What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-07-24 compared with 2020-04-28 · 264 added, 140 removed, 214 unchanged (65% of the section changed)

19 unchanged sentences

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 property and casualty insurance business is cyclical and influenced by many factors, including price competition, economic conditions, natural or man-made disasters (for example, earthquakes, hurricanes, pandemics and terrorism), interest

rates, state regulations, court decisions and changes in the law.

One of the unique and challenging features of the property and casualty insurance business is that coverages must be priced before costs have fully developed, because premiums are charged before claims are incurred.

8 unchanged sentences

We also offer select personal lines policies, including homeowners’ coverages.

Property insurance results are subject to the variability introduced by perils such as earthquakes, fires and hurricanes.

Property insurance results are subject to the variability introduced by perils such as earthquakes, fires, hurricanes and other storms.

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 seek to limit our net aggregate exposure to a catastrophic event by minimizing the total policy limits written in a particular region, purchasing reinsurance and maintaining consistent policy terms and conditions throughout insurance 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.

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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.

The 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

2 unchanged sentences

However, this information is available in total and by segment in note 6 to the unaudited condensed consolidated interim financial statements in this quarterly report on Form 10-Q and in note 12 to the consolidated financial statements in our 2019 Annual Report on Form 10-K, regarding operating segment information.

The nearest comparable

GAAP measure is earnings before income taxes which, in addition to underwriting income, includes net investment income, net realized gains or losses, net unrealized gain or losses on equity securities, general corporate expenses, debt costs and our portion of earnings from unconsolidated investees.

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 gain or losses on equity securities, general corporate expenses, debt costs and our portion of earnings from unconsolidated investees.

A reconciliation of net earnings to underwriting income follows:

For the Three-Month Periods

For the Six-Month Periods

Ended June 30,

(in thousands)

Income tax expense

Earnings before income taxes

Equity in earnings of unconsolidated investees

General corporate expenses

Interest expense on debt

Net unrealized (gains) losses on equity securities

Net realized (gains) losses

Net investment income

Net underwriting income

Combined Ratio

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The difference between the combined ratio and 100 reflects the per-dollar rate of underwriting income or loss.

Net Unpaid Loss and Settlement Expenses

Unpaid losses and settlement expenses, as shown in the liabilities section of our consolidated 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

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IMPACT OF COVID-19

The coronavirus (COVID-19) pandemic continues to impact individuals and businesses worldwide.

The coronavirus (COVID-19) pandemic continues to impact individuals, businesses and the economy.

As an employee-owned company, the health and well-being of our customers, partners and associates is our highest priority.

Nearly all of our associates are working from home and we have suspended all nonessential travel.

Our business continuity plans were designed to address various threats and vulnerabilities, including pandemic and high absenteeism scenarios, along with other types of business interruptions.

Through a highly-distributed workforce and investments we have made in our technology infrastructure over time, we were able to seamlessly transition to a remote work model while maintaining the highest service and support levels possible for our customers.

We are fully operational, able to produce financial statements supported by controls which continue to operate effectively and we believe we are in a good position to continue working remotely for as long as necessary.

It is too early to reasonably estimate the ultimate effect of the economic shut-down as a result of the pandemic on our revenues.

Through the first quarter, our most impacted product line has been public transportation.

A large number of our passenger transportation customers have been unable to effectively operate under social-distancing protocols and stay-at-home governmental orders.

To support our customers, we allowed them to suspend coverage on vehicles that were not in use, which resulted in a $23.0 million reduction to gross written premium in the first quarter.

All of the premium was unearned and we expect the amount of cash that will be returned to customers will be approximately $6 million.

Other product lines which may be more significantly impacted could include those supporting non-essential and international cargo-haulers and the energy sector.

A number of products support construction activity and our revenues may be impacted to the extent this sector experiences disruption.

We also have many product lines that may see little to no impact, including our personal lines products, management liability products and property businesses.

While a large percentage of our associates are still working from home, our processes and controls continue to operate effectively and we have been able to maintain the highest service and support levels possible for our customers.

It is difficult to predict how and to what extent the economic slowdown will have on our revenues in the coming months.

To date, our most impacted product line has been public transportation.

A large number of our passenger transportation customers have been unable to effectively operate under social-distancing protocols and stay-at-home orders.

For the six-month period ended June 30, 2020, transportation gross written premium was down $33.3 million when compared to 2019.

We would expect transportation premium to continue to be down from prior periods until the use of public transportation increases, which may not be until after there is a vaccine, effective treatment or significant reduction in cases.

Additionally, slowdowns in the construction industry contributed to premium declines for our general liability and surety products in the second quarter.

A number of our products support the construction industry and revenues may continue to be impacted to the extent this sector experiences disruption.

However, we have many product lines that may see little to no impact on the amount of premium we write, including our personal lines products, management liability products and property businesses.

We have been fair and flexible with our customers in regards to modifying exposures and payment terms and we are in compliance with any applicable state regulatory directives on such changes.

Insureds continue to make payments in accordance with the agreed upon schedules and we have not experienced a material increase in the amount of expense associated with uncollectible receivables.

The loss exposure arising out of the spread of COVID-19 and resulting shutdown will take time to resolve.

We do not offer event cancellation, travel, trade credit or pandemic-related coverages which would be more impacted by the COVID-19 pandemic.

We do not offer event cancellation, travel, trade credit or pandemic-related coverages which would be more directly impacted by the COVID-19 pandemic.

The Company has received a number of claims, the majority of which relate to business interruption.

We are reviewing the individual circumstances of each claim submitted and will fulfill our obligation to pay if coverage applies.

To address greater expected costs to investigate and defend these claims, we recorded net reserves of $5.0 million.

Actuarial models base future emergence on historic experience, with adjustments for current trends, and the appropriateness of these assumptions involved greater uncertainty as of March 31, 2020.

The derivative implications that COVID-19 has on the economy may have negative implications on products that are correlated with the credit cycle, including, but not limited to, some of our executive products and surety offerings.

