of the major rating agencies and the fair value is not significantly less than amortized cost.
Under current accounting standards, an OTTI write-down of debt securities, where fair value is below amortized cost, is
triggered by circumstances where (1) an entity has the intent to sell a security, (2) it is more likely than not that the entity will
be required to sell the security before recovery of its amortized cost basis or (3) the entity does not expect to recover the entire
amortized cost basis of the security. If an entity intends to sell a security or if it is more likely than not the entity will be
required to sell the security before recovery, an OTTI write-down is recognized in earnings equal to the difference between the
security’s amortized cost and its fair value. If an entity does not intend to sell the security or it is not more likely than not that it
will be required to sell the security before recovery, the OTTI write-down is separated into an amount representing the credit
loss, which is recognized in earnings, and the amount related to all other factors, which is recognized in other comprehensive
income.
Part of our evaluation of whether particular securities are other-than-temporarily impaired involves assessing whether we
have both the intent and ability to continue to hold equity securities in an unrealized loss position. For fixed income securities,
we consider our intent to sell a security (which is determined on a security-by-security basis) and whether it is more likely than
not we will be required to sell the security before the recovery of our amortized cost basis. Significant changes in these factors
could result in a charge to net earnings for impairment losses. Impairment losses result in a reduction of the underlying
investment’s cost basis.
RECOVERABILITY OF REINSURANCE BALANCES
Ceded unearned premiums and reinsurance balances recoverable on paid and unpaid losses and settlement expenses are
reported separately as assets, rather than being netted with the related liabilities, since reinsurance does not relieve the
Company of its liability to policyholders. Such balances are subject to the credit risk associated with the individual reinsurer.
Additionally, the same uncertainties associated with estimating unpaid losses and settlement expenses impact the estimates for
the ceded portion of such liabilities. We continually monitor the financial condition of our reinsurers. As part of our monitoring
efforts, we review their annual financial statements, Securities and Exchange Commission (SEC) filings for reinsurers that are
publicly traded, A.M. Best and S&P rating developments and insurance industry developments that may impact the financial
condition of our reinsurers. In addition, we subject our reinsurance recoverables to detailed recoverability tests, including one
based on average default by S&P rating. Based upon our review and testing, our policy is to charge to earnings, in the form of
an allowance, an estimate of unrecoverable amounts from reinsurers. This allowance is reviewed on an ongoing basis to ensure
that the amount makes a reasonable provision for reinsurance balances that we may be unable to recover.
DEFERRED POLICY ACQUISITION COSTS
We defer incremental direct costs that relate to the successful acquisition of new or renewal insurance contracts, including
commissions and premium taxes. Acquisition-related costs may be deemed ineligible for deferral when they are based on
contingent or performance criteria beyond the basic acquisition of the insurance contract, or when efforts to obtain or renew the
insurance contract are unsuccessful. All eligible costs are capitalized and charged to expense in proportion to premium revenue
recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to
their estimated realizable value. This would also give effect to the premiums to be earned and anticipated losses and settlement
expenses, as well as certain other costs expected to be incurred as the premiums are earned. Judgments as to the ultimate
recoverability of such deferred costs are reviewed on a segment basis and are highly dependent upon estimated future loss costs
associated with the premiums written. This deferral methodology applies to both gross and ceded premiums and acquisition
costs.
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DEFERRED TAXES
We record deferred tax assets and liabilities to the extent that temporary differences between the tax basis and GAAP
basis of an asset or liability result in future taxable or deductible amounts. Our deferred tax assets relate to expected future tax
deductions arising from claim reserves and future taxable income related to changes in our unearned premium. We also have a
significant amount of deferred tax liabilities from unrealized gains on the investment portfolio and deferred acquisition costs.
Periodically, management reviews our deferred tax positions to determine if it is more likely than not that the assets will be
realized. These reviews include, among other things, the nature and amount of the taxable income and expense items, the
expected timing of when assets will be used or liabilities will be required to be reported, as well as the reliability of historical
profitability of businesses expected to provide future earnings. Furthermore, management considers tax-planning strategies it can
use to increase the likelihood that the tax assets will be realized. After conducting the periodic review, if management determines
that the realization of the tax asset does not meet the more likely than not criteria, an offsetting valuation allowance is recorded,
thereby reducing net earnings and the deferred tax asset in that period. In addition, management must make estimates of the tax
rates expected to apply in the periods in which future taxable items are realized. Such estimates include determinations and
judgments as to the expected manner in which certain temporary differences, including deferred amounts related to our equity
method investment, will be recovered. These estimates enter into the determination of the applicable tax rates and are subject to
change based on the circumstances.
We consider uncertainties in income taxes and recognize those in our financial statements as required. As it relates to
uncertainties in income taxes, our unrecognized tax benefits, including interest and penalty accruals, are not considered material to
the consolidated financial statements. Also, no tax uncertainties are expected to result in significant increases or decreases to
unrecognized tax benefits within the next 12-month period. Penalties and interest related to income tax uncertainties, should they
occur, would be included in income tax expense in the period in which they are incurred.
Additional discussion of other significant accounting policies may be found in note 1 to the consolidated financial
statements within Item 8, Financial Statements and Supplementary Data.
RESULTS OF OPERATIONS
Consolidated revenue, as displayed in the table that follows, totaled $818.1 million in 2018, compared to $797.2 million
in 2017 and $816.3 million in 2016.
CONSOLIDATED REVENUE
(in thousands)
Net premiums earned
Net investment income
Net realized gains
Net unrealized losses on equity securities
Total consolidated revenue
2016
2018
Year ended December 31,
2017
$ 791,366 $ 737,937 $ 728,608
53,075
34,645
—
$ 818,123 $ 797,224 $ 816,328
62,085
63,407
(98,735)
54,876
4,411
—
Increased levels of earned premium, investment income and realized gains all led to increased consolidated revenue in
2018. Net premiums earned were up 7 percent, driven by growth from our casualty and property segments. Premium
production was impacted by exits from our recreational vehicle and treaty reinsurance lines in 2017 and 2016, but net
premiums earned still increased on an overall basis in each of those periods, with growth of 1 percent and 4 percent,
respectively. Investment income increased by 13 percent in 2018, compared to a 3 percent increase during the prior year. The
increase was primarily due to a larger asset base as well as higher average interest rates throughout the year. We recorded net
realized gains on our investment portfolio in each of the past three years. The majority of gains realized over this period related
to sales activities versus calls or maturities. Sales activity was largely due to normal portfolio rebalancing, as well as raising
cash to support special dividends paid. Net realized gains for each of the past three years included $4.4 million, $3.4 million
and $7.2 million, respectively, of non-cash realized losses on goodwill and definite-lived intangible asset impairments. In 2018,
we recorded $98.7 million of net unrealized losses on equity securities. Upon adoption of ASU 2016-01, these losses were
recognized in consolidated revenue. Prior to 2018, unrealized gains and losses on equity securities were recognized through
other comprehensive earnings.
42
NET EARNINGS
(in thousands)
Underwriting income
Net investment income
Net realized gains
Net unrealized losses on equity securities
Interest expense on debt
General corporate expenses
Equity in earnings of unconsolidated investees
Earnings before income taxes
Income tax benefit (expense)
Net earnings
2018
2016
62,085
63,407
(98,735)
(7,437)
(9,427)
16,056
Year ended December 31,
2017
$ 41,632 $ 26,844 $ 76,125
53,075
34,645
—
(7,426)
(10,170)
10,833
$ 67,581 $ 84,589 $ 157,082
(42,162)
$ 64,179 $ 105,028 $ 114,920
54,876
4,411
—
(7,426)
(11,340)
17,224
20,439
(3,402)
Net earnings for 2018 totaled $64.2 million, down from $105.0 million in the prior year. The components of net earnings
differed significantly from prior years for two reasons. First, the inclusion of unrealized losses from equity securities in net
earnings in 2018 significantly reduced pretax earnings and lowered income tax expense. Second, our effective tax rate and
income tax expense were impacted by the application of a 21 percent federal corporate tax rate in 2018, compared to the
historical 35 percent rate applied in prior years, as a result of tax reform legislation enacted in 2017. While current tax expense
benefited from this reduction in 2018, earnings were lower because our deferred tax items were revalued to reflect the lower
enacted rate in 2017. The revaluation reduced our net deferred tax liability and income tax expense by $32.8 million in 2017,
which increased earnings, and decreased the effective tax rate by 38.8 percent. Additional information on income tax expense
and the impact of tax reform can be found in note 7 to the consolidated financial statements within Item 8, Financial Statements
and Supplementary Data.
Underwriting Results
Gross premiums written increased by 11 percent in 2018 to record levels despite intense competition across all of our
segments, which was unfavorably influenced by excess levels of capital that remain in the industry. New product initiatives
within our casualty segment, underlying economic growth and increased marketing efforts in our more established products all
contributed to growth during the year. While rates were up modestly for most products, they were up more meaningfully for
wind-exposed catastrophe and auto-related coverages.
The 2018 fiscal year was the second consecutive year of active catastrophes for our Company and the industry as a
whole. While these types of losses are not unexpected, Hurricane Michael resulted in the largest hurricane loss in our history
and was the first time we ceded loss to the first layer of our catastrophe reinsurance treaty since 2005. Catastrophe losses
totaled $40.5 million in 2018, adding 5.1 points to the combined ratio, with Hurricane Michael responsible for $23.0 million,
Hurricane Florence responsible for $7.5 million and other storms and volcanic activity in Hawaii composing the balance. In
2017, catastrophe losses totaled $39.8 million, adding 5.4 points to the combined ratio, with Hurricanes Harvey, Irma and
Maria responsible for $36.0 million of the total. Catastrophe losses in 2016 were $16.3 million, split evenly between amounts
related to spring storms and Hurricane Matthew. Apart from the impact of catastrophes, results for each of these years reflected
a combination of positive underwriting results for the current accident year and favorable loss reserve development on prior
accident years. Favorable development in prior accident years’ reserves was higher than the past two years, with results for
2018 including $50.0 million in favorable development, compared to $38.9 million in 2017 and $42.0 million in 2016. Further
discussion of reserve development can be found in note 6 to the consolidated financial statements within Item 8, Financial
Statements and Supplementary Data.
Incentive and profit-sharing amounts earned by executives, managers and associates are predominately influenced by
corporate performance including net earnings excluding after-tax net realized and unrealized gains or losses, combined ratio
and return on capital. Return on capital measures components of comprehensive earnings against a minimum required return on
capital. Return on capital is the primary measure of executive bonus achievement and a significant component of manager and
associate incentive targets. Incentive and profit sharing-related expenses attributable to the favorable reserve developments
totaled $7.8 million, $5.9 million and $6.6 million for 2018, 2017 and 2016, respectively. An additional $7.7 million in
incentive and profit-sharing-related expenses was recorded in 2017 in connection with the tax reform benefits recognized
during the year, $7.0 million of which was recorded in underwriting expenses. These performance-related expenses impact
policy acquisition, insurance operating and general corporate expenses line items in the financial statements. Partially
offsetting the 2018, 2017 and 2016 increases were $6.1 million, $4.9 million and $2.6 million, respectively, in reductions to
incentive and profit-sharing amounts earned due to losses associated with natural catastrophe activity.
43
In total, underwriting income was $41.6 million on a 94.7 combined ratio in 2018, compared to $26.8 million on a 96.4
combined ratio in 2017 and $76.1 million on an 89.5 combined ratio in 2016. We achieved our 23rd consecutive year of
underwriting profit in 2018, with all three segments contributing to the positive performance. Our ability to continue to produce
underwriting income, and to do so at margins which have consistently outperformed the broader industry, is a testament to our
underwriters’ discipline throughout the insurance cycle and our continued commitment to underwriting for a profit. We believe
our underwriting discipline can differentiate the Company from the broader insurance market by ensuring sound risk selection
and appropriate pricing, which helps slow the pace of deterioration in our underwriting results.
The following tables and narrative provide a more detailed look at individual segment performance over the last three years.
GROSS PREMIUMS WRITTEN AND NET PREMIUMS EARNED
(in thousands)
CASUALTY
Commercial excess and
personal umbrella
General liability
Commercial transportation
Professional services
Small commercial
Executive products
Medical professional liability
Other casualty
Total
Gross Premiums Written
2017
% Change
% Change
2018
2016
Net Premiums Earned
2017
2016
2018
$ 153,540
100,997
101,267
87,243
53,432
68,501
17,426
71,788
$ 654,194
12 % $ 137,265
95,217
6 %
92,449
10 %
84,019
4 %
53,302
0 %
55,598
23 %
21,847
(20)%
57 %
45,752
12 % $ 585,449
91,557
(13)% 105,697
83,672
51,391
51,291
21,060
21,680
2 % $ 134,000 $ 124,350 $ 115,543 $ 111,079
86,853
4 %
81,402
75,872
45,660
18,755
17,449
17,773
4 % $ 560,348 $ 523,472 $ 478,603 $ 454,843
90,283
78,061
78,508
49,601
18,086
17,072
31,449
93,928
81,053
79,951
51,519
21,326
16,042
55,303
0 %
4 %
8 %
4 %
111 %
PROPERTY
Commercial property
Marine
Specialty personal
Other property
Total
SURETY
Miscellaneous
Contract
Commercial
Energy
Total
Grand total
Casualty
$ 110,974
71,784
18,789
1,370
$ 202,917
15 % $ 96,770
59,663
20 %
17,804
6 %
5 %
1,301
16 % $ 175,538
$ 47,461
30,139
29,857
18,648
$ 126,105
$ 983,216
2 % $ 46,461
29,441
2 %
29,954
(0)%
1 %
18,469
1 % $ 124,325
11 % $ 885,312
0 % $ 96,701 $ 71,501 $ 63,117 $ 68,165
59,795
48,301
13 %
24,981
16,901
(31)%
(88)%
10,720
1,064
(6)% $ 186,137 $ 149,261 $ 138,346 $ 152,167
50,931
20,793
3,505
52,638
25,867
10,931
30,540
30,098
19,557
(4)% $ 48,184 $ 46,968 $ 47,237 $ 46,235
28,240
(4)%
29,105
(0)%
(6)%
18,018
(3)% $ 128,379 $ 118,633 $ 120,988 $ 121,598
1 % $ 874,864 $ 791,366 $ 737,937 $ 728,608
28,573
27,625
17,553
28,196
26,751
16,718
Gross premiums written from the casualty segment totaled $654.2 million, up 12 percent in 2018, following increases of
4 percent in 2017 and 8 percent in 2016. Almost all products within the segment posted top line growth. Within other casualty,
premiums assumed from Prime increased by 39 percent after more than doubling in 2017, while general binding authority
(GBA) more than doubled in 2018, to $12.8 million, after launching in 2017. Diversification and exposure growth led to a 23
percent increase in gross premiums written within our executive products group, as newer coverages, such as cyber liability,
supplemented growth from mature product lines. Small price increases for executive product offerings broke the trend of low
single digit rate declines that were experienced in recent years. Commercial excess and personal umbrella also grew 12 percent
in 2018. Increased marketing efforts, modest rate increases and investments in technology and customer experience initiatives
yielded this improved level of production. Continued expansion into the energy casualty space, which we entered in 2016, also
benefited the top line for commercial excess.
Premium written by commercial transportation increased by 10 percent. The increase was rate driven, as 2018 marked the
second consecutive year of low double digit increases. This follows a 13 percent decline in 2017, which occurred as a result of
44
re-underwriting actions taken in response to higher commercial auto loss trends. This business posted growth of 16 percent in
2016.
General liability growth was 6 percent, 4 percent and 5 percent in 2018, 2017 and 2016, respectively. Rates for general
liability were relatively flat. Growth was achieved from mature coverages as well as the recently-entered energy casualty line.
Production from small commercial was relatively flat in 2018 as a result of level pricing and the exit from select
underperforming lines. Small commercial posted premium growth of 4 percent in 2017 and 7 percent in 2016. Premiums were
up 4 percent for our professional services group during 2018 despite rates being relatively flat. The 20 percent decrease in
medical professional liability premiums is the result of rate decreases, market competition and changes in our underwriting
approach.
Property
Gross premiums written in the property segment increased 16 percent in 2018, after decreasing 6 percent in 2017 and 11
percent in 2016. The declines for 2017 and 2016 reflect exits from our RV, treaty reinsurance and facultative reinsurance lines.
These products were discontinued due to factors such as poor underwriting performance, lack of scale or unfavorable market
conditions. Production for 2016 was also impacted by our exit from crop reinsurance, which occurred due to the acquisition of
the cedant company.
Our commercial property business grew 15 percent in 2018, due to a combination of exposure growth and rate increases
on wind-prone business. Rates on other catastrophe coverages, such as earthquake, continued to decline, albeit at lower levels
than in recent years. Our commercial property business was relatively flat in 2017, as modest exposure growth served to offset
rate declines from the catastrophe exposed coverages, and followed a decline of 9 percent in 2016. Premiums from marine
increased by 20 percent in 2018, as we secured new business, improved retentions and increased rates on our inland marine
coverages. Marine was up 13 percent in 2017, due to a combination of exposure growth and modestly higher prices for inland
marine, after declining 2 percent in 2016.
Specialty personal lines is primarily composed of homeowners’ insurance in select locations, including Hawaii,
Massachusetts and North Carolina. Premiums from our Hawaii homeowners business increased 10 percent in 2018, after
posting a 7 percent increase during 2017 and 8 percent in 2016. Rates have been flat for this coverage, but increased marketing
efforts and recognition of our exceptional claim service following the Hawaii volcano losses have helped bring in new
business. Specialty personal offerings also included our RV product, which we exited at the end of 2016 due to poor
underwriting performance. RV wrote $10.4 million of specialty personal premium in 2016, but decreased to less than $1.0
million in 2017 and had almost no premium in 2018.
Other property increased in 2018 as a result of property exposed GBA business. Other property also includes reinsurance
premiums, which declined after we exited our treaty reinsurance business in 2016 and discontinued our facultative reinsurance
line in 2015.
Surety
Gross premiums written from our surety segment increased 1 percent in 2018, following a 3 percent decline in 2017 and 2
percent growth in 2016. Miscellaneous surety was up 2 percent in 2018, as a realignment of our sales team allowed the
Company to grow in a very competitive market. This product experienced a 4 percent decline in 2017, largely due to targeted
reductions to select programs. Contract surety was also up 2 percent in 2018. Despite competition putting pressure on rates and
terms, expansion of the commercial construction market and initiatives aimed at improving the customer experience provided
an opportunity for growth with conditions and prices that met our high underwriting standards. Contract surety was down 4
percent in 2017, as certain accounts which no longer met our underwriting appetite were non-renewed, and was up 5 percent in
2016 when growth was experienced from bonds targeted to smaller contractors. Commercial surety was down slightly in 2018
and 2017, as market conditions made it difficult to compete on new account submissions. Efforts to selectively trim the
portfolio in favor of retaining higher quality, lower risk accounts led to a decline in commercial surety premium in 2016.
Energy surety was up 1 percent in 2018 and is combating the lower energy prices and soft market conditions that resulted in the
6 percent decline in 2017. Gross premiums written from energy surety for 2016 were up slightly.
45
UNDERWRITING INCOME (LOSS)
(in thousands)
Casualty
Property
Surety
Total
$
$
2018
2017
2016
11,140 $
884
29,608
41,632 $
3,904 $
(11,859)
34,799
26,844 $
36,329
12,832
26,964
76,125
COMBINED RATIO
Casualty
Property
Surety
Total
Casualty
2018
2017
2016
97.9
99.4
75.0
94.7
99.2
108.6
71.2
96.4
92.0
91.6
77.8
89.5
Underwriting income for the casualty segment was $11.1 million on a 97.9 combined ratio in 2018. The current accident
year combined ratio in 2018 was higher than prior years due to a shift in mix of business and new products on which we take a
cautious approach to loss ratio selection. The current year loss ratio for 2018 and 2017 was also impacted by higher loss ratio
selections on transportation and other auto-related exposures and higher catastrophe losses, as hurricane losses were sustained
on certain casualty-oriented products that include ancillary property exposures.
Favorable development on prior accident years’ loss reserves benefited underwriting earnings in each of the past three
years. The total benefit from favorable development on prior years’ reserves was $33.3 million for 2018, with the largest
amounts of the development coming from accident years 2015 through 2017. Products which generated the majority of the
favorable development include commercial excess, personal umbrella, professional services, general liability and small
commercial. Increased favorable development on commercial excess, personal umbrella, general liability and professional
services was responsible for a significant amount of the difference between the release in 2018 and 2017. Additionally, our
transportation business experienced $0.5 million of favorable development in 2018 compared to $7.4 million of adverse
development in 2017 and $15.4 million of adverse development in 2016. In response to adverse commercial auto loss trends,
we began re-underwriting our transportation book in the fourth quarter 2016, with a focus on obtaining appropriate rate
increases and improving risk selection. Our transportation re-underwriting efforts were completed during the second half of
2017 and have helped stabilize the business. Partially offsetting these favorable impacts was an increased level of adverse
development on medical professional liability and adverse development on executive products.
Comparatively, overall results for the casualty segment in 2017 included favorable development of $17.5 million, with
the bulk of the development attributable to commercial excess, personal umbrella, general liability, executive products, small
commercial and professional services across accident years 2014 through 2016. For 2016, results included favorable
development of $32.4 million, with the bulk of the development attributable to general liability, executive products, small
commercial and commercial excess across accident years 2009 through 2015.
The segment’s loss ratio was 63.0 in 2018, compared to 63.9 in 2017 and 57.1 in 2016. The lower loss ratio in 2018 was
due to the higher amounts of favorable development on prior years’ reserves, partially offset by an increased current accident
year loss ratio. The expense ratio for the casualty segment was 34.9 in 2018, compared to 35.3 in 2017 and 34.9 in 2016. The
decrease in expense ratio in 2018 was a result of lower incentive and profit-sharing expenses. An additional $3.9 million of
incentive and profit-sharing expenses was recognized in connection with tax reform benefits during 2017, accounting for
nearly 1 point of the expense ratio. Adjusting for this one-time impact, an increase in the expense ratio would have been
observed in 2018, as investments were made in technology and our mix had a modest shift towards products with higher
acquisition rates.
Property
Underwriting income from the property segment was $0.9 million on a 99.4 combined ratio in 2018. Despite the largest
hurricane loss in our history, the segment was still able to achieve profitability for the year. Catastrophe losses for the property
segment totaled $38.3 million in 2018 and included $28.9 million from Hurricanes Michael and Florence and $6.1 million from
volcanic activity in Hawaii. In comparison, 2017 experienced an underwriting loss that was driven by $38.4 million in
catastrophe losses during the year, $34.9 million of which related to Hurricanes Harvey, Irma and Maria. Underwriting
profitability was also attained in 2016 and was impacted by $15.8 million of catastrophe loss related to Hurricane Matthew and
seasonal wind storms.
46
Partially offsetting the catastrophe losses described above, favorable development in prior years’ reserves benefited
underwriting results in each of the past three years. Results for 2018 included $10.8 million of favorable development on prior
years’ reserves, primarily from accident years 2017 and 2015. Our marine product was the predominant driver of the favorable
development, but our commercial property and assumed reinsurance products also contributed. Results for 2017 included $12.1
million of favorable development in prior years’ reserves, largely from marine and commercial property. Releases from marine
and other property reinsurance offset adverse development from RV in 2016, resulting in $4.8 million of total favorable
development.
The segment’s loss ratio was 56.2 in 2018 compared to 61.5 in 2017 and 46.9 in 2016. Catastrophe losses added nearly 26
points to the loss ratio, compared to 28 points and 10 points of impact from catastrophe losses in 2017 and 2016, respectively.
Higher current accident year losses from our fire business also contributed to the higher loss ratio in 2017. These items were
partially offset by approximately 5 points of favorable development on prior years’ reserves in 2018, compared to 6 points and
1 point of benefit in the two previous years. The expense ratio for the property segment was 43.2 in 2018 compared to 47.1 in
2017 and 44.7 in 2016. Lower incentive and profit-sharing expenses and a higher premium base led to the lower expense ratio
in 2018. The 2017 expense ratio was affected by $1.8 million of incentive and profit-sharing expenses that was recognized in
connection with tax reform benefits, which added approximately 1 point to the expense ratio.
Surety
Underwriting income for the surety segment totaled $29.6 million on a 75.0 combined ratio in 2018. Underwriting
performance for each of the past three years reflects a combination of positive current accident year results and favorable
development in prior accident years’ loss reserves. The current accident year combined ratio in each of the past three years has
been in the low 80s, with each product line contributing underwriting profit. Results for 2018 included $5.9 million of
favorable development in prior years’ reserves, compared to $9.3 million and $4.8 million in 2017 and 2016, respectively.
The segment’s loss ratio was 12.3 in 2018, compared to 9.0 in 2017 and 15.2 in 2016. A combination of increased current
accident year claim activity and lower amounts of favorable development on prior years’ reserves resulted in a higher loss ratio
in 2018 when compared to 2017. Increased losses on energy and contract surety in 2016 also contributed to the higher loss ratio
in that period. The expense ratio for the surety segment was 62.7 in 2018, compared to 62.2 in 2017 and 62.6 in 2016. The
increase in 2018 was due to a modest decline in earned premium, increased investments in technology and a modest shift in
mix towards miscellaneous surety, which has a higher commission structure. The 2017 expense ratio included $1.4 million of
incentive and profit-sharing expenses that were recognized in connection with tax reform benefits, which added approximately
1 point to the expense ratio.
NET INVESTMENT INCOME AND REALIZED INVESTMENT GAINS
During 2018, net investment income increased by 13 percent. The increase was primarily due to a larger asset base as
well as higher average interest rates throughout the year. The average annual yields on our investments were as follows for
2018, 2017 and 2016:
PRETAX YIELD
Taxable (on book value)
Tax-exempt (on book value)
Equities (on fair value)
AFTER-TAX YIELD
Taxable (on book value)
Tax-exempt (on book value)
Equities (on fair value)
2018
2017
2016
3.31 %
2.71 %
2.54 %
3.20 %
2.57 %
2.71 %
3.20 %
2.64 %
2.85 %
2.61 %
2.57 %
2.21 %
2.08 %
2.44 %
2.31 %
2.08 %
2.50 %
2.43 %
The after-tax yield reflects the different tax rates applicable to each category of investment. In 2018, our taxable fixed
income securities were subject to a corporate tax rate of 21.0 percent, our tax-exempt municipal securities were subject to a tax
rate of 5.3 percent and our dividend income was generally subject to a tax rate of 13.1 percent. In 2017 and 2016, our taxable
fixed income securities were subject to a corporate tax rate of 35.0 percent, our tax-exempt municipal securities were subject to
a tax rate of 5.3 percent and our dividend income was generally subject to a tax rate of 14.2 percent. During 2018, the average
after-tax yield on the taxable fixed income portfolio was 2.6 percent, an increase from 2.1 percent in the prior year due to the
47
Tax Cuts and Jobs Act of 2017, which lowered the federal corporate tax rate from 35 percent to 21 percent. The average after-
tax yield on the tax-exempt portfolio increased to 2.6 percent.
The fixed income portfolio increased by $88.3 million during the year as the majority of operating cash flows were used
for fixed income purchases. The tax-adjusted total return on a mark-to-market basis was 0.7 percent. Our equity portfolio
decreased by $60.0 million to $340.5 million in 2018 as a result of the decline in equity markets in the fourth quarter,
rebalancing to other asset classes and outright sales to support our special dividend. The total return for the year on the equity
portfolio was -5.7 percent.
Our investment results for the last five years are shown in the following table:
Net
Investment
Income (2)(3)
Net Realized
Gains
(Losses) (3)
Average
Invested
Assets (1)
1,943,172
1,957,914
1,986,685
2,081,309
2,167,510
$ 2,027,318 $
55,608
54,644
53,075
54,876
62,085
56,058 $
Pre-tax
Annualized
Return on
Change in
Unrealized
Appreciation
(3)(4)
55,180
(71,049)
(2,313)
53,719
(140,513)
(20,995)
32,182
39,829
34,645
4,411
63,407
34,895 $
Avg.
Invested
Assets
7.4 %
1.2 %
4.3 %
5.4 %
(0.7)%
3.5 %
Tax
Equivalent
Annualized
Return on
Avg.
Invested
Assets
7.7 %
1.5 %
4.6 %
5.8 %
(0.6) %
3.8 %
(in thousands)
2014
2015
2016
2017
2018
5-yr Avg.
(1) Average amounts at beginning and end of year (inclusive of cash and short-term investments).
(2) Investment income, net of investment expenses.
(3) Before income taxes.
(4) Relates to available-for-sale fixed income and equity securities.
We realized a total of $63.4 million in net gains in 2018. Included in this number is $69.9 million in net realized gains in
the equity portfolio, $2.2 million in net realized losses in the fixed income portfolio and $4.2 million in other net realized
losses, $4.4 million of which related to a non-cash impairment charge on goodwill and definite-lived intangibles. In 2017, we
realized $4.4 million in net gains. Included in this number is $10.3 million in net realized gains in the equity portfolio, $1.7
million in net realized losses in the fixed income portfolio and $4.2 million in other net realized losses, $3.4 million of which
related to a non-cash impairment charge on goodwill and definite-lived intangibles. In 2016, we realized $34.6 million in net
gains. Included in this number is $38.7 million in net realized gains in the equity portfolio, $4.2 million in net realized gains in
the fixed income portfolio and $8.3 million in other net realized losses, $7.2 million of which related to a non-cash impairment
charge on goodwill.
We regularly evaluate the quality of our investment portfolio. When we determine that a fixed income security has
suffered an other-than-temporary decline in value, the investment’s value is adjusted by reclassifying the decline from
unrealized to realized losses. This has no impact on shareholders’ equity. We recognized $0.2 million, $2.6 million and $0.1
million in impairment losses in 2018, 2017 and 2016, respectively. All losses were taken on fixed income securities we no
longer had the intent to hold until recovery.
The fixed income portfolio contained 777 positions at an unrealized loss as of December 31, 2018. Of these 777
securities, 302 have been in an unrealized loss position for 12 consecutive months or longer and represent $19.7 million in
unrealized losses. All fixed income securities in the investment portfolio continue to pay the expected coupon payments under
the contractual terms of the securities. Based on our analysis, our fixed income portfolio is of a high credit quality and we
believe we will recover the amortized cost basis.