In the second quarter of 2020, $5.8 million of net reserves were established to address the increased risk of loss and expense that emanated from the economic downturn brought on by the pandemic.

Combined with the reserves established in the first quarter

that addressed the expected increase in costs to investigate and defend business interruption claims, $10.8 million of COVID-19 related net losses have been recognized in the first six months of 2020.

Actuarial models base future emergence on historic experience, with adjustments for current trends, and the appropriateness of these assumptions involved greater uncertainty as of June 30, 2020.

We expect there will be impacts to the timing of loss emergence and ultimate loss ratios for certain coverages.

The industry is experiencing new issues, including the temporary suspension of civil court cases in most states, the extension of certain statutes of limitations and a significant reduction in economic activity and insured exposure in some classes.

Our booked reserves include consideration of these factors, but legislative, regulatory or judicial actions could result in loss reserve deficiencies and reduce earnings in future periods.

Market declines resulted in $130.4 million of unrealized losses on equity securities, driving a net loss for the quarter.

The fixed income portfolio also experienced unrealized losses as widening credit spreads more than offset declining interest rates.

Our fixed income portfolio is weighted towards higher rated bonds (85 percent rated A or better at March 31, 2020) and our equity portfolio is part of a long-term strategy that has contributed significantly to our growth in book value in the past.

Reinvestment rates may be at lower levels if treasury yields remain low and credit spreads normalize, but we cannot anticipate how the market will perform in the coming months.

Investee earnings in Maui Jim, Inc.

The industry is experiencing new issues, including the postponement of civil court cases, the extension of various statutes of limitations, changes in settlement trends and a significant reduction in economic activity and insured exposure in some classes.

Our booked reserves include consideration of these factors, but the duration and degree to which these issues persist, along with potential legislative, regulatory or judicial actions, could result in loss reserve deficiencies and reduce earnings in future periods.

We continue to evaluate opportunities for expense savings and efficiencies and have taken targeted actions to reduce or defer expenses, including certain hiring freezes, position consolidations and executive merit increase suspensions.

Travel was limited and any decision on granting share-based compensation, which normally takes place at our May board meeting, was deferred until a later date, resulting in a reduced level of compensation expense in the second quarter.

Bonus and profit sharing expense is correlated with company performance and is responsible for the largest portion of the total expense decline for the six-month period ended June 30, when compared to 2019.

The performance-related expenses recognized for the 2020 fiscal year will be dependent on the full year’s results and may increase or decrease in the second half of the year.

Although we have recovered a large portion of the market value declines recorded in the first quarter, equity securities have not fully returned to levels recorded at year end.

Net after-tax realized and unrealized losses on equity securities were $33.9 million in the first half of 2020.

Conversely, lower interest rates increased the fair value of the fixed income portfolio, which resulted in $40.5 million of after-tax other comprehensive earnings for the six-month period ended June 30, 2020.

With the decline in yields, reinvestment rates are now lower than in previous years, which will cap the portfolio’s ability to generate higher levels of investment income, absent a larger invested asset base.

Maui Jim, Inc.

(Maui Jim) and Prime Holdings Insurance Services, Inc.

(Prime) continued to post positive results in the quarter.

While earnings for Prime were modestly higher, Maui Jim results were down, reflective of the current retail and economic environment.

The length of any economic downturn will impact the results of these investees, particularly any lasting impact on the retail sector as it relates to Maui Jim.

We believe we are financially strong despite the impact of the COVID-19 pandemic and continued to produce solid operating results in the first quarter.

We are also confident in our liquidity position.

In March, we replaced our revolving credit facility that was set to expire in May with an arrangement that provided for an increased borrowing capacity of $60.0 million and can be increased to $120.0 million under certain circumstances.

(Prime) continued to contribute towards positive net earnings.

While earnings for Prime were modestly higher, Maui Jim results were negatively impacted by the shutdown much of the traditional retail sector experienced during the second quarter.

The economic downturn may continue to impact the results of these investees, particularly if there is any lasting impact on the retail sector as it relates to Maui Jim.

We produced solid operating results in the first half of the year and believe our financial position has remained strong despite the impact of the COVID-19 pandemic.

We generated $83.8 million of net operating cash inflows and believe we have adequate liquidity.

Our revolving credit facility provides for a borrowing capacity of $60.0 million, which can be increased to $120.0 million under certain circumstances.

Additionally, our membership in the Federal Home Loan Bank system provides a secured lending facility with an aggregate borrowing capacity of approximately $30.0 million.

There were no amounts outstanding under any of these facilities as of March 31, 2020.

In addition to the $99.4 million of cash and other investments maturing within one year as of March 31, 2020, we believe that cash generated from operations, the liquidity of our fixed income portfolio and our unused lines of credit provide sufficient sources of cash to meet our anticipated needs over the next 12 to 24 months.

Amid rapidly changing dynamics, we are continuing to evaluate all aspects of our operations and making necessary adjustments to manage our business.

Ultimately, the extent of the impact will depend on how long it takes for the economy to return to some degree of normality.

Our diversified portfolio of products and financial strength have allowed us to remain on solid footing and we believe we are able to diligently serve our customers and other stakeholders now and in the future.

There were no amounts outstanding under any of these facilities as of June 30, 2020.

In addition to the $160.7 million of cash and other investments maturing within one year as of June 30, 2020, we believe that cash generated from operations, the liquidity of our fixed income portfolio and our unused lines of credit provide sufficient sources of cash to meet our anticipated needs over the next 12 to 24 months.

Ultimately, the extent to which COVID-19 will impact our business will be influenced by how long it takes for the economy to recover.

We continue to evaluate all aspects of our operations and are making necessary adjustments to manage our business.

Our diversified portfolio of products and financial strength have allowed us to remain on solid footing.

We believe we have a strong and sustainable underwriting approach that will allow us to weather the economic downturn and uncertainty we are currently experiencing.

RESULTS OF OPERATIONS

Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019

Consolidated revenue for the first quarter of 2020 decreased $145.7 million from the first quarter of 2019 as performance in the equity portfolio varied significantly between the periods.

Overall market declines resulted in $130.4 million of unrealized losses on equity securities in 2020, while a market rebound generated $33.5 million of unrealized gains in our equity portfolio in the first quarter of 2019.

Six Months Ended June 30, 2020 Compared to Six Months Ended June 30, 2019

Consolidated revenue for the first half of 2020 decreased $85.6 million from the first half of 2019 as performance in the equity portfolio varied significantly between the periods.

Overall market declines resulted in $55.7 million of unrealized losses on equity securities in 2020, while positive returns generated $42.3 million of unrealized gains in our equity portfolio in the first half of 2019.

Net premiums earned for the Group increased 3 percent, driven by growth from our casualty and property segments.

Investment income increased 3 percent due to a larger asset base relative to the prior year.

Realized gains during the quarter were $15.2 million and were comprised of $15.2 million of realized gains on equity securities from rebalancing our portfolio, $2.3 million of realized gains on the fixed income portfolio and $2.3 million of other realized losses.

This compares to $8.4 million of realized gains on the equity portfolio and $0.6 million of realized losses on the fixed income portfolio for the same period in 2019.

For the Three-Month Periods

Ended March 31,

Realized gains during the first half were $13.0 million and were comprised of $12.8 million of realized gains on equity securities from rebalancing our portfolio, $2.6 million of realized gains on the fixed income portfolio and $2.4 million of other realized losses.

This compares

to $12.3 million of realized gains on the equity portfolio, $1.3 million of realized gains on the fixed income portfolio and $0.2 million of other realized gains for the same period in 2019.

For the Six-Month Periods

Ended June 30,

Consolidated revenues (in thousands)

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Net investment income

Net realized gains

Net realized gains (losses)

Net unrealized gains (losses) on equity securities

Total consolidated revenue

Net loss for the first quarter of 2020 totaled $61.3 million, compared to $65.5 million of net earnings for the same period last year.

Net earnings for the first six months of 2020 totaled $30.9 million, compared to $105.9 million for the same period last year.

The decrease in earnings for 2020 was primarily attributed to $44.0 million of net after-tax unrealized losses on equity securities, compared to $33.4 million of after-tax unrealized gains in 2019.

Underwriting results for both periods reflect profitable current accident year results and favorable development from prior years’ loss reserves.

Favorable development on prior years’ loss reserves provided additional pretax earnings of $15.2 million in the first quarter of 2020 compared to $19.6 million in 2019.

Catastrophe activity was light for both periods, with $0.5 million of pretax storm losses in the first quarter of 2020 and $1.0 million for the same period in the prior year.

Favorable development on prior years’ loss reserves provided additional pretax earnings of $40.8 million in the first half of 2020 and 2019.

Pretax losses from storms and civil unrest were $6.5 million, compared to $5.0 million of storm losses for the same period in 2019.

Pretax bonus and profit sharing-related expenses associated with the net impact of prior years’ reserve development and catastrophe losses totaled $5.1 million in 2020, compared to $5.3 million in 2019.

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Bonus and profit-sharing amounts earned by executives, managers and associates are predominately influenced by corporate performance including operating earnings, combined ratio and return on capital.

During the first quarter of 2020, equity in earnings of unconsolidated investees totaled $4.5 million.

During the first half of 2020, equity in earnings of unconsolidated investees totaled $9.6 million.

This amount includes $5.2 million from Maui Jim and $4.4 million from Prime.

Comparatively, the first quarter of 2019 reflected $5.3 million of earnings, including $3.6 million from Maui Jim and $1.7 million from Prime.

Comprehensive loss totaled $74.3 million for the first quarter of 2020, compared to $94.8 million of comprehensive earnings for the first quarter of 2019.

Other comprehensive earnings primarily included after-tax unrealized gains and losses from the fixed income portfolio.

The first quarter’s $13.0 million of other comprehensive loss was due to unrealized losses on the fixed income portfolio as declines in interest rates were more than offset by wider credit spreads.

This compares to $29.3 million of other comprehensive earnings for the same period in 2019, primarily attributable to declining interest rates during the period.

Gross premiums written for the Group increased $14.9 million, or 6 percent, for the first quarter of 2020 when compared to the same period of 2019.

Products in our casualty and property segments drove the growth.

Net premiums earned increased $10.9 million, or 5 percent, also driven by products in our casualty and property segments.

Comparatively, the first half of 2019 reflected $13.8 million of earnings, including $10.1 million from Maui Jim and $3.7 million from Prime.

The decline in earnings from Maui Jim is reflective of the shutdown much of the traditional retail sector experienced as a result of the pandemic during the second quarter.

Comprehensive earnings totaled $71.4 million for the first six months of 2020, compared to $163.1 million for the first half of 2019.

Other comprehensive earnings primarily included net after-tax unrealized gains from the fixed income portfolio and totaled $40.5 million in the first half of 2020, compared to $57.2 million in 2019.

The unrealized gains were attributable to declining interest rates in both periods, which increased the fair value of securities held in the fixed income portfolio.

However, wider credit spreads partially offset the impact of the lower treasury rates in 2020.

Gross premiums written for the Group increased $18.8 million, or 4 percent, for the first half of 2020 when compared to the same period of 2019.

Products in our property and casualty segments drove the growth.

Net premiums earned increased $12.1 million, or 3 percent, also driven by products in our property and casualty segments.

Gross Premiums Written

Net Premiums Earned

For the Three-Month Periods Ended March 31,

For the Six-Month Periods Ended June 30,

(in thousands)

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General liability

Commercial transportation

Professional services

Commercial transportation

Small commercial

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Miscellaneous

Gross premiums written for the casualty segment were up 5 percent, or $7.1 million, in the first quarter of 2020.

Premiums from commercial excess and personal umbrella increased $14.6 million, due to an expanded distribution base in personal umbrella, rate increases and overall exposure growth.

Gross premiums written for the casualty segment were up $8.1 million in the first six months of 2020.

Premiums from commercial excess and personal umbrella increased $25.1 million, due to an expanded distribution base in personal umbrella and rate increases.

Small commercial continued to benefit from new production sources and geographic expansion.