Key components to our OTTI procedures are discussed in our critical accounting policy on investment valuation and
OTTI and in note 2 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.
Based on our analysis, we have concluded that the securities in an unrealized loss position were not other-than-temporarily
impaired at December 31, 2018.
48
INVESTMENTS
We maintain a diversified investment portfolio with a prudent mix of fixed income and risk assets. We continually
monitor economic conditions, our capital position and the insurance market to determine our tactical allocation. As of
December 31, 2018, the portfolio had a fair value of $2.2 billion, an increase of $53.4 million from the end of 2017.
We determined the fair value of certain financial instruments based on their underlying characteristics and relevant
transactions in the marketplace. We maximize the use of observable inputs and minimize the use of unobservable inputs when
measuring fair value. For additional information, see notes 1 and 2 to the consolidated financial statements within Item 8,
Financial Statements and Supplementary Data.
As of December 31, 2018, our investment portfolio had the following asset allocation breakdown:
PORTFOLIO ALLOCATION
(in thousands)
Asset Class
U. S. government
U.S. agency
Non-U.S. govt & agency
Agency MBS
ABS/CMBS**
Corporate
Municipal
Total fixed income
Equities
Short-term investments
Other invested assets
Cash
Total portfolio
Cost or
Amortized
Unrealized
% of Total
Gain/(Loss) Fair Value
$
Fair Value
Cost
199,982 $
31,716
8,170
402,992
137,224
681,909
314,472
200,229 $
31,904
7,639
395,253
136,723
668,679
320,088
247
188
(531)
(7,739)
(501)
(13,230)
5,616
$ 1,776,465 $ 1,760,515 $ (15,950)
340,483 $ 120,110
$
11,550 $
—
$
(218)
51,542
—
30,140
$ 2,090,288 $ 2,194,230 $ 103,942
220,373 $
11,550 $
51,760
30,140
Quality*
9.1 % AAA
1.5 % AAA
0.3 % BBB+
18.0 % AAA
6.2 % AAA
30.5 % A-
14.6 % AA
80.2 % AA-
15.5 %
0.5 %
2.4 %
1.4 %
100.0 %
* Quality ratings provided by Moody’s, S&P and Fitch
** Non-agency asset-backed and commercial mortgage-backed
Quality in the previous table and in all subsequent tables is an average of each bond’s credit rating, adjusted for its
relative weighting in the portfolio.
Fixed income represented 80 percent of our total 2018 portfolio, up 2 percent from 2017. As of December 31, 2018, the
fair value of our fixed income portfolio consisted of 48 percent AAA-rated securities, 16 percent AA-rated securities, 20
percent A-rated securities, 10 percent BBB-rated securities and 6 percent non-investment grade or non-rated securities. This
compares to 38 percent AAA-rated securities, 28 percent AA-rated securities, 17 percent A-rated securities, 11 percent BBB-
rated securities and 6 percent non-investment grade or non-rated securities in 2017.
In selecting the maturity of securities in which we invest, we consider the relationship between the duration of our fixed
income investments and the duration of our liabilities, including the expected ultimate payout patterns of our reserves. We
believe that both liquidity and interest rate risk can be minimized by such asset/liability management. As of December 31,
2018, our fixed income portfolio’s duration was 4.5 years.
Our equity portfolio had a fair value of $340.5 million at December 31, 2018. Equities comprised 16 percent of our total
2018 portfolio, down 3 percent over 2017. Securities within the equity portfolio are well diversified and are primarily invested
in large-cap issues with a preference for dividend income. Our strategy has a value tilt and security selection takes precedence
over market timing. Likewise, low turnover throughout our long investment horizon minimizes transaction costs and taxes.
49
FIXED INCOME PORTFOLIO
As of December 31, 2018, our fixed income portfolio had the following rating distributions:
FAIR VALUE
(in thousands)
Bonds:
AAA
AA
A
BBB
Grade
No Rating Fair Value
Below
Investment
U.S. government & agency (GSE) $ 222,277 $
Non-U.S. government & agency
Corporate - financial
All other corporate
Corporate financial - private
placements
All other corporate - private
placements
Municipal
—
—
15,553
—
72,826
2,972
9,856 $
—
30,025
26,018
— $
690
132,639
119,609
6,949
42,705
100,351
— $
—
3,114
21,475
— $
— $
—
—
—
232,133
7,639
208,483
283,006
13,550
18,440
4,558
5,759
—
45,279
4,801
197,593
38,851
46,461
22,101
—
66,158
—
—
3,208
131,911
320,088
Structured:
GSE - RMBS
ABS - utility
ABS - credit cards
ABS - auto loans
All other ABS
GSE - CMBS
CMBS
Total
$ 291,278 $
15,508
31,100
49,990
14,077
103,975
26,048
291,278
15,508
31,100
49,990
14,077
103,975
26,048
$ 845,604 $ 281,843 $ 356,690 $ 176,664 $ 96,506 $ 3,208 $ 1,760,515
— $
—
—
—
—
—
—
— $
—
—
—
—
—
—
— $
—
—
—
—
—
—
— $
—
—
—
—
—
—
— $
—
—
—
—
—
—
Mortgage-Backed, Commercial Mortgage-Backed and Asset-Backed Securities
The following table summarizes the distribution of our mortgage-backed securities (MBS) portfolio by investment type,
as of the dates indicated:
AGENCY MBS
(in thousands)
2018
Pass-throughs
Sequential
Planned amortization class
Total
2017
Pass-throughs
Sequential
Planned amortization class
Total
Amortized
Cost
Fair Value
% of Total
$
$
$
$
262,752 $
107,951
32,289
402,992 $
259,728
103,975
31,550
395,253
210,492 $
82,766
35,871
329,129 $
211,706
81,355
35,410
328,471
65.7 %
26.3 %
8.0 %
100.0 %
64.4 %
24.8 %
10.8 %
100.0 %
Our allocation to agency mortgage-backed securities totaled $395.3 million as of December 31, 2018. MBS represented
22 percent of the fixed income portfolio compared to $328.5 million or 20 percent of that portfolio as of December 31, 2017.
50
We believe MBS investments add diversification, liquidity, credit quality and additional yield to our portfolio. Our
objective for the MBS portfolio is to provide reasonable cash flow stability where we are compensated for the call risk
associated with residential refinancing. The MBS portfolio includes mortgage-backed pass-through securities and collateralized
mortgage obligations (CMO) which include planned amortization classes (PACs) and sequential pay structures. Our MBS
portfolio does not include interest-only securities or principal-only securities. As of December 31, 2018, all of the securities in
our MBS portfolio were rated AAA and issued by Government Sponsored Enterprises (GSEs) such as the Governmental
National Mortgage Association (GNMA), Federal National Mortgage Association (FNMA) or the Federal Home Loan
Mortgage Corporation (FHLMC).
Variability in the average life of principal repayment is an inherent risk of owning mortgage-related securities. However,
we reduce our portfolio’s exposure to prepayment risk by seeking characteristics that tighten the probable scenarios for
expected cash flows. As of December 31, 2018, the MBS portfolio contained 66 percent of pure pass-throughs compared to 64
percent as of December 31, 2017. An additional 26 percent of the MBS portfolio was invested in sequential payer, up from 25
percent in 2017.
The following table summarizes the distribution of our asset-backed and commercial mortgage-backed securities
portfolio as of the dates indicated:
ABS/CMBS
(in thousands)
2018
Auto
Credit card
CMBS
CLO
Equipment
Student
Other
Total
2017
Auto
Credit card
CMBS
CLO
Equipment
Student
Other
Total
Amortized
Cost
Fair Value
% of Total
$
$
$
$
50,062 $
31,058
26,490
15,582
5,870
4,594
3,568
137,224 $
49,990
31,100
26,048
15,508
5,878
4,616
3,583
136,723
28,664 $
5,187
29,807
—
3,866
—
2,881
70,405 $
28,503
5,207
30,102
—
3,860
—
2,854
70,526
36.6 %
22.7 %
19.1 %
11.3 %
4.3 %
3.4 %
2.6 %
100.0 %
40.4 %
7.4 %
42.7 %
— %
5.5 %
— %
4.0 %
100.0 %
An asset-backed security (ABS) or commercial mortgage-backed security (CMBS) is a securitization collateralized by the
cash flows from a specific pool of underlying assets. These asset pools can include items such as credit card payments, auto
loans, structured bank loans in the form of collateralized loan obligations (CLOs) and residential or commercial mortgages. As
of December 31, 2018, ABS/CMBS investments were $136.7 million (8 percent) of the fixed income portfolio, compared to
$70.5 million (4 percent) as of December 31, 2017. All of the securities in the ABS/CMBS portfolio were rated AAA as of
December 31, 2018. We believe that ABS/CMBS investments add diversification and additional yield to the portfolio while
often adding superior cash flow stability over mortgage pass-throughs or CMOs.
When making investments in MBS/ABS/CMBS, we evaluate the quality of the underlying collateral, the structure of the
transaction (which dictates how any losses in the underlying collateral will be distributed) and prepayment risks. All of our
collateralized securities carry the highest credit rating by one or more major rating agencies and continue to pay according to
contractual terms. We had $10.3 million in unrealized losses in these asset classes as of December 31, 2018.
51
Municipal Fixed Income Securities
As of December 31, 2018, municipal bonds totaled $320.1 million (18 percent) of our fixed income portfolio, compared
to $636.2 million (38 percent) as of December 31, 2017. We reduced our allocation to municipal bonds during 2018 as the
lower corporate tax rate from the TCJA diminished the asset class’ relative value when compared to other sectors. Despite the
change, we still believe municipal fixed income securities can provide diversification and additional tax-advantaged yield to
our portfolio. Our objective for the municipal fixed income portfolio is to provide reasonable cash flow stability and increased
after-tax yield.
Our municipal fixed income portfolio is comprised of general obligation (GO) and revenue securities. The revenue
sources include sectors such as sewer and water, public improvement, school, transportation and colleges and universities.
As of December 31, 2018, approximately 42 percent of the municipal fixed income securities in the investment portfolio
were GO and the remaining 58 percent were revenue based. Eighty-five percent of our municipal fixed income securities were
rated AA or better, while 99 percent were rated A or better.
Corporate Debt Securities
As of December 31, 2018, our corporate debt portfolio totaled $668.7 million (38 percent) of the fixed income portfolio
compared to $519.0 million (31 percent) as of December 31, 2017. The corporate allocation includes floating rate bank loans
and bonds that are below investment grade in credit quality and offer incremental yield over our core fixed income portfolio.
Non-investment grade bonds totaled $96.5 million at the end of 2018. The corporate debt portfolio has an overall quality rating
of A- diversified among 628 issues.
The following table illustrates our corporate debt exposure to the financial and non-financial sectors as of December 31,
2018, including fair value, cost basis and unrealized gains and losses:
CORPORATES
(in thousands)
Bonds:
Corporate - financial
All other corporate
Financials - private placements
All other corporate - private placements
Total
Amortized
Gross
Unrealized
Cost
Fair Value
Gains
Gross
unrealized
losses
$
$
211,023 $
288,737
45,661
136,488
681,909 $
208,483 $
283,006
45,279
131,911
668,679 $
1,112 $
1,292
304
186
2,894 $
(3,652)
(7,023)
(686)
(4,763)
(16,124)
We believe corporate debt investments add diversification and additional yield to our portfolio. Because corporates make
up a large portion of the fixed income opportunity set, the corporate debt investments will continue to be a significant part of
our investment program.
The amortized cost and fair value of fixed income securities at December 31, 2018, by contractual maturity, are shown as
follows:
TOTAL FIXED INCOME
(in thousands)
Due in one year or less
Due after one year through five years
Due after five years through 10 years
Due after 10 years
Mtge/ABS/CMBS*
Total fixed income
* Mortgage-backed, asset backed and commercial mortgage-backed
52
Amortized Cost Fair Value
41,319 $
$
41,333
410,680
608,115
168,412
531,975
$ 1,776,465 $ 1,760,515
411,154
615,060
168,716
540,216
EQUITY SECURITIES
As of December 31, 2018, our equity portfolio totaled $340.5 million (16 percent) of the investment portfolio, compared
to $400.5 million (19 percent) as of December 31, 2017. The securities within the equity portfolio remain primarily invested in
large-cap issues with a focus on dividend income. In addition, we have investments in three broadly diversified, exchange
traded funds (ETFs) that represent market indexes similar to the Russell 1000 Index, Russell 2000 Index and the S&P 500
Index. The ETF portfolio is congruent with the actively managed equity portfolios and solves for exposures that line up with
our overall benchmark index, the Russell 3000.
INTEREST AND CORPORATE EXPENSE
We incurred $7.4 million of interest expense on outstanding debt during 2018, 2017 and 2016. At December 31, 2018,
2017 and 2016, our long-term debt consisted of $150.0 million in senior notes maturing September 15, 2023, and paying
interest semi-annually at the rate of 4.875 percent.
As discussed previously, general corporate expenses tend to fluctuate relative to our incentive compensation plans. Our
compensation model measures components of comprehensive earnings against a minimum required return on our capital.
Bonuses are earned as we generate earnings in excess of this required return. In 2018, 2017 and 2016, we exceeded the
required return, resulting in the accrual of executive bonuses. Decreased levels of comprehensive earnings in 2018 resulted in
lower variable compensation earned than in 2017 and 2016.
INVESTEE EARNINGS
We maintain a 40 percent equity interest in Maui Jim, a manufacturer of high-quality sunglasses. Maui Jim’s chief
executive officer owns a controlling majority of the outstanding shares of Maui Jim. Maui Jim is a private company and, as
such, the market for its stock is limited. Our investment in Maui Jim is carried at the holding company, RLI Corp., level as it is
not core to our insurance operations. As a minority shareholder, we are subject to the decisions of the controlling shareholder,
which may impact the value of our investment. In 2018, we recorded $12.5 million in earnings from this investment compared
to $14.4 million in 2017 and $9.7 million in 2016. Sunglass sales were up 1 percent in 2018, after increasing 9 percent in 2017
and 2 percent in 2016. The decrease in Maui Jim’s earnings in 2018 was related to increased advertising expense and foreign
exchange losses in 2018, compared to foreign exchange gains in 2017, and benefits recognized in 2017 associated with tax
reform.
In 2018 and 2016, we received a dividend from Maui Jim. Dividends from Maui Jim have been irregular in nature and
while they provide added liquidity when received, we do not rely on those dividends to meet our liquidity needs. While these
dividends do not flow through the investee earnings line, they do result in the recognition of a tax benefit, which is discussed in
the income tax section that follows.
As of December 31, 2018, we had a 23 percent interest in the equity and earnings of Prime Holdings Insurance Services,
Inc. (Prime). Prime writes business through two Illinois domiciled insurance carriers, Prime Insurance Company, an excess and
surplus lines company, and Prime Property and Casualty Insurance Inc., an admitted insurance company. As a minority
shareholder, we are subject to the decisions of the controlling shareholder, which may impact the value of our investment. In
2018, we recorded $3.6 million in investee earnings for Prime, compared to $2.8 million in 2017 and $1.1 million in 2016.
Additionally, we maintained a 25 percent quota share reinsurance treaty with Prime, which contributed $41.1 million of gross
premiums written and $34.2 million of net premiums earned during 2018, compared to $29.6 million of gross premiums
written and $21.0 million of net premiums earned during 2017 and $13.4 million of gross premiums written and $11.4 million
of net premiums earned during 2016. Our participation on the quota share reinsurance treaty will be reduced to 6 percent in
2019 as discussed in the Outlook for 2019 section below.
INCOME TAXES
Our effective tax rates were 5.0 percent, -24.2 percent and 26.8 percent for 2018, 2017 and 2016, respectively. Effective
rates are dependent upon components of pretax earnings and the related tax effects. While the effective rate was low in 2018, it
was significantly lower in 2017 as a result of the impact of tax reform. Major factors contributing to the low rate in 2018 are
the inclusion of unrealized losses from equity securities in pretax earnings in 2018, a reduced federal tax rate and adjustments
to provisional deferred tax amounts recorded in 2017.
53
Among other provisions, the Tax Cuts and Jobs Act of 2017 (TCJA) lowered the federal corporate tax rate from 35
percent to 21 percent effective January 1, 2018. Our deferred tax items were revalued as of year-end 2017 to reflect the lower
rate, which reduced our net deferred tax liability and income tax expense by $32.8 million and decreased the effective tax rate
by 38.8 percent.
Except for two aspects, the accounting for the tax effects of the enactment of the TCJA were completed as of December
31, 2017. The first provisional item recorded in 2017 was related to an expected disallowance of deductions for certain
performance based compensation, including bonuses and stock options. At the time of enactment, there was a lack of clarity on
whether some amounts could be grandfathered in as deductible. The Internal Revenue Service (IRS) and Treasury Department
provided additional guidance and we were able to finalize the accounting in 2018 by recording a $2.3 million deferred tax
benefit to restore the deferred tax assets related to those performance based compensation amounts. The second provisional
item related to discount factors on loss reserves that the IRS had not yet published. The IRS published the factors in the fourth
quarter of 2018 and we were able to complete the accounting for the effects of the enactment of the TCJA. While there was no
net impact to the deferred tax amount that was recorded at December 31, 2017, we implemented the new discounting
methodology and will recognize the adjustment ratably over the allowed eight-year period beginning in 2018.
New accounting guidance required the excess tax benefit on share-based compensation to flow through income tax
expense beginning in 2017. Prior to the adoption, excess tax benefits on share-based compensation were recorded directly to
shareholders’ equity and had no impact on the effective tax rate. Due to the new accounting method, we recognized a $4.5
million and $5.8 million tax benefit in 2018 and 2017, respectively, which decreased the effective tax rate by 6.7 percent and
6.9 percent, respectively.
Our net earnings include equity in earnings of unconsolidated investees, Maui Jim and Prime. The investees do not have a
policy or pattern of paying dividends. As a result, we record a deferred tax liability on the earnings at the recently revised
corporate capital gains rate of 21 percent in anticipation of recovering our investments through means other than through the
receipt of dividends, such as a sale. In the fourth quarter of 2017, Maui Jim gave notification that a $9.9 million dividend
would be paid in January 2018. Even though no dividend was received in 2017, we were aware that the lower tax rate
applicable to affiliated dividends (7.4 percent in 2018) would be applied when the dividend was paid in 2018 and we therefore
recorded a $1.4 million tax benefit in 2017. We received a $9.9 million dividend from Maui Jim in the fourth quarter of 2016
and recognized a $2.8 million tax benefit from applying the lower tax rate applicable to affiliated dividends (7.0 percent in
2016), as compared to the corporate capital gains rate on which the deferred tax liabilities were based. Standing alone, the
dividends resulted in a 1.6 percent and 1.8 percent reduction to the 2017 and 2016 effective tax rates, respectively. As no
additional dividends were declared from unconsolidated investees in 2018, there was no impact to the 2018 effective tax rate.
Dividends paid to our Employee Stock Ownership Plan (ESOP) also result in a tax deduction. Dividends paid to the
ESOP in 2018, 2017 and 2016 resulted in tax benefits of $1.2 million $2.9 million and $3.3 million, respectively. These tax
benefits reduced the effective tax rate for 2018, 2017 and 2016 by 1.8 percent, 3.4 percent and 2.1 percent, respectively.
In addition, our pretax earnings in 2018 included $21.1 million of investment income that is partially exempt from federal
income tax, compared to $25.4 million and $24.9 million in 2017 and 2016, respectively.
NET UNPAID LOSSES AND SETTLEMENT EXPENSES
The primary liability on our balance sheet relates to unpaid losses and settlement expenses, which represents our
estimated liability for losses and related settlement expenses before considering offsetting reinsurance balances recoverable.
The largest asset on our balance sheet, outside of investments, is the reinsurance balances recoverable on unpaid losses and
settlement expenses, which serves to offset this liability.
The liability can be split into two parts: (1) case reserves representing estimates of losses and settlement expenses on
known claims and (2) IBNR reserves representing estimates of losses and settlement expenses on claims that have occurred but
have not yet been reported to the Company. Our gross liability for both case and IBNR reserves is reduced by reinsurance
balances recoverable on unpaid losses and settlement expenses to calculate our net reserve balance. This net reserve balance
increased to $1,096.3 million at December 31, 2018, from $969.5 million as of December 31, 2017. This reflects incurred
losses of $428.2 million in 2018 offset by paid losses of $301.4 million compared to incurred losses of $401.6 million offset by
$283.2 million paid in 2017. For more information on the changes in loss and LAE reserves by segment, see note 6 to the
consolidated financial statements within Item 8, Financial Statements and Supplementary Data.
54
Gross reserves (liability) and the reinsurance balances recoverable (asset) are generally subject to the same influences that
affect net reserves, though changes to our reinsurance agreements can cause reinsurance balances recoverable to behave
differently. Total gross loss and LAE reserves increased to $1.5 billion at December 31, 2018 from $1.3 billion at
December 31, 2017 while ceded loss and LAE reserves increased to $365.0 million from $302.0 million over the same period.
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
We have three primary types of cash flows: (1) operating cash flows, which consist mainly of cash generated by our
underwriting operations and income earned on our investment portfolio, (2) investing cash flows related to the purchase, sale
and maturity of investments and (3) financing cash flows that impact our capital structure, such as changes in debt and shares
outstanding. The following table summarizes these three cash flows over the last three years:
(in thousands)
Operating cash flows
Investing cash flows (uses)
Financing cash flows (uses)
2018
2017
$ 217,102 $ 197,525 $ 174,463
(53,622)
(113,653)
(81,212)
(110,311)
(134,209)
(77,024)
2016
We have posted positive operating cash flow in each of the last three years. Variations in operating cash flow between
periods are largely driven by the volume and timing of premium receipt, claim payments, reinsurance and taxes. In addition,
fluctuations in insurance operating expenses impact operating cash flow. During 2018, the majority of cash flow uses were
related to financing and investing activities, and associated with the payments of dividends and net purchases of investments,
respectively.
We have entered into certain contractual obligations that require the Company to make recurring payments. The
following table summarizes our contractual obligations as of December 31, 2018:
CONTRACTUAL OBLIGATIONS
(in thousands)
Loss and settlement expense reserves
Long-term debt
Operating leases
Other invested assets
Total
Payments due by period
More than
Less than 1
yr.
1-3 yrs.
3-5 yrs.
$ 405,882 $ 545,320 $ 271,154 $ 238,992 $ 1,461,348
150,000
150,000
32,165
10,343
26,238
587
$ 426,698 $ 567,745 $ 432,084 $ 243,224 $ 1,669,751
—
11,943
10,482
—
5,911
14,905
—
3,968
264
5 yrs.
Total
Loss and settlement expense reserves represent our best estimate of the ultimate cost of settling reported and unreported
claims and related expenses. As discussed previously, the estimation of loss and loss expense reserves is based on various
complex and subjective judgments. Actual losses and settlement expenses paid may deviate, perhaps substantially, from the
reserve estimates reflected in our financial statements. Similarly, the timing for payment of our estimated losses is not fixed
and is not determinable on an individual or aggregate basis. The assumptions used in estimating the payments due by periods
are based on our historical claims payment experience. Due to the uncertainty inherent in the process of estimating the timing
of such payments, there is a risk that the amounts paid in any period can be significantly different than the amounts disclosed
above. Amounts disclosed above are gross of anticipated amounts recoverable from reinsurers. Reinsurance balances
recoverable on unpaid loss and settlement reserves are reported separately as assets, instead of being netted with the related
liabilities, since reinsurance does not discharge the Company of our liability to policyholders. Reinsurance balances
recoverable on unpaid loss and settlement reserves totaled $365.0 million at December 31, 2018, compared to $302.0 million in
2017.
The next largest contractual obligation relates to long-term debt outstanding. On October 2, 2013, we completed a public
debt offering of $150.0 million in senior notes maturing September 15, 2023, (a 10-year maturity) and paying interest semi-
annually at the rate of 4.875 percent. The notes were issued at a discount resulting in proceeds, net of discount and
commission, of $148.6 million. We are not party to any off-balance sheet arrangements. See note 4 to the consolidated
financial statements within Item 8, Financial Statements and Supplementary Data for more information on our long-term debt.
Additionally, see note 2 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data
for information on our obligations for other invested assets.
55
Our primary objective in managing our capital is to preserve and grow shareholders’ equity and statutory surplus to
improve our competitive position and allow for expansion of our insurance operations. Our insurance subsidiaries must
maintain certain minimum capital levels in order to meet the requirements of the states in which we are regulated. Our
insurance companies are also evaluated by rating agencies that assign financial strength ratings that measure our ability to meet
our obligations to policyholders over an extended period of time.
We have historically grown our shareholders’ equity and/or policyholders’ surplus as a result of three sources of funds:
(1) earnings on underwriting and investing activities, (2) appreciation in the value of our investments and (3) the issuance of
common stock and debt.
At December 31, 2018, we had cash, short-term investments and other investments maturing within one year of
approximately $83.0 million and an additional $410.7 million of investments maturing between 1 to 5 years. We maintain a
revolving line of credit with JP Morgan Chase Bank N.A., which permits the Company to borrow up to an aggregate principal
amount of $50.0 million. This facility was entered into during the second quarter of 2018 and replaced the previous $40.0
million facility which expired on May 28, 2018. Under certain conditions, the line may be increased up to an aggregate
principal amount of $75.0 million. The facility has a two-year term that expires on May 24, 2020. As of and during the year
ended December 31, 2018, no amounts were outstanding on this facility.
Additionally, two of our insurance companies, RLI Ins. and Mt. Hawley, are members of the Federal Home Loan Bank of
Chicago (FHLBC). Membership in the Federal Home Loan Bank system provides both companies access to an additional
source of liquidity via a secured lending facility. Based on qualifying assets at year-end, aggregate borrowing capacity is
approximately $20 million. However, under certain circumstances, that capacity may be increased based on additional FHLBC
stock purchased and available collateral. Our membership allows each insurance subsidiary to determine tenor and structure at
the time of borrowing. As of and during the year ended December 31, 2018, there were no outstanding borrowings with the
FHLBC.
We believe that cash generated by operations, cash generated by investments and cash available from financing activities
will provide sufficient sources of liquidity to meet our anticipated needs over the next 12 to 24 months. We have consistently
generated positive operating cash flow. The primary factor in our ability to generate positive operating cash flow is
underwriting profitability, which we have achieved for 23 consecutive years.
OPERATING ACTIVITIES
The following list highlights some of the major sources and uses of cash flow from operating activities:
Sources
Premiums received
Loss payments from reinsurers
Investment income (interest & dividends)
Unconsolidated investee dividends from affiliates
Funds held
Uses
Claims
Ceded premium to reinsurers
Commissions paid
Operating expenses
Interest expense
Income taxes
Funds held
Our largest source of cash is from premiums received from our customers, which we receive at the beginning of the
coverage period for most policies. Our largest cash outflow is for claims that arise when a policyholder incurs an insured loss.
Because the payment of claims occurs after the receipt of the premium, often years later, we invest the cash in various
investment securities that earn interest and dividends. We use cash to pay commissions to brokers and agents, as well as to pay
for ongoing operating expenses such as salaries, rent, taxes and interest expense. We also utilize reinsurance to manage the risk
that we take on our policies. We cede, or pay out, part of the premiums we receive to our reinsurers and collect cash back when
losses subject to our reinsurance coverage are paid.
The timing of our cash flows from operating activities can vary among periods due to the timing by which payments are
made or received. Some of our payments and receipts, including loss settlements and subsequent reinsurance receipts, can be
significant, so their timing can influence cash flows from operating activities in any given period. We are subject to the risk of
incurring significant losses on catastrophes, both natural (such as earthquakes and hurricanes) and man-made (such as
56
terrorism). If we were to incur such losses, we would have to make significant claims payments in a relatively concentrated
period of time.
INVESTING ACTIVITIES
The following list highlights some of the major sources and uses of cash flow from investing activities:
Sources
Proceeds from sale, call or maturity of bonds
Proceeds from sale of stocks
Proceeds from sale of other invested assets
Uses
Purchase of bonds
Purchase of stocks
Purchase of other invested assets
Acquisitions
Purchase of property & equipment
We maintain a diversified investment portfolio representing policyholder funds that have not yet been paid out as claims,
as well as the capital we hold for our shareholders. As of December 31, 2018, our portfolio had a carrying value of $2.2 billion.
Portfolio assets at December 31, 2018, increased by $53.4 million, or 2 percent, from December 31, 2017.
Our overall investment philosophy is designed to first protect policyholders by maintaining sufficient funds to meet
corporate and policyholder obligations and then generate long-term growth in shareholders’ equity. Because our existing and
projected liabilities are sufficiently funded by the fixed income portfolio, we can improve returns by investing a portion of the
surplus (within limits) in a risk assets portfolio largely made up of equities. As of December 31, 2018, 42 percent of our
shareholders’ equity was invested in equities, compared to 47 percent at December 31, 2017 and 45 percent at December 31,
2016.
The fixed income portfolio is structured to meet policyholder obligations and optimize the generation of after-tax
investment income and total return.
FINANCING ACTIVITIES
In addition to the previously discussed operating and investing activities, we also engage in financing activities to manage
our capital structure. The following list highlights some of the major sources and uses of cash flow from financing activities:
Sources
Proceeds from stock offerings
Proceeds from debt offerings
Short-term borrowing
Shares issued under stock option plans
Uses
Shareholder dividends
Debt repayment
Share buy-backs
Our capital structure is comprised of equity and debt obligations. As of December 31, 2018, our capital structure
consisted of $149.1 million in 10-year maturity senior notes (long-term debt) and $806.8 million of shareholders’ equity. Debt
outstanding comprised 16 percent of total capital as of December 31, 2018.