Substantial rate increases led to a 27 percent increase for our executive products group.

Other casualty increased $5.3 million, as our general binding authority (GBA) business continued to grow.

Transportation was impacted by the suspension of a large portion of our public transportation book and the reversal of $23.0 million in gross premiums written.

Public transportation is focused primarily on charter or city buses, which stopped running to a large degree in March as a result of COVID-19 and the associated stay at home orders across the United States.

See the Impact of COVID-19 section above for more information on the observed effect of the pandemic on RLI Corp.

at the time of this report.

Gross premiums written for the property segment totaled $56.7 million for the first quarter of 2020, up 16 percent from the same period last year.

Our commercial property business accounted for a large portion of the increase, up $6.3 million, as an improving market has allowed our underwriters to find more opportunities with acceptable rate levels.

Additionally, rates on wind-prone and earthquake exposures continued to increase in the first quarter.

Commercial transportation has been significantly affected by the stay at home orders associated with COVID-19, particularly our public lines.

Public transportation focuses on charter, school and transit busses, which stopped running to a large degree in March.

The reduced utilization led to a $33.3 million decline in gross premiums written in the first six months of 2020.

Gross premiums written for the property segment were up $12.6 million in the first half of 2020.

Our commercial property business was up $9.6 million, as an improving market allowed our underwriters to find more opportunities with acceptable rate levels.

Additionally, rates on wind-prone and earthquake exposures continued to increase over the first half of the year.

Rate increases and market disruption, which created new business opportunities, led to $2.8 million of growth for our marine product.

Other property premium increased as a result of property exposed GBA business that continues to gain scale.

The surety segment recorded gross premiums written of $29.9 million for the first quarter of 2020, an increase of $0.1 million from the same period last year.

Refocused sales efforts contributed to growth within contract and miscellaneous, but declining oil prices and industry consolidation led to reductions within commercial lines.

The surety segment recorded gross premiums written of $57.7 million for the first six months of 2020, a decrease of $1.9 million from the same period last year.

The economic slowdown and decreased commodity pricing has reduced demand for surety bonds.

Additionally, we continually monitor our portfolio for higher risk accounts and have selectively eliminated exposures that no longer met our underwriting standards.

Underwriting Income

Underwriting income for the Group totaled $17.2 million for the first quarter of 2020, compared to $22.4 million in the same period last year.

Both periods reflect positive underwriting results for the current accident year and favorable reserve development on prior accident years, with 2019 experiencing a larger benefit.

The combined ratio for the Group totaled 92.0 in the first quarter of 2020, compared to 89.0 in the same period of 2019.

The loss ratio increased to 51.5 from 46.0, due to the decreased level of favorable development in 2020 and the addition of $5.0 million in current accident year reserves related to COVID-19 investigative and claim defense costs.

The Group’s expense ratio decreased to 40.5 from 43.0 as 2019 experienced strong earnings and growth in book value, which led to larger levels of bonus and profit-sharing expenses.

For the Three-Month Periods

Ended March 31,

Underwriting income for the Group totaled $41.4 million for the first six months of 2020, compared to $37.4 million in the same period of 2019.

Both periods reflect positive underwriting results for the current accident year and similar amounts of favorable reserve development on prior accident years.

The combined ratio for the Group totaled 90.2 in the first half of 2020, compared to 90.9 in the same period of 2019.

The loss ratio increased to 50.0 from 48.1, primarily due to the addition of $10.8 million in current accident year reserves related to COVID-19 loss and claim defense costs.

The Group’s expense ratio decreased to 40.2 from 42.8, as 2019 experienced stronger growth in book value, which led to larger levels of bonus and profit-sharing expenses.

For the Six-Month Periods

Ended June 30,

Underwriting income (in thousands)

Combined ratio

The casualty segment recorded an underwriting loss of $1.3 million in the first quarter of 2020, compared to $5.3 million of underwriting income for the same period last year.

The casualty segment recorded underwriting earnings of $8.4 million in the first half of 2020, compared to $12.3 million of underwriting income for the same period last year.

Reserve releases reduced loss and settlement expenses for the casualty segment by $27.5 million, primarily on accident years 2016 through 2019.

Transportation, small commercial and general liability were drivers of the favorable development.

In comparison, $13.3 million of reserves were released in the first quarter of 2019.

Transportation, general liability, executive products and small commercial were drivers of the favorable development.

In comparison, $30.7 million of reserves were released in the first half of 2019.

General liability, professional services, transportation, commercial excess, personal umbrella and small commercial developed favorably, while executive products developed adversely.

1 unchanged sentence

The segment’s loss ratio was 61.7 in 2020, up from 58.3 in 2019.

The loss ratio increased in 2020 as a result of less favorable development on prior years’ reserves and the addition of $3.0 million in current year reserves related to COVID-19 investigative and defense costs.

The loss ratio increased in 2020 as a result of less favorable development on prior years’ reserves and the addition of $7.7 million in current year reserves related to COVID-19 loss and defense costs.

The expense ratio for the casualty segment was 35.3, down from 37.2 for the same period last year, as reduced levels of bonus and profit-sharing expenses were incurred.

The property segment recorded underwriting income of $9.9 million for the first quarter of 2020, compared to $8.2 million for the same period last year.

Underwriting results for 2020 included $4.8 million of favorable development on prior years’ loss and catastrophe reserves, primarily from the marine business, and $0.5 million of storm losses.

The property segment recorded underwriting income of $16.1 million for the first six months of 2020, compared to $7.8 million for the same period last year.

Underwriting results for 2020 included $5.5 million of favorable development on prior years’ loss and catastrophe reserves, primarily from the marine business, $5.3 million of storm and civil unrest losses and $2.0 million of reserves related to COVID-19 investigative and defense costs.

Comparatively, the 2019 underwriting results included $2.1 million of favorable development on prior years’ loss and catastrophe reserves and $4.7 million of storm losses.

Underwriting results for the first quarter of 2020 translated into a combined ratio of 77.7, compared to 78.7 for the same period last year.

The segment’s loss ratio was 36.0 in 2020, up from 33.4 in 2019 due to the addition of $2.0 million in current year reserves related to COVID-19 investigative and defense costs.

Underwriting results for the first half of 2020 translated into a combined ratio of 82.1, compared to 90.1 for the same period last year.

The segment’s loss ratio was 41.8 in 2020, down from 45.1 in 2019 due to lower current accident year losses and more favorable development on prior years’ reserves.

The segment’s expense ratio decreased to 40.3 in 2020 from 45.0 in the prior year, as increased levels of earned premium allowed the segment to better leverage expenses.

The surety segment recorded underwriting income of $8.7 million for the first quarter of 2020, compared to $8.8 million for the same period last year.

The surety segment recorded underwriting income of $16.9 million for the first half of 2020, compared to $17.3 million for the same period last year.

Both periods reflected positive current accident year underwriting performance and benefited from favorable development on prior years’ loss reserves.

Results for 2020 included favorable development on prior accident

years’ reserves, which decreased loss and settlement expenses for the segment by $4.0 million.

Comparatively, 2019 results included favorable development on prior accident years’ loss reserves across most products, which decreased the segment’s loss and settlement expenses by $4.2 million.

The combined ratio for the surety segment totaled 68.9 for the first quarter of 2020, compared to 69.5 for the same period in 2019.

The segment’s loss ratio was 2.8 in 2020, down from 3.1 in 2019.

years’ reserves, which decreased loss and settlement expenses for the segment by $7.8 million, and offset $1.1 million in current year reserves established for COVID-19 related losses.

Comparatively, 2019 results included favorable development on prior accident years’ loss reserves, which decreased the segment’s loss and settlement expenses by $8.0 million.

The combined ratio for the surety segment totaled 69.8 for the first six months of 2020, compared to 70.4 for the same period in 2019.

The segment’s loss ratio was 5.0 in 2020, up from 3.6 in 2019.

The expense ratio was 64.8, down from 66.8 in the prior year.

Investment Income and Realized Capital Gains

Our investment portfolio generated net investment income of $17.8 million during the first quarter of 2020, an increase of 7.3 percent from that reported for the same period in 2019.

Our investment portfolio generated net investment income of $34.7 million during the first half of 2020, an increase of 3.4 percent from that reported for the same period in 2019.

The increase in investment income was largely due to a larger asset base relative to the prior year.

Yields on our fixed income investments for the first quarter of 2020 and 2019 were as follows:

Yields on our fixed income investments for the first half of 2020 and 2019 were as follows:

After-Tax Yield

We recognized $15.2 million of realized gains in the first quarter of 2020, which were comprised of $15.2 million of realized gains on equity securities from rebalancing our portfolio, $2.3 million of realized gains on the fixed income portfolio and $2.3 million of other realized losses.

This compares to realized gains of $9.1 million in the first quarter of 2019, which were comprised of $8.4 million of realized gains on the equity portfolio and $0.6 million of realized gains on the fixed income portfolio.

The following table depicts the composition of our investment portfolio at March 31, 2020 as compared to December 31, 2019:

March 31, 2020

We recognized $13.0 million of realized gains in the first half of 2020, which were comprised of $12.8 million of realized gains on equity securities from rebalancing our portfolio, $2.6 million of realized gains on the fixed income portfolio and $2.4 million of other realized losses.

This compares to realized gains of $13.8 million in the first half of 2019, which were comprised of $12.3 million of realized gains on the equity portfolio, $1.3 million of realized gains on the fixed income portfolio and $0.2 million of other realized gains.

The following table depicts the composition of our investment portfolio at June 30, 2020 as compared to December 31, 2019:

June 30, 2020

December 31, 2019

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We believe our overall asset allocation best meets our strategy to preserve capital for policyholders, provide sufficient income to support insurance operations, and to effectively grow book value over a long-term investment horizon.

The fixed income portfolio decreased by $19.5 million in the first three months of 2020.

The decrease was due to increased credit spreads more than offsetting declines in interest rates during the first three months of the year, decreasing the fair value of securities in the fixed income portfolio.

Average fixed income duration was 4.6 years at March 31, 2020, reflecting our current liability structure and sound capital position.

The equity portfolio decreased by $104.2 million during the first three months of 2020 as the equity market sold off sharply in the quarter.

Our effective tax rate for the first quarter of 2020 was 22.8 percent, compared to 19.9 percent for the same period in 2019.

The fixed income portfolio increased by $92.0 million in the first six months of 2020.

The increase was due to declines in interest rates during the first six months of the year, lifting the fair value of securities in the fixed income portfolio.

Average fixed income duration was 4.6 years at June 30, 2020, reflecting our current liability structure and sound capital position.

The equity portfolio decreased by $38.4 million during the first six months of 2020 as the equity market sold off sharply in the first quarter.

Our effective tax rate for the first six months of 2020 was 13.0 percent, compared to 18.9 percent for the same period in 2019.

Effective rates are dependent upon components of pretax earnings or losses and the related tax effects.

The effective rate was higher for the first quarter of 2020 as tax-favored adjustments increased the tax benefit realized on pretax losses.

The effective rate was lower for the first half of 2020 as lower levels of pre-tax earnings caused tax-favored adjustments to be larger on a percentage basis when compared to the prior year.

Three Months Ended June 30, 2020 Compared to Three Months Ended June 30, 2019

Consolidated revenue for the second quarter of 2020 increased $60.1 million from the second quarter of 2019.

A partial recovery from the market declines experienced in the first quarter resulted in $74.7 million of unrealized gains on equity securities in the second quarter of 2020, compared to $8.8 million of unrealized gains in the second quarter of 2019.

Net premiums earned for the Group increased 1 percent, driven by growth from our property segment, which offset declines in our surety segment.

Investment income decreased 1 percent due to lower average yields relative to the prior year.

Realized losses during the quarter were $2.1 million and were comprised of $2.3 million of realized losses on equity securities from rebalancing our portfolio, $0.3 million of realized gains on the fixed income portfolio and $0.1 million of other realized losses.