At the holding company (RLI Corp.) level, we rely largely on dividends from our insurance company subsidiaries to meet
our obligations for paying principal and interest on outstanding debt, corporate expenses and dividends to RLI Corp.
shareholders. As discussed further below, dividend payments to RLI Corp. from our principal insurance subsidiary are
restricted by state insurance laws as to the amount that may be paid without prior approval of the insurance regulatory
authorities of Illinois. As a result, we may not be able to receive dividends from such subsidiary at times and in amounts
necessary to pay desired dividends to RLI Corp. shareholders. On a GAAP basis, as of December 31, 2018, our holding
company had $806.8 million in equity. This includes amounts related to the equity of our insurance subsidiaries, which is
subject to regulatory restrictions under state insurance laws. The unrestricted portion of holding company net assets is
comprised primarily of investments and cash, including $63.1 million in liquid investment assets, which more than covers our
annual holding company expenditures. Unrestricted funds at the holding company are available to fund debt interest, general
corporate obligations and regular dividend payments to our shareholders. If necessary, the holding company also has other
potential sources of liquidity that could provide for additional funding to meet corporate obligations or pay shareholder
dividends, which include a revolving line of credit, as well as access to the capital markets.
57
Ordinary dividends, which may be paid by our principal insurance subsidiary without prior regulatory approval, are
subject to certain limitations based upon statutory income, surplus and earned surplus. The maximum ordinary dividend
distribution from our principal insurance subsidiary in a rolling 12-month period is limited by Illinois law to the greater of 10
percent of RLI Ins. policyholder surplus, as of December 31 of the preceding year, or the net income of RLI Ins. for the 12-
month period ending December 31 of the preceding year. Ordinary dividends are further restricted by the requirement that they
be paid from earned surplus. In 2018, 2017 and 2016, our principal insurance subsidiary paid ordinary dividends totaling $13.0
million, $107.0 million and $123.6 million, respectively, to RLI Corp. Any dividend distribution in excess of the ordinary
dividend limits is deemed extraordinary and requires prior approval from the IDOI. In 2018, our principal insurance subsidiary
sought and received regulatory approval prior to the payment of extraordinary dividends totaling $110.0 million. No
extraordinary dividends were paid in 2017 or 2016. Given the amount of dividends paid during the prior rolling 12-month
period, the net assets of our principal insurance subsidiary are restricted until the fourth quarter of 2019 and cannot be
distributed to RLI Corp. without prior approval of the IDOI. In addition to restrictions from our principal subsidiary’s
insurance regulator, we also consider internal models and how capital adequacy is defined by our rating agencies in
determining amounts available for distribution. However, as discussed above, RLI Corp. had the necessary amount of
unrestricted liquid net assets on hand at December 31, 2018 to cover normal annual holding company expenditures as they are
incurred and become payable in 2019.
Our 171st consecutive dividend payment was declared in February 2019 and will be paid on March 20, 2019, in the
amount of $0.22 per share. Since the inception of cash dividends in 1976, we have increased our annual dividend every year.
OUTLOOK FOR 2019
In 2018, the insurance industry experienced its second consecutive year of poor underwriting results due to severe
catastrophe activity. Our combined ratio was impacted by catastrophe losses and rose to 94.7 and 96.4 in 2018 and 2017,
respectively. Despite this elevated level of catastrophe losses, we produced an underwriting profit, exhibiting once again the
benefits of our underwriting discipline and diverse product portfolio. The result for 2018 represented our 23rd consecutive year
of producing an underwriting profit. We expect to produce a 24th year of underwriting profit in 2019.
The insurance industry’s return on equity has been generally poor, averaging 6.9 percent over the past five years. The
industry has had a difficult time maintaining pricing discipline and significant competition continues in most of our lines of
business. Broadened coverage and aggressive plaintiffs’ attorneys have also impacted loss severity trends. While we have been
impacted by broader industry events, we remain a disciplined underwriting company. We outperformed the industry on both a
combined ratio and return on equity basis and expect that to continue in 2019. While we have added new products in recent
years that are gaining momentum, we have increased our focus on modernizing and investing in our proven, mature, profitable
offerings. This focus helped produce solid premium growth in 2018, and investments made and a continued focus in these
areas should provide further growth opportunities in ongoing products in 2019. We have also taken underwriting actions,
including exiting certain unprofitable products, as discussed in the casualty section that follows. We believe these decisions
will improve the health of our product portfolio but will challenge our ability to grow premiums on an overall basis. Our
willingness to sacrifice top-line premium growth to improve profitability is a hallmark of our culture.
Within our investment portfolio, we expect investment income to grow modestly, as interest rates continue to rise and our
invested asset base grows. As a result of these factors, we have a positive outlook for 2019, as we continue to execute on our
specialty business model and focus on underwriting excellence. Some additional detail by segment follows.
CASUALTY
We expect the pricing environment in casualty to be relatively stable to modestly positive for most products. Persistent
industry adverse development in commercial auto coverages has led to significant rate increases for several years, which we
anticipate will continue. While trends impacting commercial auto have not spread more broadly, several insurers have noted
worsening loss trends in general and professional liability lines, which could lead to improved broader industry pricing
discipline. Our executive products group may face a volatile loss environment and reactionary industry pricing as products
such as directors and officers insurance have experienced elevated securities class action activity and cyber liability continues
to evolve in terms of coverage and loss expectations.
To foster growth, we expect to continue to make investments in marketing and technology in our personal lines,
transportation and professional services. Achieving growth in our small commercial package business will be difficult due to
competitive pressures, particularly with regard to workers’ compensation coverage where rate decreases are likely to continue.
58
Several of our newer products experienced significant growth in 2018. We expect this growth to continue, although at a
slower pace, in products such as energy casualty, general binding authority and cyber liability. Because we lack robust
historical loss information on these newer products, our reserving practices have tended to increase our loss ratio as the
weighting of these products has increased. Our recent re-underwriting in our transportation business has also resulted in our
overall loss ratio increasing. It is difficult to estimate the timing, magnitude or direction of future adjustment to reserves for
these products as actual loss activity matures.
From a premium perspective, casualty will be under pressure in 2019, due to a decision at the end of 2018 to curtail or
exit certain lines of business. We reduced our participation in our assumed reinsurance treaty with Prime from 25 percent to 6
percent. Our 23 percent minority interest remains unchanged. While Prime results have been positive, we are one step removed
from both underwriting and claims handling. Given their significant premium growth and the increasing portion of our total
premium they were becoming, we believed this action was necessary to reduce concentration risk. We also exited our
healthcare liability business, which included primary and excess liability coverage for long-term care facilities, and our Real
Estate Investment Trust business, which included liability coverage for large real estate portfolios. These actions were taken as
losses had exceeded our expectations and our assessment of the competitive environment did not support a conclusion that an
underwriting profit could be achieved in the near term. In combination, these decisions will reduce gross written premium by
approximately $50 million, although they should result in improved underwriting results.
PROPERTY
We expect growth in the property segment in 2019, but at a slower pace than in 2018. Industry catastrophe activity was
elevated for the second consecutive year. Industry pricing has not increased materially, but this remains a distinct possibility as
such losses have historically served as a potential catalyst for improved pricing discipline. We believe such discipline, as well
as tighter terms and conditions, are warranted. Our catastrophe book is diverse, which aided in our ability to produce an
underwriting profit in 2018, despite significant catastrophe losses incurred.
Marine has been growing and achieving rate increases for six consecutive years. Given market turmoil driven by Lloyds
re-underwriting efforts and industry losses, we expect more submissions and the ability to increase rates to continue. Our focus
on marketing and investment in technology to improve our producers’ operating efficiency in Hawaii should continue growth
for that product as well. We received positive feedback on claim handling for the catastrophe events of 2018. That is the
touchpoint that matters most to our customers and will support growth in this segment. Further expense ratio improvement is
planned given continued growth in this segment and the loss ratio should return to more historical levels absent above average
catastrophe losses in 2019.
SURETY
Our surety segment has experienced one of the most competitive environments among our product portfolio. A key driver
of this competition has been continued strong profitability, although there have been several noticeable losses in this market
recently. Our growth in surety has been curtailed by our underwriters’ reluctance to chase premium dollars and loosen terms
and conditions, which are trends we have seen among our competitors. In addition to the competitive environment, surety’s
forecast for 2019 will depend on economic activity and levels of public construction, particularly within our contract surety
products. After a lengthy period of economic expansion, we are wary of the financial health of contractors and will therefore
exercise caution when considering new business opportunities.
Our commercial and energy surety account-driven business will also be difficult to grow, given the competitive
environment. We do expect growth in the miscellaneous surety product. In the last few years, we have re-evaluated and
simplified our underwriting approach, upgraded technology and focused on ease of doing business with producers. We expect
growth trends for miscellaneous surety to continue, but the overall top line for surety to remain flat given the pressure on larger
accounts that make up the majority of this segment. The surety segment’s loss ratio may be under pressure, but we expect the
segment to produce underwriting profit in 2019.
INVESTMENTS
A confluence of headline events and a shift in market sentiment in the early fall led to a rise in market volatility in late
2018. Although the year began with significant optimism about a new tax regime and higher levels of sustained growth, it
ended with tighter financial conditions, uncertainty surrounding trade policy and risk assets in decline. Unfortunately, the
downdraft was enough to keep our portfolio’s total return results below zero for the year (-0.2 percent) for the first time since
the financial crisis. Nevertheless, we did experience an uplift in investment income, over 13 percent for the year. While we
59
cannot predict the exact path of interest rates in the new year, we would expect a larger invested asset base and wider credit
spreads to be supportive of tempered increases in investment income.
The Federal Reserve and corresponding monetary policy continues to weigh heavily on markets as higher rates are now
having an impact on housing and other rate sensitive parts of the economy. Participants’ concern centers on the regularity of
five consecutive quarterly Fed Funds increases through December 2018, and whether the new chairman is on a linear forward
path. Additionally, in the years following the financial crisis the Fed’s balance sheet was used to purchase securities as part of a
quantitative easing program. That blunt procedure is now in reverse and the economic impact of quantitative tightening is not
exceedingly clear. While monetary policy should react to the 2019 macroeconomic data, the mixed signals that accompany the
later stages of the economic cycle make the Fed’s objective all the more challenging.
We would expect a modest uplift in treasury yields over a portion of the new year, albeit capped by a more shallow
growth trajectory, nascent inflation expectations and a demographically-driven demand for interest rate sensitive sectors.
Should wage pressure accelerate, we may experience pass through pricing pressure and / or corporate margin compression,
both of which would be a headwind. The differential in long-term versus short-term yields will likely remain very narrow over
the course of 2019, which will allow an opportunity to adjust yield curve exposure without a degradation of potential income.
As asset prices and credit spreads were under pressure in the later stages of 2018, the starting point for the new year
contains some cushion in both lower valuations and higher risk premia. While this raises the probability of positive total return
results for 2019, we shall remain vigilant to our long-standing risk management practices focused on diversification and regular
rebalancing. Our invested asset base has been a consistent support to RLI’s insurance operations through investment income
and remains an important component of our long-term growth in book value.
PROSPECTIVE ACCOUNTING STANDARDS
Prospective accounting standards are those which we have not implemented because the implementation date has not yet
occurred. For a discussion of relevant prospective accounting standards, see note 1.D. to the consolidated financial statements
within Item 8, Financial Statements and Supplementary Data.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
MARKET RISK DISCLOSURE
Market risk is a general term describing the potential economic loss associated with adverse changes in the fair value of
financial instruments. Management of market risk is a critical component of our investment decisions and objectives. We
manage our exposure to market risk by using the following tools:
Monitoring the fair value of all financial assets on a constant basis,
Changing the character of future investment purchases as needed and
Maintaining a balance between existing asset and liability portfolios.
FIXED INCOME AND INTEREST RATE RISK
The most significant short-term influence on our fixed income portfolio is a change in interest rates. Because there is
intrinsic difficulty predicting the direction and magnitude of interest rate moves, we attempt to minimize the impact of interest
rate risk on the balance sheet by matching the duration of assets to that of our liabilities. Furthermore, the diversification of
sectors and given issuers is core to our risk management process, increasing the granularity of individual credit risk. Liquidity
and call risk are elements of fixed income that we regularly evaluate to ensure we are receiving adequate compensation. Our
fixed income portfolio has a meaningful impact on financial results and is a key component in our enterprise risk simulations.
Interest rate risk can also affect our income statement due to its impact on interest expense. As of December 31, 2018 and
2017, we had no short-term debt obligations. We maintain a debt obligation that is long-term in nature and carries a fixed
interest rate. As such, our interest expense on this obligation is not subject to changes in interest rates. As this debt is not due
until 2023, we will not assume additional interest rate risk in our ability to refinance this debt for more than four years.
60
EQUITY PRICE RISK
Equity price risk is the potential that we will incur economic loss due to the decline of common stock prices. Beta
analysis is used to measure the sensitivity of our equity portfolio to changes in the value of the S&P 500 Index (an index
representative of the broad equity market). Our current equity portfolio has a beta of 0.9 in comparison to the S&P 500 with a
beta of 1.0. This lower beta statistic reflects our long-term emphasis on maintaining a value-oriented, dividend-driven
investment philosophy for our equity portfolio.
SENSITIVITY ANALYSIS
The tables that follow detail information on the market risk exposure for our financial investments as of December 31,
2018. Listed on each table is the December 31, 2018 fair value for our assets and the expected pretax reduction in fair value
given the stated hypothetical events. This sensitivity analysis assumes the composition of our assets remains constant over the
period being measured and also assumes interest rate changes are reflected uniformly across the yield curve. For example, our
ability to hold non-trading securities to maturity mitigates price fluctuation risks. For purposes of this disclosure, market-risk-
sensitive instruments are all classified as held for non-trading purposes, as we do not hold any trading securities. The examples
given are not predictions of future market events, but rather illustrations of the effect such events may have on the fair value of
our investment portfolio.
As of December 31, 2018, our fixed income portfolio had a fair value of $1.8 billion. The sensitivity analysis uses
scenarios of interest rates increasing 100 and 200 basis points from their December 31, 2018, levels with all other variables
held constant. Such scenarios would result in modeled decreases in the fair value of the fixed income portfolio of $63.2 million
and $118.6 million, respectively.
As of December 31, 2018, our equity portfolio had a fair value of $340.5 million. The base sensitivity analysis uses
market scenarios of the S&P 500 Index declining both 10 percent and 20 percent. These scenarios would result in approximate
decreases in the equity fair value of $29.3 million and $58.5 million, respectively.
While the declines in market value outlined below are modeled as instantaneous changes, we would expect movements in
capital markets to occur over time, with investment income offering an offset to any decrease in prices.
Under the assumptions of rising interest rates and a decreasing S&P 500 Index, the fair value of our assets will decrease
from their present levels by the indicated amounts.
Effect of a 100-basis-point increase in interest rates and a 10 percent decline in the S&P 500:
(in thousands)
Held for non-trading purposes:
Fixed income securities
Equity securities
Total non-trading
12/31/18 Fair
Value
Interest
Rate Risk
Equity
Risk
$ 1,760,515 $
340,483
$ 2,100,998 $
(63,168) $
—
(63,168) $
—
(29,259)
(29,259)
Effect of a 200-basis-point increase in interest rates and a 20 percent decline in the S&P 500:
(in thousands)
Held for non-trading purposes:
Fixed income securities
Equity securities
Total non-trading
12/31/18 Fair
Value
Interest
Rate Risk
Equity
Risk
$ 1,760,515 $
(118,622) $
340,483
—
$ 2,100,998 $
(118,622) $
—
(58,519)
(58,519)
Comparatively, under the assumptions of falling interest rates and an increasing S&P 500 Index, the fair value of our
assets will increase from their present levels by the indicated amounts.
61
Effect of a 100-basis-point decrease in interest rates and a 10 percent increase in the S&P 500:
(in thousands)
Held for non-trading purposes:
Fixed income securities
Equity securities
Total non-trading
12/31/18 Fair
Value
Interest
Rate Risk
Equity
Risk
$ 1,760,515 $
340,483
$ 2,100,998 $
65,232 $
—
65,232 $
—
29,259
29,259
Effect of a 200-basis-point decrease in interest rates and 20 percent increase in the S&P 500:
(in thousands)
Held for non-trading purposes:
Fixed income securities
Equity securities
Total non-trading
12/31/18 Fair
Value
Interest
Rate Risk
Equity
Risk
$ 1,760,515 $
340,483
$ 2,100,998 $
135,752 $
—
135,752 $
—
58,519
58,519
62
Item 8. Financial Statements and Supplementary Data
Index to Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Earnings and Comprehensive Earnings
Consolidated Statements of Shareholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
Page
64
65
66
67
68-107
108
63
Consolidated Balance Sheets
(in thousands, except per share data)
Assets
Investments and Cash:
Fixed income:
Available-for-sale, at fair value (amortized cost - $1,776,465 in 2018 and $1,646,411
in 2017)
Equity securities, at fair value (cost - $220,373 in 2018 and $182,002 in 2017)
Short-term investments, at cost which approximates fair value
Other invested assets
Cash
Total investments and cash
Accrued investment income
Premiums and reinsurance balances receivable, net of allowances for uncollectible
amounts of $16,967 in 2018 and $16,935 in 2017
Ceded unearned premiums
Reinsurance balances recoverable on unpaid losses and settlement expenses, net of
allowances for uncollectible amounts of $9,793 in 2018 and $10,014 in 2017
Deferred policy acquisition costs, net
Property and equipment, at cost, net of accumulated depreciation of $54,275 in 2018
and $47,676 in 2017
Investment in unconsolidated investees
Goodwill and intangibles
Other assets
Total assets
Liabilities and Shareholders’ Equity
Liabilities:
Unpaid losses and settlement expenses
Unearned premiums
Reinsurance balances payable
Funds held
Income taxes - deferred
Bonds payable, long-term debt
Accrued expenses
Other liabilities
Total liabilities
Shareholders’ equity:
Common stock ($0.01 par value in 2018 and $1.00 par value in 2017)
(100,000,000 share authorized, 67,434,257 shares issued and 44,504,043 shares
outstanding in 2018)
(100,000,000 share authorized, 67,078,569 shares issued and 44,148,355 shares
outstanding in 2017)
Paid-in capital
Accumulated other comprehensive earnings, net of tax
Retained earnings
Deferred compensation
Treasury stock, at cost (22,930,214 shares in 2018 and 2017)
Total shareholders’ equity
Total liabilities and shareholders’ equity
See accompanying notes to consolidated financial statements.
64
December 31,
2018
2017
$ 1,760,515
340,483
11,550
51,542
30,140
$ 2,194,230
14,033
$
$ 1,672,239
400,492
9,980
33,808
24,271
$ 2,140,790
15,166
$
152,576
71,174
364,999
84,934
134,351
57,928
301,991
77,716
54,692
94,967
54,534
18,926
$ 3,105,065
55,849
90,067
59,302
14,084
$ 2,947,244
$ 1,461,348
496,505
22,591
72,309
24,238
149,115
45,124
26,993
$ 2,298,223
$ 1,271,503
451,449
21,624
74,560
53,768
148,928
52,848
18,966
$ 2,093,646
$
674
305,660
(14,572)
908,079
8,354
(401,353)
$
806,842
$ 3,105,065
$
67,079
233,077
157,919
788,522
8,640
(401,639)
$
853,598
$ 2,947,244
2018
2016
54,876
6,970
(2,559)
—
62,085
63,624
(217)
(98,735)
Years ended December 31,
2017
$ 791,366 $ 737,937 $ 728,608
53,075
34,740
(95)
—
$ 818,123 $ 797,224 $ 816,328
$ 428,193 $ 401,584 $ 349,778
249,612
252,515
53,093
56,994
7,426
7,426
10,170
11,340
$ 766,598 $ 729,859 $ 670,079
10,833
$ 67,581 $ 84,589 $ 157,082
267,738
53,803
7,437
9,427
17,224
16,056
$ 23,917 $
(20,515)
9,302 $ 41,034
1,128
3,402 $ (20,439) $ 42,162
$
$ 64,179 $ 105,028 $ 114,920
(29,741)
(33,997)
(1,164)
$ 30,182 $ 140,337 $ 113,756
35,309
$
$
1.45 $
0.68 $
2.39 $
3.19 $
2.63
2.60
$
$
1.43 $
0.67 $
2.36 $
3.15 $
2.59
2.56
44,358
44,835
44,033
44,500
43,772
44,432
Consolidated Statements of Earnings and Comprehensive Earnings
(in thousands, except per share data)
Net premiums earned
Net investment income
Net realized gains
Other-than-temporary-impairment losses on investments
Net unrealized losses on equity securities
Consolidated revenue
Losses and settlement expenses
Policy acquisition costs
Insurance operating expenses
Interest expense on debt
General corporate expenses
Total expenses
Equity in earnings of unconsolidated investees
Earnings before income taxes
Income tax expense (benefit):
Current
Deferred
Income tax expense (benefit):
Net earnings
Other comprehensive earnings (loss), net of tax
Comprehensive earnings
Basic:
Net earnings per share
Comprehensive earnings per share
Diluted:
Net earnings per share
Comprehensive earnings per share
Weighted average number of common shares outstanding
Basic
Diluted
See accompanying notes to consolidated financial statements.
65
Consolidated Statements of Shareholders’ Equity
Common
Shareholders’ Common
Total
Accumulated
Other
(in thousands, except per share data)
Balance, January 1, 2016
Net earnings
Other comprehensive earnings (loss), net
of tax
Deferred compensation under Rabbi trust
plans
Stock option excess tax benefit
Share-based compensation
Dividends and dividend equivalents ($2.79
per share)
Balance, December 31, 2016
Net earnings
Other comprehensive earnings (loss), net
of tax
Deferred compensation under Rabbi trust
plans
Stock option excess tax benefit
Share-based compensation
Dividends and dividend equivalents ($2.58
per share)
Balance, December 31, 2017
Cumulative-effect adjustment from ASU
2016-01 and 2018-02
Par value conversion from $1.00 per share
to $0.01 per share
Net earnings
Other comprehensive earnings (loss), net
of tax
Deferred compensation under Rabbi trust
plans
Stock option excess tax benefit
Share-based compensation
Dividends and dividend equivalents ($1.87
per share)
Balance, December 31, 2018
Shares
43,544,128 $
— $
Stock
Equity
823,469 $ 66,474 $ 221,345 $
— $
114,920 $
— $
123,774 $ 804,875 $
— $ 114,920 $
10,647 $
— $
Paid-in
Capital
Comprehensive Retained
Earnings (Loss) Earnings
Deferred
Compensation
Treasury Stock
at Cost
(403,646)
—
—
(1,164)
—
—
(1,164)
—
—
400,569
—
9,576
(741)
—
—
401
—
9,576
(1,142)
—
—
—
—
—
—
—
—
849
—
—
—
(849)
—
—
—
(122,488)
—
—
— (122,488)
43,944,697 $
— $
823,572 $ 66,875 $ 229,779 $
— $
105,028 $
— $
122,610 $ 797,307 $
— $ 105,028 $
—
35,309
—
—
35,309
—
—
203,658
—
—
3,502
—
—
204
—
—
3,298
—
—
—
—
—
—
—
—
(113,813)
—
—
— (113,813)
44,148,355 $
853,598 $ 67,079 $ 233,077 $
157,919 $ 788,522 $
—
11,496 $
— $
—
(404,495)
—
—
—
(2,856)
—
—
2,856
—
—
—
8,640 $
—
(401,639)
— $
86 $
— $
— $
(138,494) $ 138,580 $
— $
—
—
— (66,409)
—
64,179
66,409
—
—
—
—
64,179
—
(33,997)
—
—
(33,997)
—
—
—
(286)
—
—
—
—
—
—
—
—
—
—
286
—
—
—
—
355,688
—
—
—
6,178
—
—
4
—
—
6,174
—
—
—
44,504,043 $
(83,202)
806,842 $
—
674 $ 305,660 $
—
—
(83,202)
(14,572) $ 908,079 $
—
8,354 $
—
(401,353)
See accompanying notes to consolidated financial statements.
66
Consolidated Statements of Cash Flows
(in thousands)
Cash flows from operating activities:
Net earnings
Adjustments to reconcile net earnings to net cash provided by operating activities:
Net realized gains
Net unrealized losses on equity securities
Depreciation
Other items, net
Change in:
Accrued investment income
Premiums and reinsurance balances receivable (net of direct write-offs and commutations)
Reinsurance balances payable
Funds held
Ceded unearned premium
Reinsurance balances recoverable on unpaid losses
Deferred policy acquisition costs
Accrued expenses
Unpaid losses and settlement expenses
Unearned premiums
Income taxes:
Current
Deferred
Stock option excess tax benefit
Changes in investment in unconsolidated investees:
Undistributed earnings
Dividends received
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of:
Fixed income, available-for-sale
Equity securities
Short-term investments, net
Property and equipment
Acquisition of agency
Other
Proceeds from sale of:
Fixed income, available-for-sale
Equity securities
Short-term investments, net
Property and equipment
Subsidiary or agency
Other
Proceeds from call or maturity of:
Fixed income, available-for-sale
Net cash used in investing activities
Cash flows from financing activities:
Stock option excess tax benefit
Proceeds from stock option exercises
Cash dividends paid
Net cash used in financing activities
Net increase in cash
Cash at beginning of year
Cash at end of year
See accompanying notes to consolidated financial statements.
2018
2017
2016
$
64,179 $
105,028 $
114,920
(63,407)
98,735
7,042
6,171
1,132
(18,225)
967
(2,251)
(13,246)
(63,008)
(7,218)
(7,724)
189,845
45,056
5,725
(20,515)
—
(4,411)
—
6,944
16,368
(573)
(7,964)
3,696
1,818
(5,755)
(13,767)
(4,569)
856
132,166
17,672
(3,019)
(29,741)
—
(34,645)
—
6,430
17,699
285
17,275
(19,628)
18,488
660
9,620
(3,318)
(3,750)
35,552
11,683
12,573
1,128
(9,576)
(16,056)
9,900
217,102 $
(17,224)
—
197,525 $
(10,833)
9,900
174,463
(725,675) $
(115,921)
(1,570)
(6,087)
—
(18,754)
(430,727) $
(20,719)
(4,965)
(9,238)
—
(19,112)
(557,067)
(36,335)
—
(16,155)
(850)
(7,722)
395,019
147,838
—
167
—
3,394
168,760
36,573
—
128
408
2,063
329,091
89,909
2,564
1,688
—
—
$
$
187,380
(134,209) $
195,617
(81,212) $
141,255
(53,622)
$
$
— $
— $
6,076
(83,100)
(77,024) $
3,502
(113,813)
(110,311) $
$
9,576
(741)
(122,488)
(113,653)
$
5,869 $
6,002 $
7,188
$
24,271 $
18,269 $
11,081
$
30,140 $
24,271 $
18,269
67
Notes to Consolidated Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. DESCRIPTION OF BUSINESS
RLI Corp. (the “Company”) is an insurance holding company that was founded in 1965. On May 4, 2018, RLI Corp.
changed its state of incorporation from the State of Illinois to the State of Delaware (the “Reincorporation”). The
Reincorporation was effected by merging RLI Corp., an Illinois corporation (“RLI Illinois”) into RLI Corp., a Delaware
corporation (“RLI Delaware”). The separate corporate existence of RLI Illinois ceased and RLI Delaware continues in
existence as the surviving corporation and possesses all rights, privileges, powers and franchises of RLI Illinois. The
Reincorporation did not result in any change in the name, business, management, fiscal year, location of the principal executive
offices, assets or liabilities of the Company. Each outstanding share of RLI Illinois common stock, which had a par value of
$1.00 per share, was automatically converted into one outstanding share of RLI Delaware common stock, with a par value of
$0.01 per share. In order to reflect the new par value of common stock on the balance sheet, a $66.4 million reclassification
from common stock to paid-in-capital was made. For more information on the Reincorporation, see RLI Corp.’s Form 8-K
filed on May 7, 2018.
We underwrite select property and casualty insurance coverages through major subsidiaries collectively known as RLI
Insurance Group. We conduct operations principally through three insurance companies. RLI Insurance Company (RLI Ins.), a
subsidiary of RLI Corp. and our principal insurance subsidiary, writes multiple lines of insurance on an admitted basis in all 50
states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam. Mt. Hawley Insurance Company (Mt. Hawley), a
subsidiary of RLI Ins., writes surplus lines insurance on a non-admitted basis in all 50 states, the District of Columbia, Puerto
Rico, the Virgin Islands and Guam. Contractors Bonding and Insurance Company (CBIC), a subsidiary of RLI Ins., writes
multiple lines of insurance on an admitted basis in all 50 states and the District of Columbia.
B. PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The accompanying consolidated financial statements were prepared in conformity with generally accepted accounting
principles in the United States of America (GAAP), which differ in some respects from those followed in reports to insurance
regulatory authorities. The consolidated financial statements include the accounts of our holding company and our subsidiaries.
All significant intercompany balances and transactions have been eliminated. Certain reclassifications were made to 2017 and
2016 to conform to the classifications used in the current year. The Company has evaluated subsequent events through the date
these consolidated financial statements were issued. There were no subsequent events requiring adjustment to the financial
statements or disclosure.
C. ADOPTED ACCOUNTING STANDARDS
ASU 2014-09, Revenue from Contracts with Customers (Topic 606)
ASU 2014-09 was issued to clarify and remove inconsistencies within revenue recognition requirements. The core
principle of the update is that an entity should recognize revenue to depict the transfer of promised goods or services to
customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or
services. To achieve that core principle, the transaction price for a contract is allocated among separately identifiable
performance obligations and a portion of the transaction price is recognized as revenue when the associated performance
obligation has been completed or transferred to the customer. All contracts and fulfillment activities within the scope of Topic
944, Financial Services – Insurance, investment income, investment-related gains and losses and equity in earnings of
unconsolidated investees are outside the scope of this ASU.
We adopted ASU 2014-09 on January 1, 2018. However, nearly all (over 99 percent) of our consolidated revenue is
scoped out and therefore exempt from the guidance contained within this ASU. For the remaining portion, the revenue
recognition policy we utilize aligns with the new guidance and there were no changes to the way we recognize revenue.
Although the recognition of earnings from equity method investees is out of scope from the update, the recognition of revenue
by our equity method investees would be subject to the new guidance if the revenue streams are within this update’s scope.
Any impact on revenues would affect the net income of each of the equity method investees, upon which we calculate our
portion of earnings to recognize. Our equity method investees are private companies and this guidance becomes effective for
private companies in periods beginning after December 15, 2018. As a result, their earnings and our portion of those earnings
68
are not impacted in 2018. We expect that revenue generated by both of our equity method investees will either be outside the
scope of this update or largely unaffected by the changes.
ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and
Financial Liabilities
This ASU was issued to improve the recognition and measurement of financial instruments. The new guidance makes
targeted improvements to GAAP as follows:
a. Requires equity investments (except those accounted for under the equity method of accounting or those that result in
consolidation of the investee) to be measured at fair value with changes in fair value recognized in net earnings,
b. Simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a
qualitative assessment to identify impairment,
c. Eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to
estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the
balance sheet,
d. Requires public business entities to use the exit price notion when measuring the fair value of financial instruments for
disclosure purposes,
e. Requires an entity to present separately in other comprehensive earnings the portion of the total change in the fair
value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure
the liability at fair value in accordance with the fair value option for financial instruments,
f. Requires separate presentation of financial assets and financial liabilities by measurement category and form of
financial asset on the balance sheet or the accompanying notes to the financial statements and
g. Clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-
for-sale securities in combination with the entity’s other deferred tax assets.
We adopted ASU 2016-01 on January 1, 2018. A cumulative-effect adjustment to the balance sheet was made as of the
beginning of the year, which moved $142.2 million of net unrealized gains and losses on equity securities from accumulated
other comprehensive earnings to retained earnings. During 2018, we recognized $98.7 million of unrealized losses on equity
securities within net earnings and $20.7 million of income tax benefit. This compares to $24.0 million and $5.6 million of
unrealized gains on equity securities, net of tax, that were recognized through other comprehensive earnings for the comparable
periods in 2017 and 2016, respectively. The future impact to our net earnings will vary depending upon the level of volatility in
the performance of the securities held in our equity portfolio and the overall market. There were no other material impacts to
the financial statements.
ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments
ASU 2016-15 was issued to reduce the diversity in practice of how certain cash receipts and payments, for which
previous guidance was silent, are classified in the statement of cash flows. The update addresses eight specific issues, including
contingent consideration payments made after a business combination, distributions received from equity method investees and
the classification of cash receipts and payments that have aspects of more than one class of cash flows. We adopted ASU 2016-
15 on January 1, 2018. The adoption did not have a material impact on our statement of cash flows.
ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from
Accumulated Other Comprehensive Income
ASU 2018-02 was issued as a result of the enactment of the Tax Cuts and Jobs Act of 2017 (TCJA) on December 22,
2017. Accounting guidance required deferred tax items to be revalued based on the new tax laws (the most significant of which
reduced the corporate tax rate to 21 percent from 35 percent) with the change included in income from continuing operations.
Since other comprehensive income was not affected by the revaluation of the deferred tax items, the net accumulated other
comprehensive income (AOCI) balance was reflective of the historic 35 percent tax rate instead of the newly enacted rate, a
difference that is referred to as a stranded tax effect. This ASU allows for the option to reclassify the stranded tax effects
resulting from the implementation of the TCJA out of AOCI and into retained earnings. ASU 2018-02 does not replace the
guidance requiring changes from the enactment of other tax laws or rates to be included within income from continuing
operations and is applicable only to changes from the TCJA.
We adopted ASU 2018-02 during the first quarter of 2018. A current period adjustment was made to the balance sheet,
which moved $3.7 million of stranded tax effects on the unrealized balances of our fixed income securities and equity method
investees from accumulated other comprehensive earnings to retained earnings. The entire unrealized balance on equity
69
securities was reclassified from AOCI into retained earnings from the adoption of ASU 2016-01 on January 1, 2018 and was
therefore unaffected by this ASU. As there was no impact to net earnings and the balance sheet effect is limited to a
reclassification within the equity section, there was not a material impact on our financial statements.
D. PROSPECTIVE ACCOUNTING STANDARDS
ASU 2016-02, Leases (Topic 842)
ASU 2016-02 was issued to improve the financial reporting of leasing transactions. Under current guidance for lessees,
leases are only included on the balance sheet if certain criteria, classifying the agreement as a capital lease, are met. This
update will require the recognition of a right-of-use asset and a corresponding lease liability, discounted to the present value,
for all leases that extend beyond 12 months. For operating leases, the asset and liability will be amortized over the lease term
on a straight-line basis, with all cash flows included in the operating section of the statement of cash flows. For finance leases,
interest on the lease liability will be recognized separately from the amortization of the right-of-use asset in the statement of
comprehensive income and the repayment of the principal portion of the lease liability will be classified as a financing activity
while the interest component will be included in the operating section of the statement of cash flows.
This ASU is effective for annual and interim reporting periods beginning after December 15, 2018. Early adoption is
permitted. ASU 2018-10, Codification Improvements to Topic 842, Leases was issued to clarify certain aspects of ASU 2016-
02 and the two updates will be adopted concurrently. ASU 2016-02 requires leases to be recognized and measured at the
beginning of the earliest period presented using a modified retrospective approach upon adoption. However, ASU 2018-11,
Leases (Topic 842): Targeted Improvements provides an alternative transition method by which leases are recognized at the
date of adoption and a cumulative-effect adjustment to the opening balance of retained earnings is recognized in the period of
adoption. We plan to adopt using this alternative. It is expected that total assets and total liabilities will increase by
approximately $25 million to $30 million upon implementation and the adoption of this update will not have a material impact
on net earnings.
ASU 2016-13, Financial Instruments – Credit Losses (Topic 326)
ASU 2016-13 was issued to provide more decision-useful information about the expected credit losses on financial
instruments. Current GAAP delays the recognition of credit losses until it is probable a loss has been incurred. The update will
require a financial asset measured at amortized cost, including reinsurance balances recoverable, to be presented at the net
amount expected to be collected by means of an allowance for credit losses that runs through net earnings. Credit losses
relating to available-for-sale debt securities will also be recorded through an allowance for credit losses. However, the
amendments would limit the amount of the allowance to the amount by which fair value is below amortized cost. The
measurement of credit losses on available-for-sale securities is similar under current GAAP, but the update requires the use of
the allowance account through which amounts can be reversed, rather than through an irreversible write-down.
This ASU is effective for annual and interim reporting periods beginning after December 15, 2019. Early adoption is
permitted beginning after December 15, 2018. Upon adoption, the update will be applied using the modified-retrospective
approach, by which a cumulative-effect adjustment will be made to retained earnings as of the beginning of the first reporting
period presented. This update will have the most impact on our available-for-sale fixed income portfolio and reinsurance
balances recoverable. However, as our fixed income portfolio is weighted towards higher rated bond (84 percent rated A or
better at December 31, 2018) and we purchase reinsurance from financially strong reinsurers for which we already have an
allowance for uncollectible reinsurance amounts, we do not expect that the effect of adoption will be material.
ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased
Callable Debt Securities
Under current practices, the amortization period for callable debt securities held at a premium is generally the contractual
life of the instrument. However, if an entity has a large number of similar loans, it may consider estimates of future principal
prepayments. For those who choose to not incorporate an estimate of future prepayments, ASU 2017-08 shortens the
amortization period for premium on debt securities to the earliest call date, rather than the maturity date, to align the
amortization method with how the securities are quoted, priced and traded. After the earliest call date, if the call option is not
exercised, the entity shall reset the effective yield using the payment terms of the debt security. Any excess of the amortized
cost basis over the amount payable will be amortized to the next call date or to maturity if there are no other call dates. The
method of accounting for a discount does not change and will continue to be amortized over the life of the bond.
70
This ASU is effective for annual and interim reporting periods beginning after December 15, 2018. Early adoption is
permitted. The update will be applied using a modified retrospective basis through a cumulative-effect adjustment to retained
earnings as of the beginning of the period of adoption. As we currently incorporate estimates of future principal prepayments
when calculating the effective yield for bonds carrying a premium, we do not expect the adoption of this update to have a
material impact on our financial statements.
ASU 2018-07, Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment
Accounting
ASU 2018-07 was issued to simplify the accounting for share-based transactions by expanding the scope of Topic 718
from only being applicable to share-based payments to employees to also include share-based payment transactions for
acquiring goods and services from nonemployees. As a result, nonemployee share-based transactions will be measured by
estimating the fair value of the equity instruments at the grant date, taking into consideration the probability of satisfying
performance conditions. This ASU is effective for annual and interim reporting periods beginning after December 15, 2018.
Early adoption is permitted. Our long-term incentive plan limits the awards of share-based payments to employees and
directors of the Company or any affiliate. The share-based compensation expense to nonemployee directors was $0.3 million in
2018. Costs associated with such payments are not expected to materially increase and we do not expect this update to have a
material impact on our financial statements.
ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for
Fair Value Measurement
ASU 2018-13 modifies the disclosure requirements for assets and liabilities measured at fair value. The requirements to
disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing
of transfers between levels and the valuation processes for Level 3 fair value measurements have all been removed. However,
the changes in unrealized gains and losses included in other comprehensive income for recurring Level 3 fair value
measurements held at the end of the reporting period must be disclosed along with the range and weighted average of
significant unobservable inputs used to develop Level 3 fair value measurements (or other quantitative information if it is more
reasonable). Finally, for investments measured at net asset value, the requirements have been modified so that the timing of
liquidation and the date when restrictions from redemption might lapse are only disclosed if the investee has communicated the
timing to the entity or announced the timing publicly.
This ASU is effective for annual and interim reporting periods beginning after December 15, 2019. As the amendments
are only disclosure-related and we do not currently have any assets or liabilities that are measured based on Level 3 inputs, our
financial statements will not be materially impacted by this update.
ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for
Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract
ASU 2018-15 requires a customer in a cloud computing arrangement (i.e. hosting arrangement) that is a service contract
to follow the internal-use software guidance to determine which implementation costs to capitalize as assets or expense as
incurred. Relevant implementation costs in the development stage are capitalized, while costs incurred during the preliminary
project and post-implementation stages are expensed as the activities are performed. Capitalized costs are expensed over the
term of the hosting arrangement. This ASU is effective for annual and interim reporting periods beginning after December 15,
2019. Early adoption is permitted. This update can either be applied retrospectively or prospectively to all implementation
costs incurred after the date of adoption. We have not yet completed the analysis of how adopting this ASU will affect our
financial statements.
E. INVESTMENTS:
Equity securities are carried at fair value with unrealized gains and losses recorded within net earnings in 2018. Prior to
2018, unrealized gains and losses on equity securities were recognized through other comprehensive earnings. We classify our
investments in fixed income securities into one of three categories: trading, held-to-maturity or available-for-sale.
AVAILABLE-FOR-SALE SECURITIES
Debt securities not included as held-to-maturity or trading are classified as available-for-sale and reported at fair value.
Unrealized gains and losses on these securities are excluded from net earnings but are recorded as a separate component of
71
comprehensive earnings and shareholders’ equity, net of deferred income taxes. All of our debt securities are classified as
available-for-sale.
HELD-TO-MATURITY SECURITIES
Debt securities that we have the positive intent and ability to hold to maturity are classified as held-to-maturity and
carried at amortized cost. Except for declines that are other-than-temporary, changes in the fair value of these securities are not
reflected in the financial statements. We do not hold any debt security classified as held-to-maturity.
TRADING SECURITIES
Debt securities purchased for short-term resale are classified as trading securities. These securities are reported at fair
value with unrealized gains and losses included in earnings. We do not hold any debt securities classified as trading.
OTHER THAN TEMPORARY IMPAIRMENT
We regularly evaluate our fixed income securities using quantitative and qualitative criteria to determine impairment
losses for other-than-temporary declines in the fair value of the investments. The following are the key factors for determining
if a security is other-than-temporarily impaired:
The length of time and the extent to which the fair value has been less than amortized cost,
The probability of significant adverse changes to the cash flows,
The occurrence of a discrete credit event resulting in the issuer defaulting on a material obligation, the issuer
seeking protection from creditors under the bankruptcy laws, the issuer proposing a voluntary reorganization
under which creditors are asked to exchange their claims for cash or securities having a fair value substantially
lower than par value of their claims or
The probability that we will recover the entire amortized cost basis of our fixed income securities prior to
maturity.
Quantitative criteria considered during this process include, but are not limited to: the degree and duration of current fair
value as compared to the amortized cost of the security, degree and duration of the security’s fair value being below cost and
whether the issuer is in compliance with terms and covenants of the security. Qualitative criteria include the credit quality,
current economic conditions, the anticipated speed of cost recovery, the financial health of and specific prospects for the issuer,
as well as our absence of intent to sell or requirement to sell fixed income securities prior to recovery. In addition, we consider
price declines in our other-than-temporary impairment (OTTI) analysis when they provide evidence of declining credit quality,
and we distinguish between price changes caused by credit deterioration, as opposed to rising interest rates. See note 2 for
further discussion of OTTI.
Interest on fixed maturities and short-term investments is credited to earnings on an accrual basis. Premiums and
discounts are amortized or accreted over the lives of the related fixed maturities. Dividends on equity securities are credited to
earnings on the ex-dividend date. Realized gains and losses on disposition of investments are based on specific identification of
the investments sold on the settlement date.
F. CASH, SHORT-TERM INVESTMENTS AND OTHER INVESTED ASSETS
Cash consists of uninvested balances in bank accounts. Short-term investments consist of investments with original
maturities of 90 days or less, primarily AAA-rated prime and government money market funds. Short-term investments are
carried at cost. We have not experienced losses on these instruments. Other invested assets include investments in low income
housing tax credit partnerships (LIHTC), membership in the Federal Home Loan Bank of Chicago (FHLBC) and investments
in private funds. Our LIHTC investments are carried at amortized cost, and our investment in FHLBC stock is carried at cost.
Due to the nature of cash, short-term investments, the LIHTC and our membership in the FHLBC, their carrying amounts
approximate fair value. The private funds are carried at fair value, using each investment’s net asset value.
72
G. REINSURANCE
Ceded unearned premiums and reinsurance balances recoverable on paid and unpaid losses and settlement expenses are
reported separately as assets, instead of being netted with the related liabilities, since reinsurance does not relieve the Company
of our legal liability to our policyholders.
We continuously monitor the financial condition of our reinsurers. As part of our monitoring efforts, we review their
annual financial statements, quarterly disclosures and Securities and Exchange Commission (SEC) filings for reinsurers that
are publicly traded. We also review insurance industry developments that may impact the financial condition of our reinsurers.
We analyze the credit risk associated with our reinsurance balances recoverable by monitoring the A.M. Best and Standard &
Poor’s (S&P) ratings of our reinsurers. In addition, we subject our reinsurance recoverables to detailed recoverable tests,
including one based on average default by S&P rating. Based upon our review and testing, our policy is to charge to earnings,
in the form of an allowance, an estimate of unrecoverable amounts from reinsurers. This allowance is reviewed on an ongoing
basis to ensure that the amount makes a reasonable provision for reinsurance balances that we may be unable to recover.
H. POLICY ACQUISITION COSTS
We defer incremental direct costs that relate to the successful acquisition of new or renewal insurance contracts, including
commissions and premium taxes. Acquisition-related costs may be deemed ineligible for deferral when they are based on
contingent or performance criteria beyond the basic acquisition of the insurance contract or when efforts to obtain or renew the
insurance contract are unsuccessful. All eligible costs are capitalized and charged to expense in proportion to premium revenue
recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to
their estimated realizable value. This would also give effect to the premiums to be earned and anticipated losses and settlement
expenses, as well as certain other costs expected to be incurred as the premiums are earned. Judgments as to the ultimate
recoverability of such deferred costs are reviewed on a segment basis and are highly dependent upon estimated future loss costs
associated with the premiums written. This deferral methodology applies to both gross and ceded premiums and acquisition
costs.
I. PROPERTY AND EQUIPMENT
Property and equipment are presented at cost less accumulated depreciation and are depreciated on a straight-line basis
for financial statement purposes over periods ranging from 3 to 10 years for equipment and up to 30 years for buildings and
improvements.
J.
INVESTMENT IN UNCONSOLIDATED INVESTEES
We maintain a 40 percent interest in the equity and earnings of Maui Jim, Inc. (Maui Jim), a manufacturer of high-quality
sunglasses, which is accounted for under the equity method. We also maintain a similar minority representation on their board
of directors. Maui Jim’s chief executive officer owns a controlling majority of the outstanding shares of Maui Jim. We carry
this investment at the holding company level as it is not core to our insurance operations. Our investment in Maui Jim was
$79.5 million in 2018 and $77.7 million in 2017. In 2018, we recorded $12.5 million in investee earnings for Maui Jim,
compared to $14.4 million in 2017 and $9.7 million in 2016. Maui Jim recorded net income of $30.3 million in 2018, $34.4
million in 2017 and $26.9 million in 2016. Additional summarized financial information for Maui Jim for 2018 and 2017 is
outlined in the following table:
(in millions)
Total assets
Total liabilities
Total equity
2018
2017
$ 265.6 $ 259.4
88.0
171.4
90.4
175.2
Approximately $68.9 million of undistributed earnings from Maui Jim are included in our retained earnings as of
December 31, 2018. We received dividends of $9.9 million from Maui Jim in 2018 and 2016. No dividends were received in
2017.
As of December 31, 2018, we had a 23 percent interest in the equity and earnings of Prime Holdings Insurance Services,
Inc. (Prime), which is accounted for under the equity method. Prime writes business through two Illinois domiciled insurance
carriers, Prime Insurance Company, an excess and surplus lines company, and Prime Property and Casualty Insurance Inc., an
admitted insurance company. Our investment in Prime was $15.4 million at December 31, 2018 and $12.4 million at December
73
31, 2017. In 2018, we recorded $3.6 million in investee earnings for Prime, compared to $2.8 million in 2017 and $1.1 million
in 2016. Additionally, we maintain a 25 percent quota share reinsurance treaty with Prime, which contributed $41.1 million of
gross premiums written and $34.2 million of net premiums earned during 2018, compared to $29.6 million of gross premiums
written and $21.0 million of net premiums earned during 2017 and $13.4 million of gross premiums written and $11.4 million
of net premiums earned during 2016.
We perform annual impairment reviews of our investments in unconsolidated investees, which take into consideration
current valuation and operating results. Based upon the most recent reviews, the assets were not impaired.
K. INTANGIBLE ASSETS
Goodwill and intangibles totaled $54.5 million and $59.3 million at December 31, 2018 and 2017, respectively, as
detailed in the following table.
Goodwill and Intangible Assets
(in thousands)
Goodwill
Energy surety
Miscellaneous and contract surety
Small Commercial
Medical professional liability *
Total goodwill
Intangibles
State insurance licenses
Definite-lived intangibles, net of accumulated amortization of $3,062
at 12/31/18 and $5,678 at 12/31/17
Total intangibles
Total goodwill and intangibles
2018
2017
$ 25,706 $ 25,706
15,110
15,110
5,246
5,246
3,595
-
$ 46,062 $ 49,657
$
7,500 $
7,500
972
8,472 $
2,145
9,645
$
$ 54,534 $ 59,302
* The medical professional liability goodwill balance reflects a cumulative non-cash impairment charge of $12.4 million and
$8.8 million as of December 31, 2018 and 2017, respectively.
As the amortization of goodwill and indefinite-lived intangible assets is not permitted, the assets are tested for
impairment on an annual basis, or earlier if there is reason to suspect that their values may have been diminished or impaired.
Annual impairment testing was performed on each of our goodwill and indefinite-lived intangible assets during 2018. Based
upon these reviews, our energy surety goodwill, miscellaneous and contract surety goodwill, small commercial goodwill and
state insurance license indefinite-lived intangible asset were not impaired. In addition, as of December 31, 2018, there were no
triggering events on the above-mentioned goodwill and intangible assets that would suggest an updated review was necessary.
As previously disclosed, adverse loss experience triggered the need to test the medical professional liability reporting unit
during the first quarter of 2018 and the second quarters of 2017 and 2016. The testing resulted in a $4.4 million non-cash
impairment charge on goodwill and intangible assets in 2018, a $3.4 million non-cash impairment charge on goodwill and
intangible assets in 2017 and a $7.2 million non-cash impairment charge on goodwill in 2016. In each instance, a fair value for
the medical professional liability reporting unit’s agency relationships, carried as a definite-lived intangible asset, was
determined by using a discounted cash flow valuation. In 2018, the carrying value exceeded the fair value, resulting in a $0.8
million non-cash impairment charge. In 2017, the resulting non-cash impairment charge on definite-lived intangibles was $1.8
million. A fair value for the medical professional liability reporting unit’s goodwill was determined by using a weighted
average of a market approach and discounted cash flow valuation. The carrying value exceeded the fair value in each year,
resulting in a $3.6 million non-cash impairment charge in 2018, a $1.6 million non-cash impairment charge during 2017 and a
$7.2 million non-cash impairment charge in 2016. Subsequent to the 2018 impairment, the medical professional liability
reporting unit had no remaining goodwill or intangible assets. All impairment charges were recorded as net realized losses in
the respective period’s consolidated statement of earnings.
74
The definite-lived intangible assets are amortized against future operating results based on their estimated useful lives.
Amortization of intangible assets was $0.4 million, $0.7 million and $0.9 million for 2018, 2017 and 2016, respectively. We
anticipate we will recognize amortization expense of $0.4 million in 2019 and 2020 and $0.1 million in 2021.
L. UNPAID LOSSES AND SETTLEMENT EXPENSES
The liability for unpaid losses and settlement expenses represents estimates of amounts needed to pay reported and
unreported claims and related expenses. The estimates are based on certain actuarial and other assumptions related to the
ultimate cost to settle such claims. Such assumptions are subject to occasional changes due to evolving economic, social and
political conditions. All estimates are periodically reviewed and, as experience develops and new information becomes known,
the reserves are adjusted as necessary. Such adjustments are reflected in the results of operations in the period in which they are
determined. Due to the inherent uncertainty in estimating reserves for losses and settlement expenses, there can be no assurance
that the ultimate liability will not exceed recorded amounts. If actual liabilities do exceed recorded amounts, there will be an
adverse effect. Furthermore, we may determine that recorded reserves are more than adequate to cover expected losses, which
would lead to a reduction in our reserves.
M. INSURANCE REVENUE RECOGNITION
Insurance premiums are recognized ratably over the term of the contracts, net of ceded reinsurance. Unearned premiums
are calculated on a monthly pro rata basis.
N. INCOME TAXES
We file a consolidated federal income tax return. Federal income taxes are accounted for using the asset and liability
method under which deferred income taxes are recognized for the tax consequences of temporary differences by applying
enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the
tax bases of existing assets and liabilities, operating losses and tax credit carry forwards. The effect on deferred taxes for a
change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced by a
valuation allowance if it is more likely than not that all or some of the deferred tax assets will not be realized.
We consider uncertainties in income taxes and recognize those in our financial statements as required. As it relates to
uncertainties in income taxes, our unrecognized tax benefits, including interest and penalty accruals, are not considered
material to the consolidated financial statements. Also, no tax uncertainties are expected to result in significant increases or
decreases to unrecognized tax benefits within the next 12-month period. Penalties and interest related to income tax
uncertainties, should they occur, would be included in income tax expense in the period in which they are incurred.
As an insurance company, we are subject to minimal state income tax liabilities. On a state basis, since the majority of
our income is from insurance operations, we pay premium taxes which are calculated as a percentage of gross premiums
written in lieu of state income taxes. Premium taxes are a component of policy acquisition costs.
O. EARNINGS PER SHARE
Basic earnings per share (EPS) is computed by dividing income available to common shareholders by the weighted-
average number of common shares outstanding for the period. Diluted EPS reflects the dilution that could occur if securities or
other contracts to issue common stock or common stock equivalents were exercised or converted into common stock. When
inclusion of these items increases the earnings per share or reduces the loss per share, the effect on earnings is anti-dilutive.
Under these circumstances, the diluted net earnings or net loss per share is computed excluding these items.
75
The following represents a reconciliation of the numerator and denominator of the basic and diluted EPS computations
contained in the consolidated financial statements:
(in thousands, except per share data)
For the year ended December 31, 2018
Basic EPS
Income available to common shareholders
Stock options
Diluted EPS
Income available to common shareholders and assumed conversions
For the year ended December 31, 2017
Basic EPS
Income available to common shareholders
Stock options
Diluted EPS
Income available to common shareholders and assumed conversions
For the year ended December 31, 2016
Basic EPS
Income available to common shareholders
Stock options
Diluted EPS
Income available to common shareholders and assumed conversions
P. COMPREHENSIVE EARNINGS
Income
(Numerator)
Weighted Average
Shares
(Denominator)
Per Share
Amount
$ 64,179
—
44,358 $
477
1.45
$ 64,179
44,835 $
1.43
$ 105,028
—
44,033 $
467
2.39
$ 105,028
44,500 $
2.36
$ 114,920
—
43,772 $
660
2.63
$ 114,920
44,432 $
2.59
Our comprehensive earnings include net earnings plus after-tax unrealized gains and losses on our available-for-sale
fixed income portfolio in 2018. In 2017 and 2016, after-tax unrealized gains and losses on our equity portfolio were also
included. With the adoption of ASU 2016-01 on January 1, 2018, we began recognizing unrealized gains and losses on the
equity portfolio through net income. See note 1.C for more information. In reporting the components of comprehensive
earnings, we used the federal statutory tax rate of 21 percent in 2018 and 35 percent in 2017 and 2016. Other comprehensive
income (loss), as shown in the consolidated statements of earnings and comprehensive earnings, is net of tax expense (benefit)
of $(9.0) million, $19.0 million and $(0.6) million for 2018, 2017 and 2016, respectively.
The following table illustrates the changes in the balance of each component of accumulated other comprehensive
earnings for each period presented in the consolidated financial statements. The 2016 and 2017 activity and balances include
the net unrealized gain and loss activity on both fixed income and equity securities, while the 2018 activity and ending balance
reflect only the net unrealized gain and loss activity on fixed income securities due to the aforementioned adoption of ASU
2016-01.
Unrealized Gains/Losses on Available-for-Sale Securities
(in thousands)
For the Year Ended December 31,
2016
2017
2018
Beginning balance
Cumulative effect adjustment of ASU 2016-01
Adjusted beginning balance
$ 157,919 $ 122,610 $ 123,774
—
15,700 $ 122,610 $ 123,774
(142,219)
—
$
Other comprehensive earnings before reclassifications
Amounts reclassified from accumulated other comprehensive earnings
Net current-period other comprehensive earnings (loss)
(35,763)
1,766
40,887
26,740
(5,578) (27,904)
$ (33,997) $ 35,309 $ (1,164)
Reclassification of stranded tax effect per ASU 2018-02 (see note 1.C)
Ending balance
76
3,725
—
$ (14,572) $ 157,919 $ 122,610
—
The sale or other-than-temporary impairment of an available-for-sale security results in amounts being reclassified from
accumulated other comprehensive earnings to current period net earnings. The effects of reclassifications out of accumulated
other comprehensive earnings by the respective line items of net earnings are presented in the following table. As previously
mentioned, 2018 activity is reflective of activity on fixed income securities classified as available-for-sale, while 2017 and
2016 also includes activity from the equity portfolio.
Amount Reclassified from Accumulated Other Comprehensive Earnings
(in thousands)
Component of Accumulated
Other Comprehensive Earnings
For the Year Ended December 31,
2016
2017
2018
Affected line item in the
Statement of Earnings
Unrealized gains and losses on available-for-sale
securities
$
(2,018) $ 11,141 $
43,024 Net realized investment gains
(217)
(2,235) $
469
(1,766) $
$
$
(2,559)
8,582 $
(3,004)
5,578 $
(95)
Other-than-temporary impairment
(OTTI) losses on investments
42,929 Earnings before income taxes
(15,025) Income tax benefit (expense)
27,904 Net earnings
Q. FAIR VALUE DISCLOSURES
Fair value is defined as the price in the principal market that would be received for an asset to facilitate an orderly
transaction between market participants on the measurement date. We determined the fair value of certain financial instruments
based on their underlying characteristics and relevant transactions in the marketplace. We maximize the use of observable
inputs and minimize the use of unobservable inputs when measuring fair value.
The following are the levels of the fair value hierarchy and a brief description of the type of valuation inputs that are used
to establish each level. Financial assets are classified based upon the lowest level of significant input that is used to determine
fair value.
Pricing Level 1 is applied to valuations based on readily available, unadjusted quoted prices in active markets for
identical assets.
Pricing Level 2 is applied to valuations based upon quoted prices for similar assets in active markets, quoted prices
for identical or similar assets in inactive markets; or valuations based on models where the significant inputs are
observable (e.g. interest rates, yield curves, prepayment speeds, default rates, loss severities) or can be corroborated
by observable market data.
Pricing Level 3 is applied to valuations that are derived from techniques in which one or more of the significant
inputs are unobservable.
As a part of management’s process to determine fair value, we utilize widely recognized, third-party pricing sources to
determine our fair values. We have obtained an understanding of the third-party pricing sources’ valuation methodologies and
inputs. The following is a description of the valuation techniques used for financial assets that are measured at fair value,
including the general classification of such assets pursuant to the fair value hierarchy.
Corporate, Agencies, Government and Municipal Bonds: The pricing vendor employs a multi-dimensional model
which uses standard inputs including (listed in approximate order of priority for use) benchmark yields, reported trades,
broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, market bids/offers and other reference data. The
pricing vendor also monitors market indicators, as well as industry and economic events. All bonds valued using these
techniques are classified as Level 2. All Corporate, Agencies, Government and Municipal securities are deemed Level 2.
Mortgage-backed Securities (MBS)/Collateralized Mortgage Obligations (CMO) and Asset-backed Securities
(ABS): The pricing vendor evaluation methodology includes principally interest rate movements and new issue data.
Evaluation of the tranches (non-volatile, volatile or credit sensitivity) is based on the pricing vendors’ interpretation of
accepted modeling and pricing conventions. This information is then used to determine the cash flows for each tranche,
benchmark yields, pre-payment assumptions and to incorporate collateral performance. To evaluate CMO volatility, an option
77
adjusted spread model is used in combination with models that simulate interest rate paths to determine market price
information. This process allows the pricing vendor to obtain evaluations of a broad universe of securities in a way that reflects
changes in yield curve, index rates, implied volatility, mortgage rates and recent trade activity. MBS/CMO and ABS with
corroborated, observable inputs are classified as Level 2. All of our MBS/CMO and ABS are deemed Level 2.