This compares to realized gains of $4.8 million in the second quarter of 2019, which were comprised of $3.9 million of realized gains on the equity portfolio, $0.7 million of realized gains on the fixed income portfolio and $0.2 million of miscellaneous realized gains.

For the Three-Month Periods

Ended June 30,

Consolidated revenues (in thousands)

Net premiums earned

Net investment income

Net realized gains (losses)

Net unrealized gains (losses) on equity securities

Total consolidated revenue

Net earnings for the second quarter of 2020 totaled $92.2 million, compared to $40.5 million for the same period in 2019.

The increase in earnings for 2020 was primarily attributed to $59.0 million of net after-tax unrealized gains on equity securities, compared to $7.0 million in 2019.

Underwriting results for both periods reflect profitable current accident year results and favorable development from prior years’ loss reserves.

Favorable development on prior years’ loss reserves provided additional pretax earnings of $25.6 million in the second quarter of 2020, compared to $21.2 million in 2019.

Catastrophe activity consisted of $6.0 million of pretax storm and civil unrest losses in the second quarter of 2020, compared to $4.0 million of storm losses in 2019.

Pretax bonus and profit sharing-related expenses associated with the net impact of prior years’ reserve development and catastrophe losses totaled $2.9 million in 2020, compared to $2.5 million in 2019.

These performance-related expenses affected policy acquisition, insurance operating and general corporate expenses.

During the second quarter of 2020, equity in earnings of unconsolidated investees totaled $5.1 million.

This amount includes $2.6 million from Maui Jim and $2.5 million from Prime.

Comparatively, the second quarter of 2019 reflected $8.5 million of earnings, including $6.5 million from Maui Jim and $2.0 million from Prime.

The decline in earnings from Maui Jim is reflective of the shutdown much of the traditional retail sector experienced as a result of the pandemic.

Comprehensive earnings totaled $145.7 million for the second quarter of 2020, compared to $68.3 million of comprehensive earnings for the second quarter of 2019.

Other comprehensive earnings primarily included after-tax unrealized gains and losses from the fixed income portfolio.

The second quarter’s $53.6 million of other comprehensive earnings was due to declines in interest rates, which increased the market value of the portfolio.

This compares to $27.9 million of other comprehensive earnings for the same period in 2019.

Gross premiums written for the Group increased $3.9 million for the second quarter of 2020 when compared to the same period of 2019.

Rate increases across the property and casualty portfolios were the largest influence on growth.

Net premiums earned increased $1.2 million, also driven by products in the property segment.

Gross Premiums Written

Net Premiums Earned

For the Three-Month Periods Ended June 30,

(in thousands)

Commercial excess and personal umbrella

General liability

Commercial transportation

Professional services

Small commercial

Executive products

Other casualty

Commercial property

Specialty personal

Other property

Miscellaneous

Gross premiums written for the casualty segment were up $0.9 million in the second quarter of 2020.

Premiums from commercial excess and personal umbrella increased $10.5 million, due to an expanded distribution base in personal umbrella, which supplemented rate increases.

Substantial rate increases led to a 22 percent increase for our executive products group.

Transportation continues to be significantly affected by the stay at home orders associated with COVID-19.

This is particularly impactful on our public transportation book that has a focus on charter or city buses, which stopped running to a large degree in March.

A slowdown or suspension of construction activity in certain parts of the country also led to the decline in general liability.

Gross premiums written for the property segment totaled $69.3 million for the second quarter of 2020, up $4.9 million from the same period last year.

Our commercial property business was up $3.4 million, as rates on wind-prone and earthquake exposures continued to increase.

Market disruption created new business opportunities and led to $1.7 million of growth for our marine product.

Other property premium increased as a result of property exposed GBA business that continues to gain scale.

The surety segment recorded gross premiums written of $27.8 million for the second quarter of 2020, a decrease of $2.0 million from the same period last year.

The surety market remains very competitive.

Additionally, the economic downturn, decreased commodity pricing and less regulation has reduced demand for bonds.

Underwriting Income

Underwriting income for the Group totaled $24.2 million for the second quarter of 2020, compared to $14.9 million in the same period last year.

Both periods reflect positive underwriting results for the current accident year and favorable reserve

development on prior accident years, with 2020 experiencing a larger benefit.

The combined ratio for the Group totaled 88.4 in the second quarter of 2020, compared to 92.8 in the same period of 2019.

The loss ratio decreased to 48.5 from 50.1, due to the increased level of favorable development in 2020.

The Group’s expense ratio decreased to 39.9 from 42.7, as 2019 experienced stronger earnings and growth in book value in the six-month period ended June 30, which led to larger levels of bonus and profit-sharing expenses.

For the Three-Month Periods

Ended June 30,

Underwriting income (loss) (in thousands)

Combined ratio

The casualty segment recorded underwriting income of $9.7 million in the second quarter of 2020, compared to $6.9 million for the same period last year.

Reserve releases reduced loss and settlement expenses for the casualty segment by $21.1 million, primarily on accident years 2016 through 2018.

Transportation, executive products, general liability and professional services were drivers of the favorable development.

Partially offsetting these benefits, $4.7 million of current year reserves were established in the second quarter of 2020 for COVID-19 related loss and defense costs.

In comparison, $17.5 million of reserves were released in the second quarter of 2019, with nearly every product contributing to the favorable development.

The combined ratio for the casualty segment was 92.8 in 2020, compared to 95.0 in 2019.

The segment’s loss ratio was 57.4 in 2020, down from 57.9 in 2019.

The loss ratio decreased in 2020 as a result of a shift in mix of business towards products with lower loss booking ratios and more favorable development on prior years’ reserves.

The expense ratio for the casualty segment was 35.4, down from 37.1 for the same period last year, as reduced levels of bonus and profit-sharing expenses were incurred.

The property segment recorded underwriting income of $6.2 million for the second quarter of 2020, compared to $0.4 million of underwriting loss for the same period last year.

Underwriting results for 2020 included $0.7 million of favorable development on prior years’ loss and catastrophe reserves and $4.8 million of storm and civil unrest losses.

Comparatively, the 2019 underwriting results included $0.1 million of adverse development on prior years’ loss and catastrophe reserves and $3.9 million of storm losses.

Underwriting results for the second quarter of 2020 translated into a combined ratio of 86.4, compared to 101.1 for the same period last year.

The segment’s loss ratio was 47.5 in 2020, down from 56.5 in 2019 due to the combination of a larger amount of favorable development and decreased current accident year non-catastrophe losses.

The segment’s expense ratio decreased to 38.9 in 2020 from 44.6 in the prior year, as increased levels of earned premium allowed the segment to better leverage expenses and reduced levels of bonus and profit-sharing expenses were incurred.

The surety segment recorded underwriting income of $8.3 million for the second quarter of 2020, compared to $8.4 million for the same period last year.

Both periods reflected positive current accident year underwriting performance and benefited from favorable development on prior years’ loss reserves.

Results for 2020 and 2019 included favorable development on prior accident years’ loss reserves across all products, which decreased the segment’s loss and settlement expenses by $3.8 million.

Additionally, $1.1 million of reserves were established in 2020 for COVID-19 related losses.

The combined ratio for the surety segment totaled 70.6 for the second quarter of 2020, compared to 71.2 for the same period in 2019.

The segment’s loss ratio was 7.1 in 2020, up from 4.1 in 2019 due to the recognition of COVID-19 related losses.

The expense ratio was 63.5, down from 67.1 in the prior year as stronger growth in book value led to increased bonus and profit-sharing expenses in 2019.

Investment Income and Realized Capital Gains

Our investment portfolio generated net investment income of $16.9 million during the second quarter of 2020, a decrease of 0.5 percent from that reported for the same period in 2019.

The decrease in investment income was largely due to a decline in yields relative to the prior year.

Yields on our fixed income investments for the second quarter of 2020 and 2019 were as follows:

After-Tax Yield

We recognized $2.1 million of realized losses in the second quarter of 2020, which were comprised of $2.3 million of realized losses on equity securities from rebalancing our portfolio, $0.3 million of realized gains on the fixed income portfolio and $0.1 million of other realized losses.

Our effective tax rate for the second quarter of 2020 was 19.8 percent, compared to 17.1 percent for the same period in 2019.

Effective rates are dependent upon components of pretax earnings or losses and the related tax effects.

The effective rate was higher for the second quarter of 2020 due to higher levels of pre-tax earnings and lower levels of tax-favored adjustments compared to 2019.

LIQUIDITY AND CAPITAL RESOURCES

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(1) cash flows from operating activities, which consist mainly of cash generated by our underwriting operations and income earned on our investment portfolio, (2) cash flows from investing activities related to the purchase, sale and maturity of investments, and (3) cash flows from financing activities that impact our capital structure, such as shareholder dividend payments and changes in debt and shares outstanding.

The following table summarizes cash flows provided by (used in) our activities for the three-month periods ended March 31, 2020 and 2019:

The following table summarizes cash flows provided by (used in) our activities for the six-month periods ended June 30, 2020 and 2019:

(in thousands)

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Cash flows from operating activities can vary among periods due to the timing in which these payments are made or received.

Operating cash flows in the first quarter of 2020 were impacted by increased levels of loss and settlement expense payments relative to the first quarter of 2019.

Additionally, improved financial performance in 2019 resulted in a higher level of bonus and profit-sharing contributions that were paid in the first quarter of 2020, which also reduced operating cash flows in the current period.

Operating cash flows in the first half of 2020 were impacted by increased levels of loss and settlement expense payments relative to the first six months of 2019.

We have $149.4 million in debt outstanding.

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The notes were issued at a discount resulting in proceeds, net of discount and commission, of $148.6 million.

The estimated fair value for the senior note at March 31, 2020 was $154.7 million.

The estimated fair value for the senior note at June 30, 2020 was $162.7 million.

The fair value of our debt is estimated based on the limited observable prices that reflect thinly traded securities.

As of March 31, 2020, we had cash and other investments maturing within one year of approximately $99.4 million and an additional $449.4 million maturing between one to five years.

As of June 30, 2020, we had cash and other investments maturing within one year of approximately $160.7 million and an additional $496.0 million maturing between one to five years.

Whereas our strategy is to be fully invested at all times, short-term investments in excess of demand deposit balances are considered a component of investment activities, and thus are classified as investments in our consolidated balance sheets.

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The facility has a three-year term that expires on March 27, 2023.

As of and during the three-month period ended March 31, 2020, no amounts were outstanding on either facility.

As of and during the three-month period ended June 30, 2020, no amounts were outstanding on either facility.

Additionally, two of our insurance companies, RLI Ins.

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Our membership allows each insurance subsidiary to determine tenor and structure at the time of borrowing.

As of and during the three-month period ended March 31, 2020, there were no outstanding borrowing amounts with the FHLBC.

As of and during the six-month period ended June 30, 2020, there were no outstanding borrowing amounts with the FHLBC.

We believe that cash generated by operations and investments will provide sufficient sources of liquidity to meet our anticipated needs over the next 12 to 24 months.

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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 March 31, 2020, our investment portfolio had a balance sheet value of $2.4 billion.

Invested assets at March 31, 2020 have decreased $144.1 million from December 31, 2019.

As of March 31, 2020, our investment portfolio had the following asset allocation breakdown:

Invested assets at June 30, 2020 have increased $85.2 million from December 31, 2019.

As of June 30, 2020, our investment portfolio had the following asset allocation breakdown:

Portfolio Allocation

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Quality is an average of each bond’s credit rating, adjusted for its relative weighting in the portfolio.

As of March 31, 2020, our fixed income portfolio had the following rating distribution:

As of March 31, 2020, the duration of the fixed income portfolio was 4.6 years.

As of June 30, 2020, our fixed income portfolio had the following rating distribution:

As of June 30, 2020, the duration of the fixed income portfolio was 4.6 years.

Our fixed income portfolio remained well diversified, with 1,288 individual issues.

Our investment portfolio has limited exposure to structured asset-backed securities.