For all of our fixed income securities classified as Level 2, as described above, we periodically conduct a review to assess
the reasonableness of the fair values provided by our pricing services. Our review consists of a two-pronged approach. First,
we compare prices provided by our pricing services to those provided by an additional source. In some cases, we obtain prices
from securities brokers and compare them to the prices provided by our pricing services. In our comparisons, if discrepancies
are found, we compare our prices to actual reported trade data for like securities. No changes to the fair values supplied by our
pricing services have occurred as a result of our reviews. Based on these assessments, we have determined that the fair values
of our Level 2 securities provided by our pricing services are reasonable.
Common Stock: All but one of our common stock holdings are traded on an exchange. Exchange traded equities have
readily observable price levels and are classified as Level 1 (fair value based on quoted market prices). Pricing for the equity
security not traded on an exchange is provided by a third-party pricing source and is classified as Level 2.
Due to the relatively short-term nature of cash, short-term investments, accounts receivable and accounts payable, their
carrying amounts are reasonable estimates of fair value. Our investments in private funds, classified as other invested assets,
are measured using the investments’ net asset value per share and are not categorized within the fair value hierarchy. The fair
value of our long-term debt is discussed further in note 4.
R. STOCK-BASED COMPENSATION
We expense the estimated fair value of employee stock options and similar awards. We measure compensation cost for
awards of equity instruments to employees based on the grant-date fair value of those awards and recognize compensation
expense over the service period that the awards are expected to vest.
The tax effects related to share-based payments were made through net earnings in 2018 and 2017. In 2016, the tax
effects of share-based compensation were recognized in additional paid-in capital under the alternative transition method. The
alternative transition method used simplified methods to determine the impact on the additional paid-in capital pool and
consolidated statements of cash flows.
See note 8 for further discussion and related disclosures regarding stock options.
S. RISKS AND UNCERTAINTIES:
Certain risks and uncertainties are inherent to our day-to-day operations and to the process of preparing our consolidated
financial statements. The more significant risks and uncertainties, as well as our attempt to mitigate, quantify and minimize
such risks, are presented below and throughout the notes to the consolidated financial statements.
Insurance Risks
We compete with a large number of other companies in our selected lines of business. During periods of intense
competition for premium, we are vulnerable to the actions of other companies who may seek to write business without the
appropriate regard for risk and profitability. The insurance industry is currently operating under highly competitive conditions
and, as a result, margins in the industry are under pressure. During these times, it is very difficult to grow or maintain premium
volume without sacrificing underwriting discipline and income. Our profitability can be affected significantly by the ability of
our underwriters to accurately select and price risk and our claim personnel to appropriately deliver fair outcomes. We attempt
to mitigate this risk by incentivizing our underwriters to maximize underwriting profit and remain disciplined in pricing and
selecting risks. If we are unable to compete effectively in the markets in which we operate or expand our operations into new
markets, our underwriting revenues may decline, as well as overall business results.
Our loss reserves are based on estimates and may be inadequate to cover our actual insured losses, which would
negatively impact our profitability. As of December 31, 2018 we had $1.5 billion of gross loss and LAE reserves. Significant
periods of time often elapse between the occurrence of an insured loss, the reporting of the loss to the Company and our
payment of that loss. As part of the reserving process, we review historical data and consider the impact of various factors such
as trends in claim frequency and severity, emerging economic and social trends, inflation and changes in the regulatory and
78
litigation environments. If the actual amount of insured losses is greater than the amount we have reserved for these losses, our
profitability would suffer.
Catastrophe Exposures
Our insurance coverages include exposure to catastrophic events. We monitor all catastrophe exposures by quantifying
our exposed policy limits in each region and by using computer-assisted modeling techniques. Additionally, we limit our risk
to such catastrophes through restraining the total policy limits written in each region and by purchasing reinsurance. Our major
catastrophe exposure is to losses caused by earthquakes, primarily on the West Coast. In 2018, we had reinsurance protection
of $300 million in excess of $25 million first-dollar retention for earthquakes in California and $325 million in excess of a $25
million first-dollar retention for earthquakes outside of California. These amounts are subject to certain co-participations by the
Company on losses in excess of the $25 million retentions. Our second largest catastrophe exposure is to losses caused by wind
storms to commercial properties throughout the Gulf and East Coasts, as well as to homes we insure in Hawaii. In 2018, these
coverages were supported by $225 million in excess of a $25 million first-dollar retention in traditional catastrophe reinsurance
protection, subject to certain co-participations by the Company in the excess layers. In addition, we have incidental exposure to
international catastrophic events.
Our catastrophe reinsurance treaty renewed on January 1, 2019. We purchased reinsurance protection of $400 million in
excess of $25 million first-dollar retention for earthquakes in California and $425 million in excess of a $25 million first-dollar
retention for earthquakes outside of California. For other CAT events, such as hurricanes, we purchased reinsurance protection
of $275 million in excess of a $25 million first dollar retention. These amounts are subject to certain co-participations by the
Company on losses in excess of the $25 million retentions. We actively manage our catastrophe program to keep our net
retention in line with risk tolerances and to optimize the risk/return trade off.
Environmental Exposures
We are subject to environmental claims and exposures primarily through our commercial excess, general liability and
discontinued assumed casualty reinsurance lines of business. Although exposure to environmental claims exists in these lines
of business, we seek to mitigate or control the extent of this exposure on the vast majority of this business through the
following methods: (1) our policies include pollution exclusions that have been continually updated to further strengthen them,
(2) our policies primarily cover moderate hazard risks and (3) we began writing this business after the insurance industry
became aware of the potential pollution liability exposure and implemented changes to limit exposure to this hazard.
We offer coverage for low to moderate environmental liability exposures for small contractors and asbestos and mold
remediation specialists. We also provide limited coverage for individually underwritten underground storage tanks. The overall
exposure is mitigated by focusing on smaller risks with low to moderate exposures. Risks that have large-scale exposures are
avoided including petrochemical, chemical, mining, manufacturers and other risks that might be exposed to superfund sites.
This business is covered under our casualty ceded reinsurance treaties.
We made loss and settlement expense payments on environmental liability claims and have loss and settlement expense
reserves for others. We include this historical environmental loss experience with the remaining loss experience in the
applicable line of business to project ultimate incurred losses and settlement expenses as well as related incurred but not
reported (IBNR) loss and settlement expense reserves.
Although historical experience on environmental claims may not accurately reflect future environmental exposures, we
used this experience to record loss and settlement expense reserves in the exposed lines of business. See further discussion of
environmental exposures in note 6.
Reinsurance
Reinsurance does not discharge the Company from our primary liability to policyholders, and to the extent that a
reinsurer is unable to meet its obligations, we would be liable. We continuously monitor the financial condition of prospective
and existing reinsurers. As a result, we purchase reinsurance from a number of financially strong reinsurers. We provide an
allowance for reinsurance balances deemed uncollectible. See further discussion of reinsurance exposures in note 5.
79
Investment Risk
Our investment portfolio is subject to market, credit and interest rate risks. The equity portfolio will fluctuate with
movements in the overall stock market. While the equity portfolio has been constructed to have lower downside risk than the
market, the portfolio is positively correlated with movements in domestic stocks. The bond portfolio is affected by interest rate
changes and movement in credit spreads. We attempt to mitigate our interest rate and credit risks by constructing a well-
diversified portfolio with high-quality securities with varied maturities. Downturns in the financial markets could have a
negative effect on our portfolio. However, we attempt to manage this risk through asset allocation, duration and security
selection.
Liquidity Risk
Liquidity is essential to our business and a key component of our concept of asset-liability matching. Our liquidity may
be impaired by an inability to collect premium receivable or reinsurance recoverable balances in a timely manner, an inability
to sell assets or redeem our investments, an inability to access funds from our insurance subsidiaries, unforeseen outflows of
cash or large claim payments or an inability to access debt or equity capital markets. This situation may arise due to
circumstances that we may be unable to control, such as a general market disruption, an operational problem that affects third
parties or the Company, or even by the perception among market participants that we, or other market participants, are
experiencing greater liquidity risk.
Our credit ratings are important to our liquidity. A reduction in our credit ratings could adversely affect our liquidity and
competitive position by increasing our borrowing costs or limiting our access to the capital markets.
Financial Statements
The preparation of the accompanying consolidated financial statements in conformity with GAAP requires management
to make estimates and assumptions about future events. These estimates and the underlying assumptions affect the amounts of
assets and liabilities reported, disclosures about contingent assets and liabilities and reported amounts of revenues and
expenses. The most significant of these amounts is the liability for unpaid losses and settlement expenses. Other estimates
include investment valuation and OTTIs, the collectability of reinsurance balances, recoverability of deferred tax assets and
deferred policy acquisition costs. These estimates and assumptions are based on management’s best estimates and judgment.
Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors,
including the current economic environment, which management believes to be reasonable under the circumstances. We adjust
such estimates and assumptions when facts and circumstances dictate. Although recorded estimates are supported by actuarial
computations and other supportive data, the estimates are ultimately based on our expectations of future events. As future
events and their effects cannot be determined with precision, actual results could differ significantly from these estimates.
Changes in those estimates resulting from continuing changes in the economic environment will be reflected in the
consolidated financial statements in future periods.
External Factors
Our insurance subsidiaries are highly regulated by the state in which they are incorporated and by the states in which they
do business. Such regulations, among other things, limit the amount of dividends, impose restrictions on the amount and types
of investments and regulate rates insurers may charge for various coverages. We are also subject to insolvency and guaranty
fund assessments for various programs designed to ensure policyholder indemnification. We generally accrue an assessment
during the period in which it becomes probable that a liability has been incurred from an insolvency and the amount of the
related assessment can be reasonably estimated.
The National Association of Insurance Commissioners (NAIC) has developed Property/Casualty Risk-Based Capital
(RBC) standards that relate an insurer’s reported statutory surplus to the risks inherent in its overall operations. The RBC
formula uses the statutory annual statement to calculate the minimum indicated capital level to support investment and
underwriting risk. The NAIC model law calls for various levels of regulatory action based on the magnitude of an indicated
RBC capital deficiency, if any. We regularly monitor our subsidiaries’ internal capital requirements and the NAIC’s RBC
developments. As of December 31, 2018, we determined that our capital levels are well in excess of the minimum capital
requirements for all RBC action levels and that our capital levels are sufficient to support the level of risk inherent in our
operations. See note 9 for further discussion of statutory information and related insurance regulatory restrictions.
80
In addition, ratings are a critical factor in establishing the competitive position of insurance companies. Our insurance
companies are rated by A.M. Best, S&P and Moody’s. Their ratings reflect their opinions of an insurance company’s and an
insurance holding company’s financial strength, operating performance, strategic position and ability to meet its obligations to
policyholders.
2. INVESTMENTS
A summary of net investment income is as follows:
NET INVESTMENT INCOME
(in thousands)
Interest on fixed income securities
Dividends on equity securities
Interest on cash, short-term investments and other invested assets
Gross investment income
Less investment expenses
Net investment income
2016
2018
9,814
2,309
2017
$ 54,491 $ 48,343 $ 46,834
10,929
10,506
120
945
$ 66,614 $ 59,794 $ 57,883
(4,808)
(4,918)
(4,529)
$ 62,085 $ 54,876 $ 53,075
Pretax net realized investment gains (losses) and net changes in unrealized gains (losses) on investments for the years
ended December 31 are summarized as follows:
REALIZED/UNREALIZED GAINS
(in thousands)
Net realized gains (losses):
Fixed income:
Available-for-sale
Available-for-sale OTTI
Equity securities
Other
Total
Net changes in unrealized gains (losses) on investments:
Fixed income:
Available-for-sale
Equity securities
Other invested assets
Investment in unconsolidated investees
Total
Net realized gains (losses) and changes in unrealized gains
(losses) on investments
2018
2017
2016
$
$
859 $
4,314
(2,018) $
(95)
(2,559)
(217)
38,709
10,282
69,868
(4,226)
(8,283)
(4,171)
63,407 $ 4,411 $ 34,645
$ (41,778) $ 16,846 $ (10,972)
8,659
—
522
$ (141,770) $ 54,323 $ (1,791)
36,844
29
604
(98,380)
(355)
(1,257)
$ (78,363) $ 58,734 $ 32,854
During 2018, we recorded $63.4 million in net realized gains, which included $4.4 million of other non-cash realized
losses from goodwill and definite-lived intangible impairments. In addition, we recorded a change in net unrealized losses of
$141.8 million. The majority of our net realized gains were due to sales of equity securities. The change in unrealized gain/loss
position was due to the realization of gains in the course of selling equity securities and the price decline in both equities and
bonds during 2018. For 2018, the net realized gains (losses) and changes in unrealized gains (losses) on investments totaled
$(78.4) million.
81
The following is a summary of the disposition of fixed income securities and equities for the years ended December 31,
with separate presentations for sales and calls/maturities.
SALES
(in thousands)
2018
Available-for-sale
Equities
2017
Available-for-sale
Equities
2016
Available-for-sale
Equities
CALLS/MATURITIES
(in thousands)
2018
Available-for-sale
2017
Available-for-sale
2016
Available-for-sale
FAIR VALUE MEASUREMENTS
Proceeds
From Sales
Gross Realized
Gains
Losses
Realized
Gain (Loss)
Net
$ 394,318 $
147,838
3,131 $ (5,349) $ (2,218)
69,868
(1,197)
71,065
$ 169,002 $
36,573
2,406 $ (1,670) $
13,178
(2,896)
736
10,282
$ 329,091 $
7,158 $ (3,287) $
89,909
39,668
(959)
3,871
38,709
Proceeds
Gains
Losses
Gross Realized
Net
Realized
Gain (Loss)
$ 187,380 $
311 $
(111) $
200
$ 195,617 $
262 $
(139) $
123
$ 141,255 $
445 $
(2) $
443
Assets measured at fair value on a recurring basis as of December 31, 2018, are summarized below:
Significant
(in thousands)
Fixed income securities - available-for-sale
U.S. government
U.S. agency
Non-U.S. govt. & agency
Agency MBS
ABS/CMBS*
Corporate
Municipal
Total fixed income securities - available-for-sale
Equity securities
Total
*Non-agency asset-backed & commercial mortgage-backed
Quoted in Active
Markets for
Identical Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
$
$
$
— $
—
—
—
—
—
—
— $ 1,760,515 $
200,229 $
31,904
7,639
395,253
136,723
668,679
320,088
339,985
339,985 $ 1,761,013 $
498
200,229
— $
31,904
—
7,639
—
395,253
—
136,723
—
668,679
—
—
320,088
— $ 1,760,515
—
340,483
— $ 2,100,998
82
Assets measured at fair value on a recurring basis as of December 31, 2017, are summarized below:
Significant
(in thousands)
Fixed income securities - available-for-sale
U.S. government
U.S. agency
Non-U.S. govt. & agency
Agency MBS
ABS/CMBS*
Corporate
Municipal
Total fixed income securities - available-for-sale
Equity securities
Total
*Non-agency asset-backed & commercial mortgage-backed
Quoted in Active
Markets for
Identical Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
$
$
$
— $
—
—
—
—
—
—
— $ 1,672,239 $
91,689 $
18,778
7,588
328,471
70,526
519,022
636,165
400,492
400,492 $ 1,672,239 $
—
91,689
— $
18,778
—
7,588
—
328,471
—
70,526
—
519,022
—
—
636,165
— $ 1,672,239
—
400,492
— $ 2,072,731
As noted in the previous tables, we did not have any assets measured at fair value on a recurring basis using significant
unobservable inputs (Level 3) as of December 31, 2018 and 2017. Additionally, there were no securities transferred in or out of
levels 1 or 2 during 2018 or 2017.
The amortized cost and estimated fair value of fixed income securities at December 31, 2018, by contractual maturity, are
shown as follows:
(in thousands)
Available-for-sale
Due in one year or less
Due after one year through five years
Due after five years through 10 years
Due after 10 years
Mtge/ABS/CMBS*
Total available-for-sale
Amortized Cost
Fair Value
$
$
41,319 $
411,153
615,061
168,716
540,216
1,776,465 $
41,333
410,680
608,115
168,412
531,975
1,760,515
* Mortgage-backed, asset-backed & commercial mortgage-backed
Expected maturities may differ from contractual maturities due to call provisions on some existing securities. At
December 31, 2018, the net unrealized losses of available-for-sale fixed income securities totaled $16.0 million pretax. At
December 31, 2017, the net unrealized appreciation of available-for-sale fixed maturities securities totaled $25.8 million
pretax.
83
In addition, the following table is a schedule of amortized costs and estimated fair values of investments in fixed income
securities as of December 31, 2018 and 2017:
2018
(in thousands)
Available-for-sale
U.S. government
U.S. agency
Non-U.S. govt. & agency
Agency MBS
ABS/CMBS*
Corporate
Municipal
Total fixed income
2017
(in thousands)
Available-for-sale
U.S. government
U.S. agency
Non-U.S. govt. & agency
Agency MBS
ABS/CMBS*
Corporate
Municipal
Total fixed income
Amortized
Gross Unrealized
Cost
Fair Value
Gains
Losses
$
200,229 $ 1,232 $
199,982 $
31,716
8,170
402,992
137,224
681,909
314,472
(985)
(215)
(531)
(9,448)
(876)
(16,124)
(1,310)
$ 1,776,465 $ 1,760,515 $ 13,539 $ (29,489)
31,904
7,639
395,253
136,723
668,679
320,088
403
—
1,709
375
2,894
6,926
Amortized
Gross Unrealized
Cost
Fair Value
Gains
Losses
$
23 $
92,561 $
18,541
7,501
329,129
70,405
508,128
620,146
(895)
(110)
(56)
(4,078)
(315)
(1,681)
(1,253)
$ 1,646,411 $ 1,672,239 $ 34,216 $ (8,388)
91,689 $
18,778
7,588
328,471
70,526
519,022
636,165
347
143
3,420
436
12,575
17,272
* Non-agency asset-backed & commercial mortgage-backed
Mortgage-Backed, Commercial Mortgage-Backed and Asset-Backed Securities
Gross unrealized losses in the collateralized securities bond portfolio increased to $10.3 million in 2018 as interest rates
increased during the year. All of our collateralized securities carry the highest credit rating by one or more major rating
agencies and continue to pay according to contractual terms.
For all fixed income securities at an unrealized loss at December 31, 2018, we believe it is probable that we will receive
all contractual payments in the form of principal and interest. In addition, we are not required to, nor do we intend to, sell these
investments prior to recovering the entire amortized cost basis of each security, which may be at maturity. We do not consider
these investments to be other-than-temporarily impaired at December 31, 2018.
Corporate Bonds
Gross unrealized losses in the corporate bond portfolio increased to $16.1 million in 2018 from $1.7 million at the end of
2017 as interest rates and credit spreads increased during the year. The corporate bond portfolio has an overall rating of A-.
Municipal Bonds
As of December 31, 2018, municipal bonds totaled $320.1 million with gross unrealized losses of $1.3 million, the same
as the previous year. As of December 31, 2018, approximately 42 percent of the municipal fixed income securities in the
investment portfolio were general obligations of state and local governments and the remaining 58 percent were revenue based.
Eighty-five percent of our municipal fixed income securities were rated AA or better while 99 percent were rated A or better.
Equity Securities
Our equity portfolio consists of common stocks and exchange traded funds (ETF). Gross unrealized losses in the equity
portfolio increased $9.2 million to $10.1 million in 2018 as equity markets declined during the year.
84
Impairment Analysis
Under current accounting standards, an OTTI write-down of debt securities, where fair value is below amortized cost, is
triggered by circumstances where: (1) an entity has the intent to sell a security, (2) it is more likely than not that the entity will
be required to sell the security before recovery of its amortized cost basis or (3) the entity does not expect to recover the entire
amortized cost basis of the security. If an entity intends to sell a security or if it is more likely than not the entity will be
required to sell the security before recovery, an OTTI write-down is recognized in earnings equal to the difference between the
security’s amortized cost and its fair value. If an entity does not intend to sell the security or it is not more likely than not that it
will be required to sell the security before recovery, the OTTI write-down is separated into an amount representing the credit
loss, which is recognized in earnings, and the amount related to all other factors, which is recognized in other comprehensive
income.
As part of our evaluation of whether particular securities are other-than-temporarily impaired, we consider our intent to
sell a security (which is determined on a security-by-security basis) and whether it is more likely than not we will be required
to sell the security before the recovery of our amortized cost basis. Significant changes in these factors could result in a charge
to net earnings for impairment losses. Impairment losses result in a reduction of the underlying investment’s cost basis.
The following table is also used as part of our impairment analysis and displays the total value of debt securities that were
in an unrealized loss position as of December 31, 2018, and December 31, 2017. The table segregates the securities based on
type, noting the fair value, amortized cost and unrealized loss on each category of investment as well as in total. The table further
classifies the securities based on the length of time they have been in an unrealized loss position.
85
(in thousands)
U.S. Government
Fair value
Amortized cost
Unrealized Loss
U.S. Agency
Fair value
Amortized cost
Unrealized Loss
Non-U.S. Government
Fair value
Amortized cost
Unrealized Loss
Agency MBS
Fair value
Amortized cost
Unrealized Loss
ABS/CMBS*
Fair value
Amortized cost
Unrealized Loss
Corporate
Fair value
Amortized cost
Unrealized Loss
Municipal
Fair value
Amortized cost
Unrealized Loss
Total fixed income
Fair value
Amortized cost
Unrealized Loss
December 31, 2018
12 Mos.
& Greater
< 12 Mos.
Total
< 12 Mos.
December 31, 2017
12 Mos.
& Greater
Total
$
7,249 $ 76,073 $
7,270
77,037
$
(21) $
(964) $
$
$
— $
—
— $
8,843 $
9,058
(215) $
83,322 $ 58,009 $ 30,888 $ 88,897
89,792
84,307
(895)
(985) $
(434) $
(461) $
31,349
58,443
8,843 $ 10,917 $
9,058
(215) $
(110) $
11,027
— $ 10,917
11,027
—
(110)
— $
$
$
5,432 $
5,571
(139) $
2,207 $
2,599
(392) $
7,639 $
8,170
(531) $
— $
—
— $
1,840 $
1,896
(56) $
1,840
1,896
(56)
$ 25,345 $ 261,325 $
25,486
270,632
$
(141) $ (9,307) $
$ 46,918 $ 32,137 $
47,146
32,785
$
(228) $
(648) $
$ 306,177 $ 147,751 $
315,428
154,624
$
(9,251) $ (6,873) $
$
6,036 $ 55,681 $
6,052
56,975
$
(16) $ (1,294) $
$ 397,157 $ 584,017 $
406,953
603,710
$
(9,796) $ (19,693) $
286,670 $ 122,130 $ 111,306 $ 233,436
237,514
296,118
(9,448) $ (1,429) $ (2,649) $ (4,078)
113,955
123,559
79,055 $ 23,406 $ 21,587 $ 44,993
45,308
79,931
(315)
(230) $
(876) $
21,817
23,491
(85) $
453,928 $ 86,946 $ 28,600 $ 115,546
470,052
117,227
(891) $ (1,681)
(16,124) $
(790) $
87,736
29,491
61,717 $ 71,059 $ 60,049 $ 131,108
132,361
63,027
(778) $ (1,253)
(1,310) $
(475) $
60,827
71,534
1,010,663
981,174 $ 372,467 $ 254,270 $ 626,737
635,125
(29,489) $ (3,323) $ (5,065) $ (8,388)
375,790
259,335
*Non-agency asset-backed & commercial mortgage-backed
The fixed income portfolio contained 777 securities in an unrealized loss position as of December 31, 2018. Of these 777
securities, 302 have been in an unrealized loss position for 12 consecutive months or longer and represent $19.7 million in
unrealized losses. All fixed income securities continue to pay the expected coupon payments under the contractual terms of the
securities. Credit-related impairments on fixed income securities that we do not plan to sell, and for which we are not more
likely than not to be required to sell, are recognized in net earnings. Any non-credit related impairment is recognized in
comprehensive earnings. Based on our analysis, our fixed income portfolio is of a high credit quality and we believe we will
recover the amortized cost basis of our fixed income securities. We continually monitor the credit quality of our fixed income
investments to assess if it is probable that we will receive our contractual or estimated cash flows in the form of principal and
86
interest. There were no OTTI losses recognized in other comprehensive earnings in the periods presented. Key factors that we
consider in the evaluation of credit quality include:
Changes in technology that may impair the earnings potential of the investment,
The discontinuance of a segment of business that may affect future earnings potential,
Reduction or elimination of dividends,
Specific concerns related to the issuer’s industry or geographic area of operation,
Significant or recurring operating losses, poor cash flows and/or deteriorating liquidity ratios and
Downgrades in credit quality by a major rating agency.
Based on our analysis, we concluded that the securities in an unrealized loss position were not other-than-temporarily
impaired at December 31, 2018 and 2017. There were $0.2 million, $2.6 million and $0.1 million in losses associated with
OTTI of securities in 2018, 2017 and 2016, respectively.
Unrealized Gains and Losses on Equity Securities
Unrealized gains (losses) recognized during 2018 on equity securities still held as of December 31, 2018 were $(28.7)
million. Unrealized gains (losses) recognized during 2017 on equity securities still held as of December 31, 2017 were $47.2
million.
Other Invested Assets
We had $51.5 million of other invested assets at December 31, 2018, compared to $33.8 million at the end of 2017. Other
invested assets include investments in low income housing tax credit (LIHTC) partnerships, membership stock in the Federal
Home Loan Bank of Chicago (FHLBC) and investments in private funds. Our LIHTC investments are carried at amortized cost
and our investment in FHLBC stock is carried at cost. Due to the nature of the LIHTC and our membership in the FHLBC,
their carrying amounts approximate fair value. The private funds are carried at fair value, using each investment’s net asset
value.
Our LIHTC interests had a balance of $20.3 million at December 31, 2018 compared to $15.5 million at December 31,
2017 and recognized a total tax benefit of $2.2 million during 2018 compared to $2.4 million during 2017 and $1.9 million
during 2016. Our unfunded commitment for our LIHTC investments totaled $7.4 million at December 31, 2018 and will be
paid out in installments through 2025.
We had $18.8 million of unfunded commitments related to our investments in private funds at December 31, 2018.
Additionally, our interest in these investments is generally restricted from being transferred or otherwise redeemed without
prior consent by the respective entities. An initial public offering would allow for the transfer of interest in some situations,
while the timed dissolution of the partnership would trigger redemption in others.
Restricted Assets
As of December 31, 2018, $16.1 million of investments were pledged as collateral with the FHLBC to ensure timely
access to the secured lending facility that ownership of the FHLBC stock provides. As of and during year ended December 31,
2018, there were no outstanding borrowings with the FHLBC.
As of December 31, 2018, fixed income securities with a carrying value of $59.2 million were on deposit with regulatory
authorities as required by law.
87
3. POLICY ACQUISITION COSTS
Policy acquisition costs deferred and amortized to income for the years ended December 31 are summarized as follows:
(in thousands)
Deferred policy acquisition costs (DAC), beginning of year
Deferred:
Direct commissions
Premium taxes
Ceding commissions
Net deferred
Amortized
DAC, end of year
Policy acquisition costs:
Amortized to expense - DAC
Period costs:
Ceding commission - contingent
Other underwriting expenses
Total policy acquisition costs
4. DEBT
2018
2017
$ 77,716 $ 73,147 $ 69,829
2016
12,654
(22,190)
$ 175,697 $ 157,723 $ 150,390
11,759
11,651
(17,488)
(18,096)
$ 166,161 $ 151,278 $ 144,661
141,343
146,709
$ 84,934 $ 77,716 $ 73,147
158,943
$ 158,943 $ 146,709 $ 141,343
(2,241)
111,036
(1,524)
(3,575)
109,793
109,381
$ 267,738 $ 252,515 $ 249,612
As of December 31, 2018, outstanding debt balances totaled $149.1 million, net of unamortized discount and debt
issuance costs, all of which were our long-term senior notes.
On October 2, 2013, we completed a public debt offering, issuing $150.0 million in senior notes maturing September 15,
2023, and paying interest semi-annually at the rate of 4.875 percent. The notes were issued at a discount resulting in proceeds,
net of discount and commission, of $148.6 million. The amount of the discount is being charged to income over the life of the
debt on an effective-yield basis. The estimated fair value for the senior note was $155.9 million as of December 31, 2018. The
fair value of our long-term debt is based on the limited observable prices that reflect thinly traded securities and is therefore
classified as a level 2 liability within the fair value hierarchy.
We paid $7.3 million of interest on our senior notes in each of the last three years. The average rate on debt was 4.91
percent in 2018, 2017 and 2016.
We maintain a revolving line of credit with JP Morgan Chase Bank N.A., which permits the Company to borrow up to an
aggregate principal amount of $50.0 million. This facility was entered into during the second quarter of 2018 and replaced the
previous $40.0 million facility which expired on May 28, 2018. Under certain conditions, the line may be increased up to an
aggregate principal amount of $75.0 million. This facility has a two-year term that expires on May 24, 2020. As of and during
the years ended December 31, 2018, 2017 and 2016, no amounts were outstanding on these facilities.
5. REINSURANCE
In the ordinary course of business, our insurance subsidiaries assume and cede premiums and selected insured risks with
other insurance companies, known as reinsurance. A large portion of the reinsurance is put into effect under contracts known as
treaties and, in some instances, by negotiation on each individual risk (known as facultative reinsurance). In addition, there are
several types of treaties including quota share, excess of loss and catastrophe reinsurance contracts that protect against losses
over stipulated amounts arising from any one occurrence or event. The arrangements allow the Company to pursue greater
diversification of business and serve to limit the maximum net loss to a single event, such as a catastrophe. Through the
quantification of exposed policy limits in each region and the extensive use of computer-assisted modeling techniques, we
monitor the concentration of risks exposed to catastrophic events.
Through the purchase of reinsurance, we also generally limit our net loss on any individual risk to a maximum of $3.0
million, although retentions can vary.
88
Premiums written and earned along with losses and settlement expenses incurred for the years ended December 31 are
summarized as follows:
(in thousands)
WRITTEN
Direct
Reinsurance assumed
Reinsurance ceded
Net
EARNED
Direct
Reinsurance assumed
Reinsurance ceded
Net
LOSSES AND SETTLEMENT EXPENSES INCURRED
Direct
Reinsurance assumed
Reinsurance ceded
Net
2018
2017
2016
$ 934,913 $ 848,153 $ 844,430
30,434
(133,912)
$ 823,175 $ 749,854 $ 740,952
48,303
(160,041)
37,159
(135,458)
$ 896,234 $ 835,118 $ 835,294
27,886
32,521
(134,572)
(129,702)
$ 791,366 $ 737,937 $ 728,608
41,926
(146,794)
$ 560,421 $ 486,986 $ 405,873
13,196
16,072
(69,291)
(101,474)
$ 428,193 $ 401,584 $ 349,778
20,376
(152,604)
At December 31, 2018, we had unearned reinsurance premiums and recoverables on paid and unpaid losses and
settlement expenses totaling $430.0 million. More than 93 percent of our reinsurance recoverables are due from companies
with financial strength ratings of “A” or better by A.M. Best and S&P rating services.
The following table displays net reinsurance balances recoverable, after consideration of collateral, from our top
reinsurers as of December 31, 2018. These reinsurers all have financial strength ratings of “A” or better by A.M. Best and
Standard and Poor’s ratings services. Also shown are the amounts of written premium ceded to these reinsurers during the
calendar year 2018.
A.M. Best
Rating
S & P
Rating
Net Reinsurer
Exposure as of Percent of
12/31/2018
Total
Ceded
Premiums
Written
Percent of
(dollars in thousands)
Munich Re / HSB
Swiss Re / Westport Ins.
Corp.
Endurance Re
Aspen UK Ltd.
Berkley Insurance Co.
Hannover Ruckversicherung
Axis Re
Transatlantic Re
Toa Re
General Re
Tokio Millennium Re
All other reinsurers*
Total ceded exposure
A+, Superior
AA-, Very Strong
$
73,593
17.1 % $
24,479
A+, Superior
A+, Superior
A, Excellent
A+, Superior
A+, Superior
A+, Superior
A+, Superior
A, Excellent
A++, Superior
A+, Superior
AA-, Very Strong
A+, Strong
A, Strong
A+, Strong
AA-, Very Strong
A+, Strong
A+, Strong
A+, Strong
AA+, Very Strong
A+, Strong
35,095
28,754
27,735
23,267
22,629
19,928
19,517
18,480
18,168
17,044
125,777
$ 429,987
8.2 %
6.7 %
6.4 %
5.4 %
5.3 %
4.6 %
4.5 %
4.3 %
4.2 %
4.0 %
29.3 %
2,100
6,000
7,906
6,335
9,458
6,424
7,911
6,495
5,170
6,947
70,816
100.0 % $ 160,041
Total
15.3 %
1.3 %
3.8 %
4.9 %
4.0 %
5.9 %
4.0 %
4.9 %
4.1 %
3.2 %
4.3 %
44.3 %
100.0 %
* All other reinsurance balances recoverable, when considered by individual reinsurer, are less than 2 percent of
shareholders’ equity.
Ceded unearned premiums and reinsurance balances recoverable on paid losses and settlement expenses are reported
separately as an asset, rather than being netted with the related liability, since reinsurance does not relieve the Company of our
liability to policyholders. Such balances are subject to the credit risk associated with the individual reinsurer. We continually
monitor the financial condition of our reinsurers and actively follow up on any past due or disputed amounts. As part of our
monitoring efforts, we review their annual financial statements and SEC filings for those reinsurers that are publicly traded. We
89
also review insurance industry developments that may impact the financial condition of our reinsurers. We analyze the credit
risk associated with our reinsurance balances recoverable by monitoring the A.M. Best and S&P ratings of our reinsurers. In
addition, we subject our reinsurance recoverables to detailed recoverability tests, including a segment-based analysis using the
average default rating percentage by S&P rating, which assists the Company in assessing the sufficiency of the existing
allowance. Additionally, we perform an in-depth reinsurer financial condition analysis prior to the renewal of our reinsurance
placements.
Our policy is to charge to earnings, in the form of an allowance, an estimate of unrecoverable amounts from reinsurers.
This allowance is reviewed on an ongoing basis to ensure that the amount makes a reasonable provision for reinsurance
balances that we may be unable to recover. Once regulatory action (such as receivership, finding of insolvency, order of
conservation or order of liquidation) is taken against a reinsurer, the paid and unpaid recoverable for the reinsurer are
specifically identified and written off through the use of our allowance for estimated unrecoverable amounts from reinsurers.
When we write-off such a balance, it is done in full. We then re-evaluate the remaining allowance and determine whether the
balance is sufficient as detailed above and if needed, an additional allowance is recognized and income charged. The amounts
of allowances for uncollectible amounts on paid and unpaid recoverables were $16.1 million and $9.8 million, respectively, at
December 31, 2018. At December 31, 2017, the amounts were $15.9 million and $10.0 million, respectively. We have no
receivables with a due date that extends beyond one year that are not included in our allowance for uncollectible amounts.
6. HISTORICAL LOSS AND LAE DEVELOPMENT
The following table is a reconciliation of our unpaid losses and settlement expenses (LAE) for the years 2018, 2017 and 2016:
(in thousands)
Unpaid losses and LAE at beginning of year:
Gross
Ceded
Net
Increase (decrease) in incurred losses and LAE:
Current accident year
Prior accident years
Total incurred
Loss and LAE payments for claims incurred:
Current accident year
Prior accident year
Total paid
2018
2017
2016
$ 1,271,503 $ 1,139,337 $ 1,103,785
(297,844)
805,941
(301,991)
969,512 $
(288,224)
851,113 $
$
$
$
478,143 $
(49,950)
428,193 $
440,452 $
(38,868)
401,584 $
391,772
(41,994)
349,778
$
(76,050) $
(225,306)
(70,540)
(234,066)
$ (301,356) $ (283,185) $ (304,606)
(73,392) $
(209,793)
Net unpaid losses and LAE at end of year
$ 1,096,349 $
969,512 $
851,113
Unpaid losses and LAE at end of year:
Gross
Ceded
Net
$ 1,461,348 $ 1,271,503 $ 1,139,337
(288,224)
851,113
(364,999)
$ 1,096,349 $
(301,991)
969,512 $
Loss development occurs when our current estimate of ultimate losses, established through our reserve analysis processes,
differs from the initial reserve estimate. The recognition of the changes in initial reserve estimates occurred over time as claims
were reported, initial case reserves were established, initial reserves were reviewed in light of additional information and ultimate
payments were made on the collective set of claims incurred as of that evaluation date. The new information on the ultimate
settlement value of claims is continually updated until all claims in a defined set are settled. As a small specialty insurer with a
diversified product portfolio, our experience will ordinarily exhibit fluctuations from period to period. While we attempt to
identify and react to systematic changes in the loss environment, we also must consider the volume of claim experience directly
available to the Company and interpret any particular period’s indications with a realistic technical understanding of the reliability
of those observations.
The following is information about incurred and paid loss development as of December 31, 2018, net of reinsurance, as well
as cumulative claim frequency, the total of IBNR liabilities included within the net incurred loss amounts and average historical
90
AY
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
AY
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
claims duration as of December 31, 2018. The loss information has been disaggregated so that only losses that are expected to
develop in a similar manner are grouped together. This has resulted in the presentation of loss information for our property and
surety segments at the segment level, while information for our casualty segment has been separated in four groupings: primary
occurrence, excess occurrence, claims made and transportation. Primary occurrence includes select lines within the professional
services product along with general liability, small commercial and other casualty products. Excess occurrence encompasses
commercial excess and personal umbrella, while claims made includes select lines within the professional services product and
medical professional liability and executive products. Reported claim counts represent claim events on a specified policy rather
than individual claimants and includes claims that did not or are not expected to result in an incurred loss. The information about
incurred and paid claims development for the years ended December 31, 2009 to 2017 is presented as unaudited required
supplementary information.
Casualty - Primary Occurrence
(in thousands, except number of claims)
2009*
85,476 $ 119,957 $
2010*
$
87,875
Incurred Losses and Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
2011*
99,765 $
96,582
91,139
2012*
91,441 $
93,589
98,428
91,807
2013*
86,888 $
88,820
94,145
78,406
80,823
2014*
82,651 $
85,034
89,622
65,893
67,297
88,092
2015*
81,138 $
80,289
86,342
61,072
62,882
79,497
94,835
2016*
80,518 $
78,685
83,181
59,028
60,329
71,592
84,975
101,950
As of December 31, 2018
Cumulative
Number of
Reported
Claims
Total IBNR
2,202
2,392
3,180
3,502
6,538
12,492
21,351
38,505
64,662
109,482
5,713
6,117
5,851
5,163
4,287
4,242
4,311
4,148
4,119
3,773
2017*
80,350 $
78,991
82,193
59,488
60,162
67,237
83,579
96,753
119,741
2018
81,445 $
80,216
82,248
60,328
59,556
66,389
78,675
90,611
111,391
141,513
$ 852,372
Cumulative Paid Loss and Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Total
2009*
2010*
$
1,972 $
9,233 $
2,587
2011*
24,115 $
13,025
5,924
2012*
43,702 $
29,312
17,124
5,897
* Presented as unaudited required supplementary information.
2017*
2013*
58,460 $
44,051
32,978
14,539
6,334
2014*
65,913 $
55,992
48,822
23,889
13,021
11,436
2015*
70,220 $
61,929
60,769
33,822
22,366
18,771
10,157
2016*
74,920 $
66,399
67,358
43,276
34,786
29,545
19,902
10,142
2018
77,175
73,318
74,814
51,611
45,753
47,343
45,056
35,764
25,933
15,066
Total $ 491,833
11,911
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance $ 372,450
75,948 $
69,514
71,413
47,970
40,609
40,270
33,020
24,186
13,154
Years
1
9.7 %
2
12.4 %
3
16.8 %
4
18.6 %
5
13.9 %
6
7
8
9
10
8.2 %
5.5 %
4.6 %
3.0 %
1.5 %
Average Annual Percentage Payout of Incurred Losses by Age, Net of Reinsurance
91
AY
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
AY
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
AY
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
AY
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Casualty - Excess Occurrence
(in thousands, except number of claims)
Incurred Losses and Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
2009*
30,267 $
$
2010*
19,719 $
29,314
2011*
14,981 $
24,244
26,272
2012*
12,893 $
22,111
17,148
29,042
2013*
12,966 $
18,932
17,443
21,558
39,984
2014*
12,459 $
20,044
18,641
21,021
34,824
50,889
2015*
12,601 $
22,044
19,160
21,885
26,857
39,095
53,672
2016*
11,982 $
21,018
20,959
21,231
25,425
35,119
50,857
56,341
Cumulative Paid Loss and Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
2009*
2010*
2011*
2012*
$
956 $
3,947 $
7
6,585 $
6,002
2,169
9,460 $
10,705
5,145
1,315
As of December 31, 2018
2017*
2018
Total IBNR
Cumulative
Number of
Reported
Claims
12,055 $ 12,072 $
20,530
21,295
22,433
25,599
32,274
47,392
49,385
62,863
20,527
22,032
23,020
24,922
33,372
42,840
37,676
55,868
69,362
$ 341,691
Total
285
369
824
1,386
3,488
8,832
14,320
25,675
43,891
63,524
567
500
581
855
933
875
669
572
473
258
2017*
2018
2013*
11,001 $
13,282
6,981
3,573
1,060
2014*
10,808 $
15,512
8,793
8,843
5,701
1,899
2015*
11,776 $
17,302
10,772
15,380
10,967
4,006
2,048
2016*
11,780 $
19,175
16,494
16,879
14,545
11,002
10,127
1,068
11,786 $ 11,787
19,308
19,256
20,214
17,769
19,310
17,747
17,956
16,967
22,541
18,852
23,184
19,571
7,441
3,396
5,679
17
2,506
Total $ 149,926
17,918
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance $ 209,683
* Presented as unaudited required supplementary information.
Years
1
4.5 %
2
15.3 %
3
18.9 %
4
17.0 %
5
10.0 %
6
7
8
9
10
8.2 %
7.4 %
3.8 %
0.2 %
0.0 %
Average Annual Percentage Payout of Incurred Losses by Age, Net of Reinsurance
Casualty - Claims Made
(in thousands, except number of claims)
Incurred Losses and Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
As of December 31, 2018
2017*
2018
Total IBNR
Cumulative
Number of
Reported
Claims
11,827 $ 16,056 $
9,024
7,852
17,612
38,473
55,350
42,206
67,760
60,572
8,735
11,506
17,569
37,959
51,554
39,906
69,493
62,450
66,128
$ 381,356
398
219
640
1,251
3,751
7,271
10,559
23,817
35,365
50,820
383
502
682
803
1,042
1,304
1,335
1,500
1,627
1,272
2009*
12,918 $
$
2010*
13,703 $
13,690
2011*
9,687 $
15,556
17,416
2012*
13,562 $
9,776
17,454
27,576
2013*
11,710 $
10,429
12,260
26,144
40,095
2014*
13,117 $
11,689
10,619
20,727
41,488
53,929
2015*
12,810 $
10,581
8,510
19,590
44,054
55,386
55,006
2016*
12,053 $
9,175
7,720
18,022
40,288
58,152
47,831
59,992
Cumulative Paid Loss and Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Total
2009*
2010*
2011*
2012*
2013*
$
113 $
442 $
259
773 $
1,548
330
3,413 $
2,308
1,949
433
2017*
2018
2014*
10,678 $
5,733
5,947
6,898
7,073
1,705
2015*
11,217 $
5,749
5,637
9,218
18,425
9,775
2,215
2016*
11,398 $
6,956
6,209
10,968
26,121
27,923
10,738
2,060
5,176 $
3,626
4,508
4,086
792
11,475 $ 11,955
8,512
8,485
7,132
6,835
15,621
14,378
32,789
29,678
40,080
35,755
20,920
16,774
27,465
14,558
11,350
2,455
1,964
Total $ 177,788
933
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance $ 204,501
* Presented as unaudited required supplementary information.
Years
1
3.0 %
2
15.3 %
3
18.5 %
4
14.7 %
5
10.0 %
6
13.4 %
7
8
9
10
7.4 %
7.1 %
0.4 %
3.0 %
Average Annual Percentage Payout of Incurred Losses by Age, Net of Reinsurance
92
AY
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
AY
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
AY
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
AY
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Casualty - Transportation
(in thousands, except number of claims)
Incurred Losses and Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
2009*
26,349 $
$
2010*
23,366 $
27,239
2011*
23,174 $
23,390
22,957
2012*
22,929 $
24,912
23,479
21,452
2013*
22,613 $
25,593
25,747
22,203
32,742
2014*
22,340 $
23,981
25,272
22,924
32,853
38,361
2015*
21,958 $
23,625
25,431
23,511
32,989
33,015
38,561
2016*
21,969 $
23,701
25,376
23,689
37,673
36,452
46,258
50,430
Cumulative Paid Loss and Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
2009*
2010*
$
5,035 $
8,698 $
6,296
2011*
14,613 $
10,116
5,295
2012*
19,933 $
15,475
9,485
4,466
As of December 31, 2018
2017*
2018
Total IBNR
Cumulative
Number of
Reported
Claims
21,926 $ 21,911 $
23,786
25,167
23,620
38,811
38,590
47,021
53,519
55,640
23,776
25,614
23,305
39,974
40,202
46,395
54,105
53,641
57,597
$ 386,520
Total
19
44
52
76
350
911
3,824
7,632
16,406
16,690
2,644
2,843
2,469
2,284
2,852
3,099
3,179
3,920
3,597
3,154
2017*
2018
2013*
21,100 $
20,045
14,477
8,533
5,306
2014*
21,325 $
21,792
19,443
12,394
11,978
7,125
2015*
21,640 $
23,063
22,375
17,318
19,761
13,933
6,984
2016*
21,650 $
23,488
23,537
20,931
28,220
19,676
20,709
8,923
21,650 $ 21,650
23,556
23,533
24,377
23,941
22,730
22,566
35,923
33,480
33,190
27,457
37,222
29,554
30,354
18,354
17,070
7,979
6,980
Total $ 253,052
90
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance $ 133,558
* Presented as unaudited required supplementary information.
Years
1
17.9 %
2
18.2 %
3
20.1 %
4
20.2 %
5
11.2 %
6
7
8
9
10
4.8 %
1.4 %
0.6 %
0.0 %
0.0 %
Average Annual Percentage Payout of Incurred Losses by Age, Net of Reinsurance
Property
(in thousands, except number of claims)
Incurred Losses and Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
As of December 31, 2018
Cumulative
Number of
Reported
Claims
Total IBNR
13
29
142
167
273
315
680
2,093
9,346
23,235
2,630
2,851
3,028
2,640
2,995
4,560
4,076
3,369
2,873
2,030
2018
2017*
49,323 $ 48,925 $
52,952
62,456
78,125
61,914
48,761
53,958
55,594
90,803
52,903
62,875
78,161
61,834
49,217
52,720
55,384
83,273
89,091
$ 634,383
2009*
59,975 $
$
2010*
55,821 $
63,194
2011*
52,286 $
59,145
70,246
2012*
49,534 $
55,427
66,924
85,485
2013*
48,969 $
53,937
64,976
80,155
63,864
2014*
48,857 $
54,153
63,724
79,181
62,090
56,587
2015*
48,707 $
52,927
62,770
77,569
62,173
49,441
59,863
2016*
49,267 $
52,964
62,570
79,175
62,114
48,801
56,103
62,900
2009*
25,464 $
$
2010*
40,775 $
25,274
2011*
43,758 $
43,091
27,676
2012*
46,004 $
47,743
48,756
39,074
Cumulative Paid Loss and Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Total
2018
2013*
48,031 $
50,055
55,778
66,509
32,208
2014*
48,297 $
52,729
59,099
72,057
50,840
30,550
2015*
48,329 $
52,426
60,272
73,705
57,407
43,380
32,184
2017*
49,173 $ 48,898
52,855
52,851
62,729
61,834
77,159
76,152
61,195
60,520
47,799
46,528
51,290
50,197
51,371
46,921
66,818
41,314
37,048
Total $ 557,162
17
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance $ 77,238
2016*
49,051 $
52,719
61,428
75,640
59,259
46,148
49,348
33,134
* Presented as unaudited required supplementary information.
Years
1
52.0 %
2
30.9 %
3
4
5
6
7
8
9
10
7.4 %
3.2 %
3.0 %
0.7 %
0.6 %
1.0 %
0.1 %
-0.6%
Average Annual Percentage Payout of Incurred Losses by Age, Net of Reinsurance
93
Surety
(in thousands, except number of claims)
Incurred Losses and Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
2009*
15,474 $
$
2010*
2011*
2012*
2013*
4,896 $
13,961
4,708 $
8,205
13,842
4,246 $
6,630
17,832
17,114
4,146 $
7,076
17,792
11,452
16,080
2014*
4,551 $
6,810
17,321
8,667
7,516
16,450
2015*
4,288 $
7,136
16,766
8,180
6,170
8,106
16,958
2016*
4,923 $
7,645
16,695
7,867
5,399
5,225
12,957
18,928
As of December 31, 2018
Cumulative
Number of
Reported
Claims
Total IBNR
2
14
13
22
50
88
824
1,543
3,630
14,535
1,665
1,540
1,674
1,469
1,400
1,337
1,201
1,307
1,409
654
2017*
4,860 $
6,244
16,480
7,471
5,271
4,427
11,113
11,062
16,127
2018
4,935 $
6,580
18,281
7,099
5,231
4,267
10,456
9,351
8,641
16,765
$ 91,606
AY
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
AY
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2009*
2010*
2011*
$
892 $
1,914 $
1,724
2,382 $
3,205
8,160
Cumulative Paid Loss and Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Total
2012*
2,493 $
5,702
16,932
1,883
2017*
2015*
2013*
3,490 $
7,092
17,151
6,680
1,116
3,919 $
7,285
17,212
7,416
4,701
4,283
3,192
2014*
4,336 $
7,151
17,403
6,726
2,856
722
2018
4,933
6,637
17,013
7,065
5,150
4,131
9,436
6,299
2,862
1,835
Total $ 65,361
1,992
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance $ 28,237
2016*
3,908 $
7,822
17,086
7,536
4,911
4,166
6,719
3,087
4,849 $
6,663
17,086
7,406
5,098
4,059
7,695
5,817
979
* Presented as unaudited required supplementary information.
Years
1
24.0 %
2
40.0 %
3
12.0 %
4
5
6
7
8
9
10
7.5 %
4.5 %
3.5 %
-1.3%
-6.1%
9.3 %
1.7 %
Average Annual Percentage Payout of Incurred Losses by Age, Net of Reinsurance
94
The following is a reconciliation of the net incurred and paid loss development tables to the liability for unpaid losses and
settlement expenses in the consolidated balance sheet:
Reconciliation of the Disclosure of Incurred and Paid Loss Development to the Liability for Unpaid Losses and
Settlement Expenses
(in thousands)
Net outstanding liabilities:
December 31, 2018
December 31, 2017
Casualty - Primary Occurrence
Casualty - Excess Occurrence
Casualty - Claims Made
Casualty - Transportation
Property
Surety
Unallocated loss adjustment expenses
Allowance for uncollectible reinsurance balances recoverable on unpaid losses and
settlement expenses
Other
$
Liabilities for unpaid loss and settlement expenses, net of reinsurance
$
Reinsurance recoverable on unpaid claims:
Casualty - Primary Occurrence
Casualty - Excess Occurrence
Casualty - Claims Made
Casualty - Transportation
Property
Surety
Allowance for uncollectible reinsurance balances recoverable on unpaid losses and
settlement expenses
Other
$
Total reinsurance balances recoverable on unpaid losses and settlement expenses
$
372,450 $
209,683
204,501
133,558
77,238
28,237
50,891
9,793
9,998
1,096,349 $
34,742 $
81,072
144,921
50,748
50,495
11,834
(9,793)
980
364,999 $
325,182
188,963
171,241
119,704
68,867
23,375
48,844
10,014
13,322
969,512
36,158
74,400
117,436
46,590
28,613
7,079
(10,014)
1,729
301,991
Total gross liability for unpaid loss and settlement expenses
$
1,461,348 $
1,271,503
DETERMINATION OF IBNR
Initial carried IBNR reserves are determined through a reserve estimation process. For most casualty and surety products,
this process involves the use of an initial loss and allocated loss adjustment expense (ALAE) ratio that is applied to the earned
premium for a given period. Payments and case reserves are subtracted from this initial estimate of ultimate loss and ALAE to
determine a carried IBNR reserve. For most property products, the IBNR reserves are determined by IBNR percentages applied
to premium earned. The percentages are determined based on historical reporting patterns and are updated periodically. No
deductions for paid or case reserves are made. Shortly after natural or man-made catastrophes, we review insured locations
exposed to the event and model losses based on our own exposures and industry loss estimates of the event. We also consider
our knowledge of frequency and severity from early claim reports to determine an appropriate reserve for the catastrophe.
Adjustments to the initial loss ratio by product and segment are made where necessary and reflect updated assumptions
regarding loss experience, loss trends, price changes and prevailing risk factors.
Actuaries perform a ground-up reserve study of the expected value of the unpaid loss and LAE derived using multiple
standard actuarial methodologies on a quarterly basis. Each method produces an estimate of ultimate loss by accident year. We
review all of these various estimates and assign weights to each based on the characteristics of the product being reviewed.
These estimates are then compared to the carried loss reserves to determine the appropriateness of the current reserve balance.
In addition, an emergence analysis is completed quarterly to determine if further adjustments are necessary.
Upon completion of our loss and LAE estimation analysis, a review of the resulting variance between the indicated
reserves and the carried reserves takes place. Our actuaries make a recommendation to management in regards to booked
reserves that reflect their analytical assessment and view of estimation risk. After discussion of these analyses and all relevant
risk factors, the Loss Reserve Committee, a panel of management including the lead reserving actuary, chief executive officer,
chief operating officer, chief financial officer and other executives, confirms the appropriateness of the reserve balances.
95
DEVELOPMENT OF IBNR RESERVES
The following table summarizes our prior accident years’ loss reserve development by segment for 2018, 2017 and 2016:
(FAVORABLE)/UNFAVORABLE RESERVE DEVELOPMENT BY SEGMENT
(in thousands)
Casualty
Property
Surety
Total
2016
2018
2017
$ (33,252) $ (17,462) $ (32,401)
(4,793)
(12,134)
(4,800)
(9,272)
$ (49,950) $ (38,868) $ (41,994)
(10,813)
(5,885)
A discussion of significant components of reserve development for the three most recent calendar years follows:
2018. We experienced favorable emergence relative to prior years’ reserve estimates in all of our segments during 2018.
Development from the casualty segment totaled $33.3 million, inclusive of unallocated loss and adjustment expenses (ULAE). The
largest amounts of favorable development came from accident years 2015 through 2017. We continued to experience emergence
that was generally better than previously estimated. We attribute the favorable emergence to loss trends in most lines outperforming
our long-term expectations. Further, we believe our underwriters’ risk selection contributed to the Company experiencing less loss
cost inflation than originally anticipated. The primary occurrence grouping had favorable development of $15.6 million, driven by
our general liability product with $6.7 million of favorable development. The excess occurrence grouping had favorable
development of $21.4 million, with commercial insureds contributing $10.8 million and personal insureds contributing the
remainder. Claims made exposures had adverse development of $3.9 million driven by medical errors and omissions coverages.
Transportation had $0.5 million of favorable development.
Our marine product was the predominant driver of the favorable development in the property segment, accounting for $5.0
million of the $10.8 million total favorable development for the segment, inclusive of ULAE. Accident years 2015 through 2017
made the largest contribution. Our excess and surplus lines commercial property product and assumed reinsurance products also
contributed $2.0 million and $2.8 million of favorable development, respectively.
The surety segment experienced $5.9 million of favorable development, inclusive of ULAE. The majority of the favorable
development came from the 2017 accident year, which served to offset the unfavorable development from accident years 2011 and
2016. Commercial and energy surety contributed favorable development of $4.6 million and $1.7 million, respectively.
Miscellaneous surety experienced adverse development totaling $0.8 million.
2017. We experienced favorable emergence relative to prior years’ reserve estimates in all of our segments during 2017.
The casualty segment contributed $17.5 million in favorable development, inclusive of ULAE. Accident years 2014, 2015 and
2016 contributed significantly to the favorable development. This was predominantly caused by favorable frequency and severity
trends that continued to be better than our long-term expectations. In addition, we believe this to be the result of our underwriters’
risk selection, which has mostly offset price declines and loss cost inflation. Nearly all of our casualty products contributed to the
favorable development. Within the primary occurrence grouping, the general liability product contributed $4.6 million to our
favorable development with all coverages contributing to the favorable development in 2017. Small commercial products were the
second largest contributor with $3.2 million in favorable development. Within the excess occurrence grouping, personal umbrella
and commercial excess were favorable by $1.1 million and $9.9 million, respectively. Within the claims made grouping, our
executive products had favorable contributions of $4.4 million, while medical professional liability was adverse $3.7 million.
Transportation was adverse $7.4 million for the year, but posted favorable experience during the last three quarters of the year.
The marine product was the primary driver of the favorable development in the property segment. Marine contributed $6.8
million of the $12.1 million total favorable property development, inclusive of ULAE. Accident years 2015 and 2016 contributed
to the marine products’ favorable development. Commercial property was favorable $3.2 million.
The surety segment experienced favorable development of $9.3 million, inclusive of ULAE. The majority of the favorable
development was from accident year 2016. Contract and commercial surety products were the main contributors with favorable
development of $4.4 million and $3.5 million, respectively. Energy surety had favorable development of $1.5 million and
miscellaneous surety had unfavorable development of $0.1 million.
96
2016. We experienced favorable emergence relative to prior years’ reserve estimates in all of our segments during 2016.
The casualty segment contributed $32.4 million in favorable development, inclusive of ULAE, which is excluded from the
incurred loss and loss adjustment expense tables above. Accident year 2015 contributed significantly to the favorable development,
with accident years 2010 to 2014 also continuing to develop favorably. The favorable development in 2016 was smaller than 2015
but continued to reflect favorable frequency and severity trends. In addition, the risk selection by our underwriters continued to
provide better results than estimated in our reserving process. Within the primary occurrence grouping, the general liability
product contributed $17.6 million to our favorable development. Small commercial products were favorable by $6.2 million.
Within the excess occurrence grouping, commercial excess was favorable by $13.8 million which was offset by adverse
development in our personal umbrella product of $4.9 million. Within the claims made grouping, executive products contributed
$14.7 million in favorable development and miscellaneous professional liability had $0.8 million of favorable development.
Transportation experienced unfavorable development of $15.4 million as adverse commercial loss trends resulted in an increase in
case reserves for accident years 2013 through 2015.
Marine contributed $2.1 million of the $4.8 million total favorable property development, inclusive of ULAE. Accident
years 2013 through 2015 contributed to the marine products’ favorable development. Assumed property contributed $2.5 million
of favorable development offsetting the unfavorable development of $0.2 million in other direct property products.
The surety segment experienced favorable development of $4.8 million, inclusive of ULAE. The majority of the favorable
development was from accident year 2015, which offset the unfavorable development from accident years 2008 through 2011 and
2014. Commercial and energy surety products were the main contributors with favorable development of $1.7 million and $1.9
million, respectively. Miscellaneous surety had favorable development of $1.1 million and contract surety had favorable
development of $0.1 million.
ENVIRONMENTAL, ASBESTOS AND MASS TORT EXPOSURES
We are subject to environmental site cleanup, asbestos removal and mass tort claims and exposures through our commercial
excess, general liability and discontinued assumed casualty reinsurance lines of business. The majority of the exposure is in the
excess layers of our commercial excess and assumed reinsurance books of business.
The following table represents paid and unpaid environmental, asbestos and mass tort claims data (including incurred but not
reported losses) as of December 31, 2018, 2017 and 2016:
(in thousands)
Loss and LAE Payments (Cumulative):
Gross
Ceded
Net
Unpaid Losses and LAE at End of Year:
Gross
Ceded
Net
2018
2017
2016
$ 136,043 $ 132,883 $ 130,358
(66,644)
(67,507)
$ 67,405 $ 65,376 $ 63,714
(68,638)
$ 24,262 $ 28,042 $ 28,815
(4,987)
$ 18,889 $ 22,327 $ 23,828
(5,373)
(5,715)
Our environmental, asbestos and mass tort exposure is limited, relative to other insurers, as a result of entering the affected
liability lines after the insurance industry had already recognized environmental and asbestos exposure as a problem and adopted
appropriate coverage exclusions. The majority of our reserves are associated with products that went into runoff at least two
decades ago. Some are for assumed reinsurance, some are for excess liability business and some followed from the acquisition of
Underwriters Indemnity Company in 1999.
During 2018, inception to date incurred environmental, asbestos and mass tort losses decreased slightly.
While our environmental exposure is limited, the ultimate liability for this exposure is difficult to assess because of the
extensive and complicated litigation involved in the settlement of claims and evolving legislation on issues such as joint and
several liability, retroactive liability and standards of cleanup. Additionally, we participate primarily in the excess layers of
coverage, where accurate estimates of ultimate loss are more difficult to derive than for primary coverage.
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7. INCOME TAXES
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax
liabilities are summarized as follows:
(in thousands)
Deferred tax assets:
Tax discounting of unpaid losses and settlement expenses
Unearned premium offset
Deferred compensation
Stock option expense
Other
Deferred tax assets before allowance
Less valuation allowance
Total deferred tax assets
Deferred tax liabilities:
2018
2017
17,864
2,700
2,702
616
$ 18,327 $ 20,020
16,528
1,435
2,283
578
$ 42,209 $ 40,844
—
$ 42,209 $ 40,844
—
Net unrealized appreciation of securities
Deferred policy acquisition costs
Discounting of unpaid losses and settlement expenses - TCJA
implementation offset
Book/tax depreciation
Intangible assets
Undistributed earnings of unconsolidated investees
Other
Total deferred tax liabilities
Net deferred tax liability
$ 22,177 $ 51,448
16,320
17,836
5,203
3,133
1,711
15,811
576
9,466
3,159
584
13,431
204
$ 66,447 $ 94,612
$ (24,238) $ (53,768)
Income tax expense (benefit) attributable to income from operations for the years ended December 31, 2018, 2017 and
2016, differed from the amounts computed by applying the U.S. federal tax rate of 21 percent, 35 percent and 35 percent,
respectively, to pretax income from continuing operations as demonstrated in the following table:
(in thousands)
Provision for income taxes at the statutory federal tax rates
Increase (reduction) in taxes resulting from:
2018
2017
2016
$ 14,192 21.0 % $ 29,606
35.0 % $ 54,979 35.0 %
Enactment of Tax Cuts and Jobs Act (TCJA)
Excess tax benefit on share-based compensation
Dividends received deduction
ESOP dividends paid deduction
Tax-exempt interest income
Unconsolidated investee dividends
Other items, net
—
—
(2,268) (3.4)%
(4,533) (6.7)%
(775) (1.1)%
(1,184) (1.8)%
(1,795) (2.7)%
— %
(235) (0.3)%
— %
(32,821) (38.8)%
— %
(6.9)%
(5,798)
(2,216) (1.4) %
(2.4)%
(2,025)
(3,302) (2.1) %
(3.4)%
(2,905)
(4,263) (2.7) %
(5.5)%
(4,671)
(2,772) (1.8) %
(1.6)%
(1,351)
(264) (0.2) %
(0.6)%
(474)
5.0 % $ (20,439) (24.2)% $ 42,162 26.8 %
—
Total
$ 3,402
Our effective tax rates were 5.0 percent, -24.2 percent and 26.8 percent for 2018, 2017 and 2016, respectively. Effective
rates are dependent upon components of pretax earnings and the related tax effects. While the effective rate was low in 2018, it
was significantly lower in 2017 as a result of the impact of tax reform. Major factors contributing to the low rate in 2018 are
the inclusion of unrealized losses from equity securities in pretax earnings in 2018, a reduced federal tax rate and adjustments
to provisional deferred tax amounts recorded in 2017.
Among other provisions, the TCJA lowered the federal corporate tax rate from 35 percent to 21 percent effective January
1, 2018. Our deferred tax items were revalued as of year-end 2017 to reflect the lower rate, which reduced our net deferred tax
liability and income tax expense by $32.8 million and decreased the effective tax rate by 38.8 percent.
Except for two aspects, the accounting for the tax effects of the enactment of the TCJA were completed as of December
31, 2017. The first provisional item recorded in 2017 was related to an expected disallowance of deductions for certain
performance based compensation, including bonuses and stock options. At the time of enactment, there was a lack of clarity on
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whether some amounts could be grandfathered in as deductible. The Internal Revenue Service (IRS) and Treasury Department
provided additional guidance and we were able to finalize the accounting in 2018 by recording a $2.3 million deferred tax
benefit to restore the deferred tax assets related to those performance based compensation amounts. The second provisional
item related to discount factors on loss reserves that the IRS had not yet published. The IRS published the factors in the fourth
quarter of 2018 and we were able to complete the accounting for the effects of the enactment of the TCJA. While there was no
net impact to the deferred tax amount that was recorded at December 31, 2017, we implemented the new discounting
methodology and will recognize the adjustment ratably over the allowed eight-year period beginning in 2018.
New accounting guidance required the excess tax benefit on share-based compensation to flow through income tax
expense beginning in 2017. Prior to the adoption, excess tax benefits on share-based compensation were recorded directly to
shareholders’ equity and had no impact on the effective tax rate. Due to the new accounting method, we recognized a $4.5
million and $5.8 million tax benefit in 2018 and 2017, respectively, which decreased the effective tax rate by 6.7 percent and
6.9 percent, respectively.
Our net earnings include equity in earnings of unconsolidated investees, Maui Jim and Prime. The investees do not have a
policy or pattern of paying dividends. As a result, we record a deferred tax liability on the earnings at the recently revised
corporate capital gains rate of 21 percent in anticipation of recovering our investments through means other than through the
receipt of dividends, such as a sale. In the fourth quarter of 2017, Maui Jim gave notification that a $9.9 million dividend would be
paid in January 2018. Even though no dividend was received in 2017, we were aware that the lower tax rate applicable to affiliated
dividends (7.4 percent in 2018) would be applied when the dividend was paid in 2018 and we therefore recorded a $1.4 million tax
benefit in 2017. We received a $9.9 million dividend from Maui Jim in the fourth quarter of 2016 and recognized a $2.8 million
tax benefit from applying the lower tax rate applicable to affiliated dividends (7.0 percent in 2016), as compared to the corporate
capital gains rate on which the deferred tax liabilities were based. Standing alone, the dividends resulted in a 1.6 percent and 1.8
percent reduction to the 2017 and 2016 effective tax rates, respectively. As no additional dividends were declared from
unconsolidated investees in 2018, there was no impact to the 2018 effective tax rate.
Dividends paid to our Employee Stock Ownership Plan (ESOP) also result in a tax deduction. Dividends paid to the ESOP
in 2018, 2017 and 2016 resulted in tax benefits of $1.2 million, $2.9 million and $3.3 million, respectively. These tax benefits
reduced the effective tax rate for 2018, 2017 and 2016 by 1.8 percent, 3.4 percent and 2.1 percent, respectively.
We have recorded our deferred tax assets and liabilities using the statutory federal tax rate of 21 percent. We believe it is
more likely than not that all deferred tax assets will be recovered, given the carry back availability as well as the results of future
operations, which will generate sufficient taxable income to realize the deferred tax asset. In addition, we believe when these
deferred items reverse in future years, our taxable income will be taxed at an effective rate of 21 percent.
Federal and state income taxes paid in 2018, 2017 and 2016, amounted to $16.4 million, $10.4 million and $26.9 million,
respectively.
Although we are not currently under audit by the IRS, tax years 2015 through 2018 remain open and are subject to
examination.
8. EMPLOYEE BENEFITS
EMPLOYEE STOCK OWNERSHIP, 401(K) AND INCENTIVE PLANS
We maintain ESOP, 401(k) and incentive plans covering executives, managers and associates. Funding of these plans is
primarily dependent upon reaching predetermined levels of operating return on equity, combined ratio and Market Value
Potential (MVP). MVP is a compensation model that measures components of comprehensive earnings against a minimum
required return on our capital. Bonuses are earned as we generate earnings in excess of this required return. While some
management incentive plans may be affected somewhat by other performance factors, the larger influence of corporate
performance ensures that the interests of our executives, managers and associates align with those of our shareholders.
Our 401(k) plan allows voluntary contributions by employees and permits ESOP diversification transfers for employees
meeting certain age and service requirements. We provide a basic 401(k) contribution of 3 percent of eligible compensation.
Participants are 100 percent vested in both voluntary and basic contributions. Additionally, an annual discretionary profit-
sharing contribution may be made to the ESOP and 401(k), subject to the achievement of certain overall financial goals and
board approval. Profit-sharing contributions vest after three years of plan service.
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Our ESOP and 401(k) cover all employees meeting eligibility requirements. ESOP and 401(k) profit-sharing contributions are
approved annually by our board of directors and are expensed in the year earned. ESOP and 401(k)-related expenses (basic and profit-
sharing) were $8.8 million, $12.5 million and $11.7 million, for 2018, 2017 and 2016, respectively.
During 2018, the ESOP purchased 98,717 shares of RLI Corp. stock on the open market at an average price of $62.80
($6.2 million) relating to the contribution for plan year 2017. Shares held by the ESOP as of December 31, 2018, totaled
2,985,390 and are treated as outstanding in computing our earnings per share. During 2017, the ESOP purchased 124,186 shares
of RLI Corp. stock on the open market at an average price of $58.02 ($7.2 million) relating to the contribution for plan year
2016. During 2016, the ESOP purchased 112,608 shares of RLI Corp. stock on the open market at an average price of $64.20
($7.2 million) relating to the contribution for plan year 2015. The above-mentioned ESOP purchases relate only to our annual
contributions to the plan and do not include amounts or shares resulting from the reinvestment of dividends.
Annual awards are provided to executives, managers and associates through our incentive plans, provided certain
financial and operational goals are met. Annual expenses for these incentive plans totaled $11.9 million, $19.7 million and
$19.2 million for 2018, 2017 and 2016, respectively.
DEFERRED COMPENSATION
We maintain rabbi trusts for deferred compensation plans for directors, key employees and executive officers through
which our shares are purchased. The employer stock in the plan is classified and accounted for as equity, in a manner
consistent with the accounting for treasury stock.
In 2018, the trusts purchased 7,049 shares of our common stock on the open market at an average price of $68.36 ($0.5
million). In 2017, the trusts purchased 7,464 shares of our common stock on the open market at an average price of $58.66
($0.4 million). In 2016, the trusts purchased 6,702 shares of our common stock on the open market at an average price of
$61.61 ($0.4 million). At December 31, 2018, the trusts’ assets were valued at $36.2 million.
STOCK PLANS
Our RLI Corp. Long-Term Incentive Plan (2010 LTIP) was in place from 2010 to 2015. The 2010 LTIP provided for
equity-based compensation, including stock options, up to a maximum of 4,000,000 shares of common stock (subject to
adjustment for changes in our capitalization and other events). Between 2010 and 2015, we granted 2,878,000 stock options
under the 2010 LTIP. The 2010 LTIP was replaced in 2015.
In 2015, our shareholders approved the 2015 RLI Corp. Long-Term Incentive Plan (2015 LTIP), which provides for equity-
based compensation and replaced the 2010 LTIP. In conjunction with the adoption of the 2015 LTIP, effective May 7, 2015,
options were no longer granted under the 2010 LTIP. Awards under the 2015 LTIP may be in the form of restricted stock, stock
options (non-qualified only), stock appreciation rights, performance units as well as other stock-based awards. Eligibility under the
2015 LTIP is limited to employees and directors of the company or any affiliate. The granting of awards under the 2015 LTIP is
solely at the discretion of the board of directors. The maximum number of shares of common stock available for distribution under
the 2015 LTIP is 4,000,000 shares (subject to adjustment for changes in our capitalization and other events). Since the plan’s
approval in 2015, we have granted 1,903,630 awards under the 2015 LTIP, including 455,055 in 2018.
Stock Options
Under the 2015 LTIP, as under the 2010 LTIP, we grant stock options for shares with an exercise price equal to the fair
market value of the shares at the date of grant (subject to adjustments for changes in our capitalization, including special
dividends and other events as set forth in such plans). Options generally vest and become exercisable ratably over a five-year
period and expire eight years after grant.
For most participants, the requisite service period and vesting period will be the same. For participants who are retirement
eligible, defined by the plan as those individuals whose age and years of service equals 75, the requisite service period is deemed
to be met and options are immediately expensed on the date of grant. For participants who will become retirement eligible during
the vesting period, the requisite service period over which expense is recognized is the period between the grant date and the
attainment of retirement eligibility. Shares issued upon option exercise are newly issued shares.
Shares issued may be less than the number of shares actually exercised, as our plan allows net settlement to cover the
option exercise price and taxes due upon option exercise. When options are exercised via net settlement, amounts withheld for
100
taxes result in a decrease to shareholders’ equity and the degree of the impact is dependent on the level of intrinsic value (i.e.
market value in excess of exercise price). During 2016, the number of option exercises facilitated via net settlement and the
level of intrinsic value on those exercises resulted in a decrease to paid-in-capital, as the reduction from tax withholdings
exceeded the impact of other share-based compensation activity. This was not the case in 2018 and 2017, and the impacts of
share-based compensation increased paid-in-capital. Refer to our consolidated statements of shareholders’ equity to see the
impact share-based compensation had on shareholders’ equity. Prior to the adoption of FASB ASU 2016-09 in 2017,
shareholders’ equity was also impacted by corporate tax deductions allowed as a result of option exercises. This tax benefit
offset our current tax liability and was recorded as an increase to paid-in-capital. Beginning in 2017, all tax effects related to
share-based payments were required to be recorded in net earnings and directly impact our effective tax rate. See note 7 for the
impact in 2018 and 2017. For 2016, refer to our consolidated statements of shareholders’ equity for the impact to paid-in
capital from this tax benefit.
The following tables summarize option activity in 2018, 2017 and 2016:
Outstanding options at January 1, 2018
Options granted
Options exercised
Options canceled/forfeited
Outstanding options at December 31, 2018
Exercisable options at December 31, 2018
Outstanding options at January 1, 2017
Options granted
Options exercised
Options canceled/forfeited
Outstanding options at December 31, 2017
Exercisable options at December 31, 2017
Number of
Options
Weighted
Average
Exercise
Weighted
Average
Remaining
Contractual
Outstanding
Price
Life
Aggregate
Intrinsic
Value
(in 000’s)
2,257,015 $ 46.80
432,000 $ 64.91
(705,785) $ 36.81
(18,350) $ 60.84
1,964,880 $ 54.24
724,730 $ 46.62
$ 24,304
5.25 $ 29,317
3.79 $ 16,212
Number of
Options
Weighted
Average
Exercise
Weighted
Average
Remaining
Contractual
Outstanding
Price
Life
Aggregate
Intrinsic
Value
(in 000’s)
2,207,110 $ 40.90
482,375 $ 57.12
(390,870) $ 26.07
(41,600) $ 48.30
2,257,015 $ 46.80
975,055 $ 38.66
$ 12,779
4.88 $ 32,620
3.25 $ 21,780
Number of
Options
Outstanding
Weighted
Average
Exercise
Weighted
Average
Remaining
Contractual
Price
Life
Aggregate
Intrinsic
Value
(in 000’s)
Outstanding options at January 1, 2016
Options granted
Options exercised
Options canceled/forfeited
Outstanding options at December 31, 2016
Exercisable options at December 31, 2016
2,582,220 $ 32.42
440,750 $ 63.54
(756,380) $ 24.87
(59,480) $ 44.39
2,207,110 $ 40.90
862,605 $ 31.23
$ 31,328
4.93 $ 49,531
3.27 $ 27,523
The majority of our stock options are granted annually at our regular board meeting in May. In addition, options are
approved at the May meeting for quarterly grants to certain retirement eligible employees. Since stock option grants to
retirement eligible employees are fully expensed when granted, the approach allows for a more even expense distribution
throughout the year.
In 2018, 432,000 options were granted with an average exercise price of $64.91 and an average fair value of $10.58. Of these
grants, 330,750 were granted at the board meeting in May with a calculated fair value of $10.31. We recognized $4.5 million of
expense during 2018 related to options vesting. Since options granted under our plan are non-qualified, we recorded a deferred tax
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benefit of $0.9 million related to this compensation expense. Total unrecognized compensation expense relating to outstanding
and unvested options was $5.6 million, which will be recognized over the remainder of the vesting period.
In 2017, 482,375 options were granted with an average exercise price of $57.12 and an average fair value of $8.00. Of these
grants, 384,750 were granted at the board meeting in May with a calculated fair value of $7.91. We recognized $4.4 million of
expense during 2017 related to options vesting. Since options granted under our plan are non-qualified, we recorded a deferred tax
benefit of $1.5 million related to this compensation expense. Total unrecognized compensation expense relating to outstanding
and unvested options was $5.7 million, which will be recognized over the remainder of the vesting period.
In 2016, 440,750 options were granted with an average exercise price of $63.54 and an average fair value of $11.38. Of
these grants, 345,750 were granted at the board meeting in May with a calculated fair value of $11.42. We recognized $4.1 million
of expense during 2016 related to options vesting. Since options granted under our plan are non-qualified, we recorded a deferred tax
benefit of $1.4 million related to this compensation expense. Total unrecognized compensation expense relating to outstanding
and unvested options was $6.2 million, which will be recognized over the remainder of the vesting period.
The fair value of options were estimated using a Black-Scholes based option pricing model with the following weighted-
average grant-date assumptions and weighted-average fair values as of December 31:
Weighted-average fair value of grants
Risk-free interest rates
Dividend yield
Expected volatility
Expected option life
2018
$ 10.58
2017
$ 8.00
2016
$ 11.38
2.72 %
2.98 %
22.87 %
1.90 %
3.60 %
22.95 %
1.21 %
1.61 %
23.06 %
5.07 years
5.05 years
5.04 years
The risk-free rate was determined based on U.S. treasury yields that most closely approximated the option’s expected life.
The dividend yield for 2018 and 2017 was determined based on the average annualized quarterly dividends paid during the
most recent five-year period and incorporated a consideration for special dividends paid in recent history. The dividend yield in
2016 was calculated based on the average annualized dividends paid during the most recent five-year period, exclusive of
consideration for special dividends. The expected volatility was calculated based on the median of the rolling volatilities for the
expected life of the options. The expected option life was determined based on historical exercise behavior and the assumption
that all outstanding options will be exercised at the midpoint of the current date and remaining contractual term, adjusted for
the demographics of the current year’s grant.
Restricted Stock Units
In addition to stock options, restricted stock units (RSUs) are granted with a value equal to the closing stock price of the
Company’s stock on the dates the shares are granted. Generally, these units have a three-year cliff vesting. When participants
terminate employment with the Company after having met the definition of retirement under the 2015 LTIP, defined as those
individuals whose age and years of service equals 75, the RSUs will become fully vested. In addition, RSUs have dividend
participation which accrue as additional units and are settled with granted stock units at the end of the vesting period.
As of December 31, 2018, 30,075 RSUs have been granted to employees under the 2015 LTIP, including 14,625 during
2018. Due to dividend participation on RSUs, which accrue as additional units, 30,567 employee RSUs were outstanding as of
December 31, 2018. We recognized $0.6 million and $0.4 million of expense on these units during 2018 and 2017, respectively.
Total unrecognized compensation expense relating to outstanding and unvested employee RSUs was $0.7 million, which will be
recognized over the remainder of the vesting period.
In 2018, each outside director received RSUs with a fair market value of $50,000 on the date of grant as part of annual
director compensation. Director RSUs vest one year from the date of grant. As of December 31, 2018, 8,430 restricted stock units
were granted to directors under the 2015 LTIP. Due to dividend participation on RSUs, which accrue as additional units, 8,629
director RSUs were outstanding as of December 31, 2018. We recognized $0.3 million of compensation expense on these units
during 2018. Total unrecognized compensation expense relating to outstanding and unvested director RSUs was $0.2 million,
which will be recognized over the remainder of the vesting period.
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9. STATUTORY INFORMATION AND DIVIDEND RESTRICTIONS
The statutory financial statements of our three insurance companies are presented on the basis of accounting practices
prescribed or permitted by the Illinois Department of Insurance (IDOI), which has adopted the NAIC statutory accounting
principles as the basis of its statutory accounting principles. We do not use any permitted statutory accounting principles that
differ from NAIC prescribed statutory accounting principles. In converting from statutory to GAAP, typical adjustments
include deferral of policy acquisition costs, the inclusion of statutory non-admitted assets and the inclusion of net unrealized
holding gains or losses in shareholders’ equity relating to fixed income securities.
The NAIC has risk based capital (RBC) requirements for insurance companies to calculate and report information under a
risk-based formula, which measures statutory capital and surplus needs based upon a regulatory definition of risk relative to the
company’s balance sheet and mix of products. As of December 31, 2018, each of our insurance subsidiaries had an RBC
amount in excess of the authorized control level RBC, as defined by the NAIC. RLI Insurance Company (RLI Ins.), our
principal insurance company subsidiary, had an authorized control level RBC of $170.9 million, $157.7 million and $127.0
million as of December 31, 2018, 2017 and 2016, respectively, compared to actual statutory capital and surplus of $829.8
million, $864.6 million and $860.0 million, respectively, for these same periods.
Year-end statutory surplus for 2018 presented in the table below includes $132.8 million of RLI Corp. stock (cost basis of
$64.6 million) held by Mt. Hawley Insurance Company, compared to $106.9 million and $104.4 million in 2017 and 2016,
respectively. The Securities Valuation Office provides specific guidance for valuing this investment, which is eliminated in our
GAAP consolidated financial statements.
The following table includes selected information for our insurance subsidiaries for the year ending and as of
December 31:
(in thousands)
Consolidated net income, statutory basis
Consolidated surplus, statutory basis
2018
2017
$ 135,791 $ 72,889 $ 128,165
$ 829,775 $ 864,554 $ 859,976
2016
As discussed in note 1.A., our three insurance companies are subsidiaries of RLI Corp, with RLI Ins. as the first-level, or
principal, insurance subsidiary. At the holding company (RLI Corp.) level, we rely largely on dividends from our insurance
company subsidiaries to meet our obligations for paying principal and interest on outstanding debt, corporate expenses and
dividends to RLI Corp. shareholders. As discussed further below, dividend payments to RLI Corp. from our principal insurance
subsidiary are restricted by state insurance laws as to the amount that may be paid without prior approval of the insurance
regulatory authorities of Illinois. As a result, we may not be able to receive dividends from such subsidiary at times and in
amounts necessary to pay desired dividends to RLI Corp. shareholders. On a GAAP basis, as of December 31, 2018, our holding
company had $806.8 million in equity. This includes amounts related to the equity of our insurance subsidiaries, which is subject to
regulatory restrictions under state insurance laws. The unrestricted portion of holding company net assets is comprised primarily of
investments and cash, including $63.1 million in liquid assets, which more than covers our annual holding company
expenditures. Unrestricted funds at the holding company are available to fund debt interest, general corporate obligations and
regular dividend payments to our shareholders. If necessary, the holding company also has other potential sources of liquidity that
could provide for additional funding to meet corporate obligations or pay shareholder dividends, which include a revolving line of
credit, as well as access to capital markets.
Ordinary dividends, which may be paid by our principal insurance subsidiary without prior regulatory approval, are
subject to certain limitations based upon statutory income, surplus and earned surplus. The maximum ordinary dividend
distribution from our principal insurance subsidiary in a rolling 12-month period is limited by Illinois law to the greater of 10
percent of RLI Ins. policyholder surplus, as of December 31 of the preceding year, or the net income of RLI Ins. for the 12-
month period ending December 31 of the preceding year. Ordinary dividends are further restricted by the requirement that they
be paid from earned surplus. In 2018, 2017 and 2016, our principal insurance subsidiary paid ordinary dividends totaling $13.0
million, $107.0 million and $123.6 million, respectively, to RLI Corp. Any dividend distribution in excess of the ordinary
dividend limits is deemed extraordinary and requires prior approval from the IDOI. In 2018, our principal insurance subsidiary
sought and received regulatory approval prior to the payment of extraordinary dividends totaling $110.0 million. No
extraordinary dividends were paid in 2017 or 2016. Given the amount of dividends paid during the prior rolling 12-month
period, the net assets of our principal insurance subsidiary are restricted until the fourth quarter of 2019 and cannot be
distributed to RLI Corp. without prior approval of the IDOI. In addition to restrictions from our principal subsidiary’s
insurance regulator, we also consider internal models and how capital adequacy is defined by our rating agencies in
determining amounts available for distribution. However, as discussed above, RLI Corp. had the necessary amount of
103
unrestricted liquid net assets on hand at December 31, 2018 to cover normal annual holding company expenditures as they are
incurred and become payable in 2019.
10. COMMITMENTS AND CONTINGENT LIABILITIES
Other Litigation
We are party to numerous claims, losses and litigation matters that arise in the normal course of our business. Many of such
claims, losses or litigation matters involve claims under policies that we underwrite as an insurer. We believe that the resolution of
these claims and losses will not have a material adverse effect on our financial condition, results of operations or cash flows. We
are also involved in various other legal proceedings and litigation unrelated to our insurance business that arise in the ordinary
course of business operations. Management believes that any liabilities that may arise as a result of these legal matters will not
have a material adverse effect on our financial condition, results of operations or cash flows.
Carriage Hill Associates Coverage Dispute
As reported in the Company’s Form 10-Q filed for the second and third quarters of 2018, Carriage Hill Associates of
Charleston, LLC and certain other plaintiffs (collectively, “Plaintiffs”) filed a complaint in the Court of Common Pleas (the
“Court”) for the Ninth Judicial Circuit of Berkeley County, South Carolina in December 2010 against Mt. Hawley Insurance
Company (“Mt. Hawley”), a subsidiary of our principal subsidiary, RLI Insurance Company, relating to a coverage dispute. The
complaint sought, among other things, compensatory damages, punitive damages and attorneys’ fees.
On May 25, 2018, the Court issued an Order finding in favor of Plaintiffs (the “Order”). The Court held that Mt. Hawley was
responsible for compensatory damages relating to the alleged breach of duty to defend, breach of duty to indemnify and breach of
duty of good faith totaling $21.7 million. The Court further held that Plaintiffs were entitled to attorneys’ fees and costs and that
punitive damages were appropriate, with a hearing to be conducted at a later date to determine the amount of attorney fees and
costs, and punitive damages.
Mt. Hawley vigorously contested all the claims against it in this matter and filed certain post-trial motions seeking to, among
other things, vacate and withdraw the Order. As the result of Court-recommended mediation between the parties, all of the claims
in this matter among all parties were settled on a confidential basis for an amount that did not have a material impact on the
Company’s financial statements. On November 15, 2018, the Court vacated and withdrew the Order and the entire matter was
dismissed with prejudice on November 28, 2018.
Commitments
We have operating lease obligations for regional office facilities. These leases expire in various years through 2035.
Expenses associated with these leases totaled $6.9 million in 2018, $6.8 million in 2017 and $6.4 million in 2016. Minimum
future rental payments under non-cancellable leases are as follows:
(in thousands)
2019
2020
2021
2022
2023
2024-2035
Total minimum future rental payments
$
$
5,911
6,019
5,924
5,884
4,459
3,968
32,165
As of December 31, 2018, we also had $18.8 million of unfunded commitments related to our investments in private
funds and $7.4 million of unfunded commitments related to our low income housing tax credit investments. See note 2 for
more information on these investments.
11. OPERATING SEGMENT INFORMATION
The segments of our insurance operations include casualty, property and surety. The casualty portion of our business
consists largely of commercial excess, personal umbrella, general liability, transportation and executive products coverages, as
104
well as package business and other specialty coverages, such as professional liability and workers’ compensation for office-
based professionals. We offer fidelity and crime coverage for commercial insureds and select financial institutions and medical
and healthcare professional liability coverage in the excess and surplus market. We also assume a limited amount of hard-to-
place risks through a quota share reinsurance agreement. The casualty business is subject to the risk of estimating losses and
related loss reserves because the ultimate settlement of a casualty claim may take several years to fully develop. The casualty
segment is also subject to inflation risk and may be affected by evolving legislation and court decisions that define the extent of
coverage and the amount of compensation due for injuries or losses.
Our property segment is comprised primarily of commercial fire, earthquake, difference in conditions and marine
coverages. We also offer select personal lines policies, including homeowners’ coverages. Our property reinsurance and
recreational vehicle products are in runoff after we began curtailing offerings at the end of 2015 and 2016, respectively.
Property insurance results are subject to the variability introduced by perils such as earthquakes, fires and hurricanes. Our
major catastrophe exposure is to losses caused by earthquakes, primarily on the West Coast. Our second largest catastrophe
exposure is to losses caused by wind storms to commercial properties throughout the Gulf and East Coast, as well as to homes
we insure in Hawaii. We limit our net aggregate exposure to a catastrophic event by minimizing the total policy limits written
in a particular region, purchasing reinsurance and maintaining policy terms and conditions throughout market cycles. We also
use computer-assisted modeling techniques to provide estimates that help the Company carefully manage the concentration of
risks exposed to catastrophic events.
The surety segment specializes in writing small to large-sized commercial and contract surety coverages, as well as those
for the energy, petrochemical and refining industries. We also offer miscellaneous bonds including license and permit, notary
and court bonds. Often, our surety coverages involve a statutory requirement for bonds. While these bonds typically maintain a
relatively low loss ratio, losses may fluctuate due to adverse economic conditions affecting the financial viability of our
insureds. The contract surety product guarantees the construction work of a commercial contractor for a specific project.
Generally, losses occur due to the deterioration of a contractor’s financial condition. This line has historically produced
marginally higher loss ratios than other surety lines during economic downturns.
Net investment income consists of the interest and dividend income streams from our investments in fixed income and
equity securities. Interest and general corporate expenses include the cost of debt, other director and shareholder relations costs
and other compensation-related expenses incurred for the benefit of the corporation, but not attributable to the operations of our
insurance segments. Investee earnings represent our share in Maui Jim and Prime earnings. We own 40 percent of Maui Jim, a
privately-held company which operates in the sunglass and optical goods industries, and 23 percent of Prime Holdings
Insurance Services, Inc., a privately-held insurance company which specializes in hard-to-place risks in the excess and surplus
market and has recently expanded into certain coverages in the admitted market. Our investment in Maui Jim, which is carried
at the holding company, is unrelated to our core insurance operations.
The following table summarizes our segment data based on the internal structure and reporting of information as it is used by
management. The net earnings of each segment are before taxes and include revenues (if applicable), direct product or segment
costs (such as commissions and claims costs), as well as allocated support costs from various support departments. While
depreciation and amortization charges have been included in these measures via our expense allocation system, the related assets
are not allocated for management use and, therefore, are not included in this schedule.
REVENUES
(in thousands)
Casualty
Property
Surety
Net premiums earned
Net investment income
Net realized gains
Net unrealized losses on equity securities
Total
2016
2018
149,261
118,633
138,346
120,988
2017
$ 523,472 $ 478,603 $ 454,843
152,167
121,598
$ 791,366 $ 737,937 $ 728,608
53,075
34,645
—
$ 818,123 $ 797,224 $ 816,328
62,085
63,407
(98,735)
54,876
4,411
—
105
INSURANCE EXPENSES
(in thousands)
Loss and settlement expenses:
Casualty
Property
Surety
Total net loss and settlement expenses
Policy acquisition costs:
Casualty
Property
Surety
Total policy acquisition costs
Other insurance expenses:
Casualty
Property
Surety
Total other insurance expenses
Total
NET EARNINGS (LOSSES)
(in thousands)
Casualty
Property
Surety
Net underwriting income
Net investment income
Net realized gains
Net unrealized losses on equity securities
General corporate expense and interest on debt
Equity in earnings of unconsolidated investees
Total earnings before incomes taxes
Income tax expense (benefit)
Total
2018
2017
2016
$ 329,763 $ 305,679 $ 259,907
71,350
18,521
$ 428,193 $ 401,584 $ 349,778
83,822
14,608
85,027
10,878
$ 151,007 $ 136,135 $ 128,566
54,167
66,879
$ 267,738 $ 252,515 $ 249,612
51,830
64,901
51,070
65,310
12,725
9,516
$ 31,562 $ 32,885 $ 30,040
13,819
9,234
$ 53,803 $ 56,994 $ 53,093
$ 749,734 $ 711,093 $ 652,483
14,108
10,001
2016
884
29,608
(11,859)
34,799
2018
$ 11,140 $
2017
3,904 $ 36,329
12,832
26,964
$ 41,632 $ 26,844 $ 76,125
53,075
34,645
—
(17,596)
10,833
$ 67,581 $ 84,589 $ 157,082
$
3,402 $ (20,439) $ 42,162
$ 64,179 $ 105,028 $ 114,920
54,876
4,411
—
(18,766)
17,224
62,085
63,407
(98,735)
(16,864)
16,056
106
The following table further summarizes revenues by major product type within each segment:
NET PREMIUMS EARNED
(in thousands)
CASUALTY
Commercial excess and personal umbrella
General liability
Commercial transportation
Professional services
Small commercial
Executive products
Medical professional liability
Other casualty
Total
PROPERTY
Commercial property
Marine
Specialty personal
Other property
Total
SURETY
Miscellaneous
Contract
Commercial
Energy
Total
Grand total
Year ended December 31,
2017
2016
2018
$ 124,350 $ 115,543 $ 111,079
86,853
81,402
75,872
45,660
18,755
17,449
17,773
$ 523,472 $ 478,603 $ 454,843
93,928
81,053
79,951
51,519
21,326
16,042
55,303
90,283
78,061
78,508
49,601
18,086
17,072
31,449
$ 71,501 $ 63,117 $ 68,165
48,301
24,981
10,720
$ 149,261 $ 138,346 $ 152,167
59,795
16,901
1,064
50,931
20,793
3,505
28,196
26,751
16,718
$ 46,968 $ 47,237 $ 46,235
28,240
29,105
18,018
$ 118,633 $ 120,988 $ 121,598
$ 791,366 $ 737,937 $ 728,608
28,573
27,625
17,553
12. UNAUDITED INTERIM FINANCIAL INFORMATION
Select unaudited quarterly information is as follows:
(in thousands, except per share data)
2018
Net premiums earned
Net investment income
Net realized gains (losses)
Net unrealized gains (losses) on equity securities
Earnings (losses) before income taxes
Net earnings (loss)
Basic earnings per share(1)
Diluted earnings per share(1)
2017
Net premiums earned
Net investment income
Net realized gains (losses)
Net unrealized gains (losses) on equity securities
Earnings (losses) before income taxes
Net earnings (loss)
Basic earnings per share(1)
Diluted earnings per share(1)
First
Second
Third
Fourth
Year
14,232
8,404
(26,772)
14,378
12,216
$ 190,027 $ 196,522 $ 200,815 $ 204,002 $ 791,366
62,085
63,407
(98,735)
67,581
64,179
1.45
1.43
16,962
15,507
(64,200)
(32,708)
(20,660)
14,577
20,849
(12,611)
39,562
33,251
16,314
18,647
4,848
46,349
39,372
(0.46) $
(0.46) $
0.75 $
0.74 $
0.89 $
0.88 $
0.28 $
0.27 $
$
$
13,005
624
—
26,443
19,828
$ 183,285 $ 184,331 $ 182,025 $ 188,296 $ 737,937
54,876
4,411
—
84,589
105,028
2.39
2.36
14,187
35
—
(862)
1,734
0.04 $
0.04 $
13,238
(1,359)
—
34,036
26,208
14,446
5,111
—
24,972
57,258
0.60 $
0.59 $
0.45 $
0.45 $
1.30 $
1.29 $
$
$
(1) Since the weighted-average shares for the quarters are calculated independently of the weighted-average shares for the
year, quarterly earnings per share may not total to annual earnings per share.
107
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of RLI Corp.:
Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of RLI Corp. and subsidiaries (the Company) as of December
31, 2018 and 2017, 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, 2018, and the related notes and financial statement
schedules I to VI (collectively, the consolidated financial statements). We also have audited the Company’s internal control
over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework
(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial
position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the
years in the three-year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2018 based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee
of Sponsoring Organizations of the Treadway Commission.
Change in Accounting Principle
As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for equity
investments in 2018 due to the adoption of ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and
Measurement of Financial Assets and Financial Liabilities.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal
control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included
in the accompanying Report on Controls and Procedures. Our responsibility is to express an opinion on the Company’s
consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our
audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States)
(PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws
and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform
the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement,
whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material
respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement
of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks.
Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated
financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by
management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal
control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the
risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based
on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the
circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to
108
permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
We have served as the Company’s auditor since 1983.
Chicago, Illinois
February 22, 2019
109
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
There were no changes in accountants or disagreements with accountants on any matters of accounting principles or
practices or financial statement disclosure.
Item 9A. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and
principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under
Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this
evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and
procedures were effective as of December 31, 2018.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as
such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our
internal control over financial reporting based on the framework in Internal Control — Integrated Framework (2013) issued by
the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in
Internal Control — Integrated Framework (2013), our management concluded that our internal control over financial reporting
was effective as of December 31, 2018.
Our internal control over financial reporting as of December 31, 2018 has been audited by KPMG LLP, an independent
registered public accounting firm, as stated in their report on page 108 of this report.
There was no change in our internal control over financial reporting during our fourth fiscal quarter ended December 31,
2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
None
Items 10 to 14.
PART III
Items 10 through 14 (inclusive) of this Part III are not included herein because the Company will file a definitive Proxy
Statement with the SEC that will include the information required by such Items, and such information is incorporated herein
by reference. The Company’s Proxy Statement will be filed with the SEC and delivered to stockholders in connection with the
Annual Meeting of Shareholders to be held on May 2, 2019, and the information under the following captions is included in
such incorporation by reference: “Share Ownership of Certain Beneficial Owners,” “Board Meetings and Compensation,”
“Compensation Discussion & Analysis,” “Executive Compensation,” “Equity Compensation Plan Information,” “Executive
Management,” “Corporate Governance and Board Matters,” “Audit Committee Report” and “Proposal three: Ratification of
Selection of Independent Registered Public Accounting Firm.”
Item 15. Exhibits and Financial Statement Schedules
(a) (l-2) See Item 8 for Consolidated Financial Statements included in this report.
PART IV
(3) Exhibits. See Exhibit Index on pages 121-122.
(b) Exhibits. See Exhibit Index on pages 121-122.
(c) Financial Statement Schedules. See Index to Financial Statement Schedules on page 111.
110
INDEX TO FINANCIAL STATEMENT SCHEDULES
Data Submitted Herewith:
Schedules:
Reference (Page)
I. Summary of Investments - Other than Investments in Related Parties at December 31, 2018.
II. Condensed Financial Information of Registrant, as of and for the three years ended December 31, 2018.
III. Supplementary Insurance Information, as of and for the three years ended December 31, 2018.
IV. Reinsurance for the three years ended December 31, 2018.
V. Valuation and Qualifying Accounts for the three years ended December 31, 2018.
VI. Supplementary Information Concerning Property-Casualty Insurance Operations for the three years
ended December 31, 2018.
112
113-115
116-117
118
119
120
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.
111
RLI CORP. AND SUBSIDIARIES
SCHEDULE I—SUMMARY OF INVESTMENTS—OTHER THAN INVESTMENTS
IN RELATED PARTIES
December 31, 2018
Column A
(in thousands)
Type of Investment
Fixed maturities:
Bonds:
Available-for-sale:
U.S. Government
U.S. Agency
Non-U.S. Government & Agency
Agency MBS
ABS/CMBS*
Corporate
Municipal
Total available-for-sale
Total fixed maturities
Equity securities:
Common stock:
Ind Misc & all other
ETFs (Ind/misc)
Total equity securities
Cash & short-term investments
Other invested assets
Total investments and cash
Column B
Column C
Cost (1)
Fair Value
Column D
Amount at
which shown in
the balance sheet
$
199,982 $
31,716
8,170
402,992
137,224
681,909
314,472
200,229 $
31,904
7,639
395,253
136,723
668,679
320,088
$ 1,776,465 $ 1,760,515 $
$ 1,776,465 $ 1,760,515 $
200,229
31,904
7,639
395,253
136,723
668,679
320,088
1,760,515
1,760,515
$
$
98,879 $
121,494
220,373 $
41,690
51,760
177,040 $
163,443
340,483 $
41,690
51,542
$ 2,090,288 $ 2,194,230 $
177,040
163,443
340,483
41,690
51,542
2,194,230
* Non-agency asset-backed & commercial mortgage-backed
Note: See notes 1E and 2 of Notes to Consolidated Financial Statements. See also the accompanying report of independent
registered public accounting firm on page 108 of this report.
(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.
112
RLI CORP. AND SUBSIDIARIES
SCHEDULE II—CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY)
CONDENSED BALANCE SHEETS
December 31,
(in thousands, except share data)
ASSETS
Cash
Short-term investments, at cost which approximates fair value
Accounts receivable, affiliates
Investments in subsidiaries
Investments in unconsolidated investee
Fixed income:
2018
2017
$
3,214 $
—
—
828,806
79,521
204
70
1,057
912,515
77,720
Available-for-sale, at fair value (amortized cost - $58,812 in 2018 and $23,184 in 2017)
Property and equipment, at cost, net of accumulated depreciation of $1,494 in 2018 and $1,426
in 2017
Income taxes receivable - current
Other assets
Total assets
59,878
23,210
1,914
—
547
1,982
1,542
156
$ 973,880 $ 1,018,456
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Accounts payable, affiliates
Income taxes payable - current
Income taxes - deferred
Bonds payable, long-term debt
Interest payable, long-term debt
Other liabilities
Total liabilities
$
130 $
32
15,081
149,115
2,153
527
$ 167,038 $
—
—
13,207
148,928
2,153
570
164,858
Shareholders’ equity:
Common stock ($0.01 par value in 2018 and $1.00 par value in 2017)
(100,000,000 share authorized, 67,434,257 shares issued and 44,504,043 shares outstanding
in 2018)
(100,000,000 share authorized, 67,078,569 shares issued and 44,148,355 shares outstanding
in 2017)
Paid-in capital
Accumulated other comprehensive earnings, net of tax
Retained earnings
Deferred compensation
Treasury stock, at cost (22,930,214 shares in 2018 and 2017)
Total shareholders’ equity
Total liabilities and shareholders’ equity
$
674 $
67,079
233,077
305,660
157,919
(14,572)
788,522
908,079
8,640
8,354
(401,639)
(401,353)
$ 806,842 $
853,598
$ 973,880 $ 1,018,456
See Notes to Consolidated Financial Statements. See also the accompanying report of independent registered public accounting
firm on page 108 of this report.
113
RLI CORP. AND SUBSIDIARIES
SCHEDULE II—CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY)—(continued)
CONDENSED STATEMENTS OF EARNINGS AND COMPREHENSIVE EARNINGS
Years ended December 31,
(in thousands)
Net investment income
Net realized losses
Equity in earnings of unconsolidated investee
Selling, general and administrative expenses
Interest expense on debt
Loss before income taxes
Income tax benefit
Net earnings (loss) before equity in net earnings of subsidiaries
Equity in net earnings of subsidiaries
Net earnings
Other comprehensive income (loss), net of tax
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the period
Less: reclassification adjustment for gains (losses) included in net earnings
Other comprehensive income - parent only
Equity in other comprehensive earnings (loss) of subsidiaries/investees
Other comprehensive earnings (loss)
Comprehensive earnings
2018
2017
2016
$
648 $
(142)
12,471
(9,427)
(7,437)
647 $
(36)
14,436
(11,340)
(7,426)
942
(360)
9,764
(10,170)
(7,426)
$ (3,887) $ (3,719) $ (7,250)
(8,467)
(16,601)
1,217
113,703
$ 64,179 $ 105,028 $ 114,920
$ (1,528) $ 12,882 $
65,707
92,146
(2,359)
$
$
21 $
6
27 $
710 $
112
822 $
308
(131)
177
(1,341)
$ (33,997) $ 35,309 $ (1,164)
$ 30,182 $ 140,337 $ 113,756
(34,819)
35,282
See Notes to Consolidated Financial Statements. See also the accompanying report of independent registered public accounting
firm on page 108 of this report.
114
RLI CORP. AND SUBSIDIARIES
SCHEDULE II—CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY)—(continued)
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31,
(in thousands)
Cash flows from operating activities
Earnings before equity in net earnings of subsidiaries
Adjustments to reconcile net losses to net cash provided by (used in) operating
activities:
Net realized losses
Depreciation
Other items, net
Change in:
Affiliate balances receivable/payable
Federal income taxes
Stock option excess tax benefit
Changes in investment in unconsolidated investee:
Undistributed earnings
Dividends received
Net cash provided by (used in) operating activities
Cash flows from investing activities
Purchase of:
Fixed income, available-for-sale
Short-term investments, net
Sale of:
Fixed income, available-for-sale
Short-term investments, net
Property and equipment
Call or maturity of:
Fixed income, available-for-sale
Cash dividends received-subsidiaries
Net cash provided by investing activities
Cash flows from financing activities
Stock option excess tax benefit
Proceeds from stock option exercises
Cash dividends paid
Net cash used in financing activities
Net (decrease) increase in cash
Cash at beginning of year
Cash at end of year
2018
2017
2016
$
(1,528) $
12,882 $
1,217
142
68
(471)
1,187
3,430
—
36
77
595
360
196
560
(930)
(6,874)
—
(535)
9,762
(9,576)
(12,471)
9,900
$
257 $
(14,436)
—
(8,650) $
(9,764)
9,900
2,120
$ (73,812) $
—
(5,773) $ (12,844)
—
(47)
12,056
70
—
24,771
—
128
4,981
63
—
6,859
75,662
73,363
123,600
87,339 $ 129,578 $ 122,659
3,499
107,000
$
$
— $
— $
6,076
(90,662)
9,576
(741)
3,502
(133,771)
(124,247)
$ (84,586) $ (120,745) $ (124,936)
(157)
$
178
21
3,010 $
204
3,214 $
183 $
21
204 $
$
Interest paid on outstanding debt amounted to $7.3 million for 2018, 2017 and 2016, respectively. See Notes to Consolidated
Financial Statements. See also the accompanying report of independent registered public accounting firm on page 108 of this
report.
115
RLI CORP. AND SUBSIDIARIES
SCHEDULE III—SUPPLEMENTARY INSURANCE INFORMATION
As of and for the years ended December 31, 2018, 2017 and 2016
(in thousands)
Year ended December 31, 2018
Casualty segment
Property segment
Surety segment
$
Deferred policy Unpaid losses
acquisition
costs
Unearned
and settlement premiums,
expenses, gross
gross
Net
premiums
earned
Incurred losses
and settlement
expenses
current year
50,040 $ 1,283,204 $ 330,836 $ 523,472 $
14,090
20,804
149,261
118,633
134,822
43,322
93,032
72,637
363,015
94,635
20,493
RLI Insurance Group
$
84,934 $ 1,461,348 $ 496,505 $ 791,366 $
478,143
Year ended December 31, 2017
Casualty segment
Property segment
Surety segment
$
44,358 $ 1,127,787 $ 296,751 $ 478,603 $
13,029
20,329
138,346
120,988
107,304
36,412
84,010
70,688
323,141
97,161
20,150
RLI Insurance Group
$
77,716 $ 1,271,503 $ 451,449 $ 737,937 $
440,452
Year ended December 31, 2016
Casualty segment
Property segment
Surety segment
$
39,131 $ 1,021,506 $ 276,096 $ 454,843 $
13,115
20,901
152,167
121,598
76,989
40,842
84,425
73,256
292,308
76,143
23,321
RLI Insurance Group
$
73,147 $ 1,139,337 $ 433,777 $ 728,608 $
391,772
NOTE 1: Investment income is not allocated to the segments, therefore net investment income has not been provided.
See the accompanying report of independent registered public accounting firm on page 108 of this report.
116
RLI CORP. AND SUBSIDIARIES
SCHEDULE III—SUPPLEMENTARY INSURANCE INFORMATION
(continued)
As of and for the years ended December 31, 2018, 2017 and 2016
(in thousands)
Year ended December 31, 2018
Casualty segment
Property segment
Surety segment
RLI Insurance Group
Year ended December 31, 2017
Casualty segment
Property segment
Surety segment
RLI Insurance Group
Year ended December 31, 2016
Casualty segment
Property segment
Surety segment
RLI Insurance Group
Incurred
losses and
settlement
expenses
prior year
Policy
acquisition
costs
Other
operating
expenses
Net
premiums
written
$ (33,252) $ 151,007 $ 31,562 $ 547,177
155,601
120,397
(10,813)
(5,885)
12,725
9,516
51,830
64,901
$ (49,950) $ 267,738 $ 53,803 $ 823,175
$ (17,462) $ 136,135 $ 32,885 $ 494,649
137,031
118,174
(12,134)
(9,272)
14,108
10,001
51,070
65,310
$ (38,868) $ 252,515 $ 56,994 $ 749,854
$ (32,401) $ 128,566 $ 30,040 $ 470,082
149,170
121,700
13,819
9,234
54,167
66,879
(4,793)
(4,800)
$ (41,994) $ 249,612 $ 53,093 $ 740,952
See the accompanying report of independent registered public accounting firm on page 108 of this report.
117
RLI CORP. AND SUBSIDIARIES
SCHEDULE IV—REINSURANCE
Years ended December 31, 2018, 2017 and 2016
(in thousands)
2018
Casualty segment
Property segment
Surety segment
Direct
amount
Ceded to
other
companies
Assumed
from other
companies
Net
amount
Percentage
of amount
assumed
to net
$ 578,643 $
193,855
123,736
96,639 $ 41,468 $ 523,472
149,261
44,634
118,633
5,521
40
418
7.9 %
0.0 %
0.4 %
RLI Insurance Group premiums earned
$ 896,234 $ 146,794 $ 41,926 $ 791,366
5.3 %
2017
Casualty segment
Property segment
Surety segment
$ 536,085 $
172,668
126,365
86,190 $ 28,708 $ 478,603
138,346
3,285
37,607
120,988
528
5,905
6.0 %
2.4 %
0.4 %
RLI Insurance Group premiums earned
$ 835,118 $ 129,702 $ 32,521 $ 737,937
4.4 %
2016
Casualty segment
Property segment
Surety segment
$ 528,691 $
179,460
127,143
89,635 $ 15,787 $ 454,843
152,167
38,353
121,598
6,584
11,060
1,039
3.5 %
7.3 %
0.9 %
RLI Insurance Group premiums earned
$ 835,294 $ 134,572 $ 27,886 $ 728,608
3.8 %
See the accompanying report of independent registered public accounting firm on page 108 of this report.
118
RLI CORP. AND SUBSIDIARIES
SCHEDULE V—VALUATION AND QUALIFYING ACCOUNTS
Years ended December 31, 2018, 2017 and 2016
(in thousands)
Balance
at beginning
of period
Amounts
charged
to expense
Amounts
recovered
(written off)
Balance
at end of
period
2018 Allowance for uncollectible reinsurance
$
25,911 $
— $
— $
25,911
2017 Allowance for uncollectible reinsurance
$
25,911 $
— $
— $
25,911
2016 Allowance for uncollectible reinsurance
$
25,911 $
— $
— $
25,911
See the accompanying report of independent registered public accounting firm on page 108 of this report.
119
RLI CORP. AND SUBSIDIARIES
SCHEDULE VI—SUPPLEMENTARY INFORMATION CONCERNING
PROPERTY-CASUALTY INSURANCE OPERATIONS
Years ended December 31, 2018, 2017 and 2016
(in thousands)
Affiliation with
Registrant (1)
Deferred policy
Claims and
acquisition
costs
claim adjustment
expense reserves
Unearned
premiums,
gross
Net
premiums
earned
Net
investment
income
2018
2017
2016
2018
2017
2016
$
$
$
84,934 $
77,716 $
73,147 $
1,461,348 $
1,271,503 $
1,139,337 $
496,505 $
451,449 $
433,777 $
791,366 $
737,937 $
728,608 $
62,085
54,876
53,075
Claims and claim adjustment
expenses incurred related to:
Current
year
Prior
year
Amortization
of deferred
acquisition costs
Paid claims and
claim adjustment
expenses
Net
premiums
written
$
$
$
478,143 $
440,452 $
391,772 $
(49,950) $
(38,868) $
(41,994) $
267,738 $
252,515 $
249,612 $
301,356 $
283,185 $
304,606 $
823,175
749,854
740,952
(1) Consolidated property-casualty insurance operations.
See the accompanying report of independent registered public accounting firm on page 108 of this report.
120
Exhibit No.
Description of Document
Reference (page)
EXHIBIT INDEX
3.1
3.2
4.1
4.2
10.1
10.2
10.3
Amended and Restated Certificate of Incorporation
By-Laws
Senior Indenture
Supplemental Indenture
Incorporated by reference to the Company’s Form 8-K
filed May 8, 2018.
Incorporated by reference to the Company’s Form 8-K
filed May 8, 2018.
Incorporated by reference to the Company’s Form 8-K
filed October 2, 2013.
Incorporated by reference to the Company’s Form 8-K
filed May 8, 2018.
The RLI Corp. Directors’ Irrevocable Trust
Agreement*
Incorporated by reference to the Company’s Form 10-K
filed February 23, 2018.
RLI Corp. Nonemployee Directors’ Deferred
Compensation Plan, as amended*
Incorporated by reference to the Company’s Form 10-Q
filed July 20, 2018.
RLI Corp. Executive Deferred Compensation Plan,
as amended*
Incorporated by reference to the Company’s Form 10-K
filed February 23, 2018.
10.4
Key Employee Excess Benefit Plan, as amended*
10.5
RLI Corp. 2010 Long-Term Incentive Plan*
10.6
RLI Corp. Annual Incentive Compensation Plan*
Incorporated by reference to the Company’s Form 10-K
filed February 25, 2009.
Incorporated by reference to the Company’s Form 8-K
filed on May 6, 2010.
Incorporated by reference to the Company’s Form 10-K
filed February 23, 2018.
10.7
10.8
Market Value Potential (MVP), Executive Incentive
Program Guideline*
Incorporated by reference to the Company’s Form 10-K
filed February 23, 2018.
Advances, Collateral Pledge, and Security
Agreement (Federal Home Loan Bank of Chicago)
Incorporated by reference to the Company’s Form 8-K
filed September 26, 2014.
10.9
Credit Agreement (JPMorgan Chase Bank, N.A.)
10.10
RLI Corp. 2015 Long-Term Incentive Plan*
Incorporated by reference to the Company’s Form 8-K
filed May 30, 2018.
Incorporated by reference to the Company’s Form 8-K
filed on May 7, 2015.
10.11
10.12
RLI Corp. Director and Officer Indemnification
Agreement
Incorporated by reference to the Company’s Form 10-Q
filed October 24, 2018.
Shareholders Agreement by and among RLI Corp.,
Walter F. Hester III, and the Walter F. Hester III
Revocable Trust
Incorporated by reference to the Company’s Form 8-K
filed on August 21, 2018.
11.0
Statement re: computation of per share earnings
Refer to Note 1.O., “Earnings per share,” on page 75.
* Management contract or compensatory plan.
121
Exhibit No.
Description of Document
Reference Page
EXHIBIT INDEX
21.1
23.1
31.1
31.2
32.1
32.2
Subsidiaries of the Registrant
Consent of KPMG LLP
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
Page 124
Page 125
Page 126
Page 127
Page 128
Page 129
101
XBRL-Related Documents
Attached as Exhibit 101
122
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/ Thomas L. Brown
Thomas L. Brown
Senior Vice President, Chief Financial Officer
Date:
February 22, 2019
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on the dates indicated.
By:
/s/ Jonathan E. Michael
By:
/s/ Thomas L. Brown
Jonathan E. Michael, Chairman & CEO
(Principal Executive Officer)
Thomas L. Brown, Senior Vice President,
Chief Financial Officer (Principal Financial
Officer and Principal Accounting Officer)
Date:
February 22, 2019
Date:
February 22, 2019
By:
/s/ Kaj Ahlmann
Kaj Ahlmann, Director
By:
/s/ Jordan W. Graham
Jordan W. Graham, Director
Date:
February 22, 2019
Date:
February 22, 2019
By:
/s/ Michael E. Angelina
By:
/s/ Jonathan E. Michael
Michael E. Angelina, Director
Jonathan E. Michael, Director
Date:
February 22, 2019
Date:
February 22, 2019
By:
/s/ John T. Baily
John T. Baily, Director
By:
/s/ Robert P. Restrepo, Jr.
Robert P. Restrepo, Jr., Director
Date:
February 22, 2019
Date:
February 22, 2019
By:
/s/ Calvin G. Butler, Jr.
By:
/s/ Debbie S. Roberts
Calvin G. Butler, Jr., Director
Debbie S. Roberts, Director
Date:
February 22, 2019
Date:
February 22, 2019
By:
/s/ David B. Duclos
David B. Duclos, Director
By:
/s/ James J. Scanlan
James J. Scanlan, Director
Date:
February 22, 2019
Date:
February 22, 2019
By:
/s/ Susan S. Fleming
Susan S. Fleming, Director
By:
/s/ Michael J. Stone
Michael J. Stone, Director
Date:
February 22, 2019
Date:
February 22, 2019
123
Subsidiaries of the Registrant
The following companies are subsidiaries of the Registrant as of December 31, 2018.
Name
RLI Corp.
RLI Insurance Company
Mt. Hawley Insurance Company
RLI Underwriting Services, Inc.
RLI Insurance Agency Ltd.
Safe Fleet Insurance Services, Inc.
Data & Staff Service Co.
Contractors Bonding and Insurance Company
Exhibit 21.1
Jurisdiction of Percentage
Incorporation Ownership
Delaware
Illinois
Illinois
Illinois
Canada
California
Washington
Illinois
100%
100%
100%
100%
100%
100%
100%
100%
124
Consent of Independent Registered Public Accounting Firm
Exhibit 23.1
The Board of Directors
RLI Corp.:
We consent to the incorporation by reference in the registration statements (Nos. 333-01637, 333-28625, 333-75251, 333-
117714, 333-124450, 333-125354, 333-166614 and 333-203957) on Form S-8 and registration statement (No. 333-185534) on
Form S-3 of RLI Corp. of our report dated February 22, 2019, with respect to the consolidated balance sheets of RLI Corp. as
of December 31, 2018 and 2017, 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, 2018, and the related
notes and financial statement schedules I to VI (collectively, the “consolidated financial statements”), and the effectiveness of
internal control over financial reporting as of December 31, 2018, which report appears in the December 31, 2018 annual
report on Form 10-K of RLI Corp.
/s/ KPMG LLP
Chicago, Illinois
February 22, 2019
125
CERTIFICATION
Exhibit 31.1
Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Jonathan E. Michael, certify that:
I have reviewed this annual report on Form 10-K of RLI Corp.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods
presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this
report based on such evaluation; and
(d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s
internal control over financial reporting; and
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons
performing the equivalent functions):
(a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial
reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report
financial information; and
(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal control over financial reporting.
Date: February 22, 2019
/s/ Jonathan E. Michael
Jonathan E. Michael
Chairman & CEO
126
Exhibit 31.2
Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
CERTIFICATION
I, Thomas L. Brown, certify that:
I have reviewed this annual report on Form 10-K of RLI Corp.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods
presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this
report based on such evaluation; and
(d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s
internal control over financial reporting; and
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons
performing the equivalent functions):
(a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial
reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report
financial information; and
(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal control over financial reporting.
Date: February 22, 2019
/s/ Thomas L. Brown
Thomas L. Brown
Senior Vice President, Chief Financial Officer
127
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32.1
In connection with the Annual Report of RLI Corp. (the “Company”) on Form 10-K for the period ending December 31, 2018
as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Jonathan E. Michael, Chief
Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley
Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of
1934, and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and
results of operations of the Company.
/s/ Jonathan E. Michael
Jonathan E. Michael
Chairman & CEO
February 22, 2019
128
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32.2
In connection with the Annual Report of RLI Corp. (the “Company”) on Form 10-K for the period ending December 31, 2018
as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Thomas L. Brown, Chief Financial
Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of
2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of
1934, and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and
results of operations of the Company.
/s/ Thomas L. Brown
Thomas L. Brown
Senior Vice President, Chief Financial Officer
February 22, 2019
129