As of March 31, 2020, we had $141.9 million in ABS which are pools of assets collateralized by cash flows from several types of loans, including home equity, credit cards, autos and structured bank loans in the form of collateralized loan obligations (CLOs).

As of March 31, 2020, we had $81.7 million in commercial mortgage backed securities and $414.3 million in mortgage backed securities backed by government sponsored enterprises (GSEs - Freddie Mac, Fannie Mae and Ginnie Mae).

As of June 30, 2020, we had $137.9 million in ABS which are pools of assets collateralized by cash flows from several types of loans, including home equity, credit cards, autos and structured bank loans in the form of collateralized loan obligations (CLOs).

As of June 30, 2020, we had $80.6 million in commercial mortgage backed securities and $409.2 million in mortgage backed securities backed by government sponsored enterprises (GSEs - Freddie Mac, Fannie Mae and Ginnie Mae).

Excluding the GSE backed MBS, our exposure to ABS and CMBS was 8.2 percent of our investment portfolio at quarter end.

We had $688.4 million in corporate fixed income securities as of March 31, 2020, which includes $93.0 million invested in a high yield credit strategy.

We had $765.1 million in corporate fixed income securities as of June 30, 2020, which includes $98.2 million invested in a high yield credit strategy.

This high-yield portfolio consists of floating rate bank loans and bonds that are below investment grade in credit quality and offer incremental yield over our core fixed income portfolio.

We also maintain an allocation to municipal fixed income securities.

As of March 31, 2020, we had $406.0 million in municipal securities.

As of June 30, 2020, we had $455.7 million in municipal securities.

The municipal portfolio includes approximately 73 percent tax-exempt securities and 27 percent taxable securities.

Approximately 86 percent of our municipal bond portfolio maintains an ‘AA’ or better rating, while 99 percent of the municipal bond portfolio is rated ‘A’ or better.

Our equity portfolio had a fair value of $356.4 million as of March 31, 2020 and is also a source of liquidity.

Our equity portfolio had a fair value of $422.2 million as of June 30, 2020 and is also a source of liquidity.

The securities within the equity portfolio remain primarily invested in large-cap issues with a focus on dividend income.

In the equity portfolio, the strategy remains one of value investing, with security selection taking precedence over market timing.

As of March 31, 2020, our equity portfolio had a dividend yield of 2.8 percent, compared to 2.3 percent for the S&P 500 index.

As of June 30, 2020, our equity portfolio had a dividend yield of 2.1 percent, compared to 1.9 percent for the S&P 500 index.

Because of the corporate dividend-received-deduction applicable to our dividend income, we pay an effective tax rate of 13.1 percent on dividends, compared to 21.0 percent on taxable interest and 5.3 percent on municipal bond interest income.

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No single stock exposure is greater than 2 percent of the equity portfolio.

We had $53.6 million of other invested assets at March 31, 2020, including investments in low income housing tax credit partnerships, membership in the FHLBC, investments in private funds and investments in restricted stock.

As of March 31, 2020, $15.1 million of investments were pledged as collateral with the FHLBC to ensure timely access to the secured lending facility that ownership of FHLBC stock provides.

As of and during the three-month period ending March 31, 2020, there were no outstanding borrowings with the FHLBC.

We had $63.4 million of other invested assets at June 30, 2020, including investments in low income housing tax credit partnerships, membership in the FHLBC, investments in private funds and investments in restricted stock.

As of June 30, 2020, $14.6 million of investments were pledged as collateral with the FHLBC to ensure timely access to the secured lending facility that ownership of FHLBC stock provides.

As of and during the six-month period ending June 30, 2020, there were no outstanding borrowings with the FHLBC.

Our investment portfolio does not have any exposure to derivatives.

Our capital structure is comprised of equity and debt outstanding.

As of March 31, 2020, our capital structure consisted of $149.3 million in 10-year maturity senior notes maturing in 2023 (debt) and $915.7 million of shareholders’ equity.

Debt outstanding comprised 14.0 percent of total capital as of March 31, 2020.

Interest and fees on debt obligations totaled $1.9 million during the first three months of 2020, the same amount as the previous year.

We have incurred interest expense on debt at an average annual interest rate of 4.91 percent for the three-month periods ended March 31, 2020 and 2019.

We paid a regular quarterly cash dividend of $0.23 per share on March 20, 2020, the same as the prior quarter.

As of June 30, 2020, our capital structure consisted of $149.4 million in 10-year maturity senior notes maturing in 2023 (debt) and $1.1 billion of shareholders’ equity.

Debt outstanding comprised 12.4 percent of total capital as of June 30, 2020.

Interest and fees on debt obligations totaled $3.8 million during the first six months of 2020, compared to $3.7 million during the same period in 2019.

We have incurred interest expense on debt at an average annual interest rate of 4.91 percent for the three-month periods ended June 30, 2020 and 2019.

We paid a regular quarterly cash dividend of $0.24 per share on June 19, 2020, a $0.01 increase over the prior quarter.

We have increased dividends in each of the last 45 years.

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shareholders.

On a GAAP basis, as of March 31, 2020, our holding company had $915.7 million in equity.

On a GAAP basis, as of June 30, 2020, our holding company had $1.1 billion in equity.

This includes amounts related to the equity of our insurance subsidiaries, which is subject to regulatory restrictions under state insurance laws.

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Any dividend distribution in excess of the ordinary dividend limits is deemed extraordinary and requires prior approval from the Illinois Department of Insurance (IDOI).

In the first three months of 2020, RLI Ins.

In the first six months of 2020, RLI Ins.

paid $22.0 million in ordinary dividends to RLI Corp.

In 2019, our principal insurance subsidiary paid ordinary dividends totaling $59.0 million.

As of March 31, 2020, $53.8 million of the net assets of our principal insurance subsidiary were not restricted and could be distributed to RLI Corp.

As of June 30, 2020, $43.3 million of the net assets of our principal insurance subsidiary were not restricted and could be distributed to RLI Corp.

as ordinary dividends without prior approval from the IDOI.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis