Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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. These assumptions are subject to various risks, uncertainties and other factors, including, without limitation those set forth in “Item 1A. Risk Factors” within the Annual Report on Form 10-K for the year ended December 31, 2021 and Part II within this report. 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.
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 (Group). Our focus is on niche markets and developing unique products that are tailored to customers’ needs. We hire underwriters and claim examiners 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 2021, we achieved our 26th consecutive year of underwriting profitability. Over the 26-year period, we averaged an 88.4 combined ratio. 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.
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 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. This requires that liabilities be estimated and recorded in recognition of future loss and settlement obligations. Due to the inherent uncertainty in estimating these liabilities, there can be no assurance that actual liabilities will equal recorded amounts. If actual liabilities differ from recorded amounts, there will be an adverse or favorable effect on net earnings.
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 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. 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, and wind storms to commercial properties throughout the Gulf and East Coast, as well as to homes we insure in Hawaii. 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 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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The surety segment specializes in writing small to large-sized commercial and contract surety coverages, including payment and performance bonds. 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. This line has historically produced marginally higher loss ratios than other surety lines during economic downturns.
The insurance marketplace is competitive across all of our segments. However, we believe that our business model is built to create underwriting income by focusing on sound risk selection and discipline. Our primary focus will continue to be on underwriting profitability, with a secondary focus on premium growth where we believe underwriting profit exists, as opposed to general premium growth or market share measurements.
GAAP, non-GAAP and Performance Measures
Throughout this quarterly report, we include certain non-generally accepted accounting principles (non-GAAP) financial measures. Management believes that these non-GAAP measures further 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.
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
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 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 2021 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 gains 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 Months
For the Nine Months
Ended September 30,
Ended September 30,
(in thousands)
2022
2021
2022
2021
Net earnings
$
439,893
$
29,243
$
485,577
$
184,070
Income tax expense
114,809
6,194
121,096
43,222
Earnings before income taxes
$
554,702
$
35,437
$
606,673
$
227,292
Equity in (earnings) loss of unconsolidated investees
17,352
(9,043)
(3,061)
(29,407)
General corporate expenses
2,755
2,505
8,553
9,533
Interest expense on debt
2,013
1,906
6,034
5,711
Net unrealized (gains) losses on equity securities
26,414
2,592
155,218
(29,526)
Net realized gains
(573,170)
(1,829)
(591,562)
(52,442)
Net investment income
(21,270)
(17,844)
(57,625)
(50,929)
Net underwriting income
$
8,796
$
13,724
$
124,230
$
80,232
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.
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Critical Accounting Policies
In preparing the unaudited condensed consolidated interim 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 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, recoverability of reinsurance balances, deferred policy acquisition costs and deferred taxes. For a detailed discussion of each of these policies, refer to our 2021 Annual Report on Form 10-K.
There have been no significant changes to critical accounting policies during the year.
IMPACT OF COVID-19
Our processes and controls continue to operate effectively and we have been able to maintain high service and support levels for our customers throughout the COVID-19 pandemic. As of September 30, 2022, our premium production was unaffected by the direct impacts of the pandemic. However, actuarial models base future loss emergence on historical experience, with adjustments for current trends, and the appropriateness of these assumptions still involves greater uncertainty. We expect there will be impacts to the timing of loss emergence and ultimate loss ratios for certain coverages. The industry experienced new issues throughout the pandemic, including the postponement of civil court cases, the extension of various statutes of limitations and changes in settlement trends. 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 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 environment and any remaining uncertainty.
RESULTS OF OPERATIONS
Nine Months Ended September 30, 2022 Compared to Nine Months Ended September 30, 2021
Net premiums earned for the Group increased 17 percent, driven by growth from our casualty and property segments. Overall market declines resulted in $155.2 million of unrealized losses on equity securities in the first nine months of 2022, while positive market performance resulted in $29.5 million of unrealized gains in our equity portfolio in 2021. Investment income was up 13 percent, due to an increased average asset base and higher interest rates relative to the prior year. Realized gains during the first nine months of 2022 were comprised of $19.8 million of realized gains on equity securities, primarily due to rebalancing within our equity strategies, $2.7 million of realized losses on the fixed income portfolio and a $574.5 million gain from the sale of our equity method investment in Maui Jim, Inc (Maui Jim). This compares to $50.6 million of realized gains on the equity portfolio, $1.7 million of realized gains on the fixed income portfolio and $0.1 million of other realized gains for the same period in 2021.
For the Nine Months
Ended September 30,
Consolidated Revenues (in thousands)
2022
2021
Net premiums earned
$
843,430
$
722,984
Net investment income
57,625
50,929
Net realized gains
591,562
52,442
Net unrealized gains (losses) on equity securities
(155,218)
29,526
Total consolidated revenue
$
1,337,399
$
855,881
Net earnings for the first nine months of 2022 totaled $485.6 million, compared to $184.1 million for the same period in 2021. The increase for 2022 was primarily attributed to the $437.7 million after tax earnings recognized from the sale of our equity method investment in Maui Jim. This gain was partially offset by $107.0 million of net after-tax realized and unrealized losses on equity securities, compared to $63.3 million of after-tax realized and unrealized gains in 2021. Underwriting results for 2022 were impacted by $40.0 million of pretax hurricane losses and $5.0 million of pretax storm losses. Comparatively, underwriting results for 2021 included $34.0 million of pretax hurricane losses and $25.0 million of pretax storm losses.
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Results for each period benefited from favorable development on prior years’ loss reserves, which provided additional pretax earnings of $103.0 million in the first nine months of 2022, compared to $97.0 million in 2021.
Bonus and profit-sharing amounts earned by executives, managers and associates are predominantly influenced by corporate performance, including operating earnings, combined ratio and return on capital. Favorable development and other drivers of growth in book value will increase bonus and profit-sharing expenses, while catastrophe losses, adverse development and decreased investment portfolio returns would lead to expense reductions. These performance-related expenses affect policy acquisition, insurance operating and general corporate expenses.
Underwriting income was $124.2 million on an 85.3 combined ratio for the first nine months of 2022, compared to $80.2 million on an 88.9 combined ratio in the same period of 2021. The loss ratio decreased to 46.1 from 49.2, due to lower levels of storm losses and higher levels of favorable development on prior years’ loss reserves in 2022. The Group’s expense ratio decreased to 39.2 from 39.7, with 2022 benefiting from a larger earned premium base.
Our equity in earnings of unconsolidated investees primarily relate to our investments in Maui Jim, a manufacturer of high-quality sunglasses, and Prime Holdings Insurance Services, Inc. (Prime), a specialty insurance company. In the first nine months of 2022, $3.1 million of investee losses were recorded for Maui Jim, primarily due to transaction related expenses from the sale of the company. We recognized $9.3 million of investee earnings from Prime. Comparatively, the first nine months of 2021 reflected investee earnings of $19.7 million and $11.7 million from Maui Jim and Prime, respectively. The decrease in earnings from Prime is largely attributable to unrealized loss on their equity security portfolio.
Comprehensive earnings totaled $191.2 million for the first nine months of 2022, compared to $142.3 million for the first nine months of 2021. Other comprehensive earnings (loss) primarily included net after-tax unrealized gains and losses from the fixed income portfolio. Other comprehensive loss of $294.4 million in the first nine months of 2022 was attributable to higher interest rates, which decreased the fair value of securities held in the fixed income portfolio. Comparatively, $41.8 million of other comprehensive loss was recognized in 2021 as interest rates increased.
Premiums
Gross premiums written for the Group increased $171.6 million for the first nine months of 2022, compared to the same period of 2021. Growth was achieved in all three segments, though the increase was largely driven by products in the property and casualty segments. Net premiums earned increased $120.4 million, also driven by products in our casualty and property segments.
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Gross Premiums Written
Net Premiums Earned
For the Nine Months
For the Nine Months
Ended September 30,
Ended September 30,
(in thousands)
2022
2021
% Change
2022
2021
% Change
Casualty
Commercial excess and personal umbrella
$
247,750
$
212,709
16
%
$
187,666
$
161,287
16
%
General liability
84,405
73,877
14
%
74,130
67,616
10
%
Commercial transportation
98,691
84,888
16
%
71,774
60,926
18
%
Professional services
79,406
74,044
7
%
71,590
66,095
8
%
Small commercial
55,529
52,784
5
%
50,463
48,302
4
%
Executive products
73,307
97,018
(24)
%
20,208
15,785
28
%
Other casualty
65,414
62,701
4
%
52,663
47,806
10
%
Total
$
704,502
$
658,021
7
%
$
528,494
$
467,817
13
%
Property
Commercial property
$
241,800
$
147,805
64
%
$
115,419
$
76,488
51
%
Marine
100,923
84,750
19
%
84,499
72,737
16
%
Specialty personal
21,338
18,127
18
%
18,405
15,761
17
%
Other property
7,468
5,914
26
%
4,651
3,407
37
%
Total
$
371,529
$
256,596
45
%
$
222,974
$
168,393
32
%
Surety
Commercial
$
39,560
$
36,988
7
%
$
35,423
$
33,594
5
%
Miscellaneous
38,394
35,866
7
%
33,691
32,604
3
%
Contract
27,713
22,654
22
%
22,848
20,576
11
%
Total
$
105,667
$
95,508
11
%
$
91,962
$
86,774
6
%
Grand Total
$
1,181,698
$
1,010,125
17
%
$
843,430
$
722,984
17
%
Casualty
Gross premiums written for the casualty segment were up $46.5 million in the first nine months of 2022. Gross premiums from commercial excess and personal umbrella increased $35.0 million, due to rate increases and an expanded distribution base. Increases in new construction projects led to the increase in general liability premium. Commercial transportation premium increased by $13.8 million, driven by our public transportation line, where customers put vehicles back in service on policies that were suspended throughout the first two years of the pandemic. Executive products premium decreased as a result of a more competitive market and the exit from our large account cyber and representations and warranties programs.
Property
Gross premiums written for the property segment were up $114.9 million in the first nine months of 2022. Our commercial property business was up $94.0 million, as rates on wind exposures continued to increase, building valuations rose and market disruption provided an opportunity to grow while strengthening terms and conditions. Rate increases, improved retention and new opportunities in the inland marine space led to $16.2 million of premium growth for our marine product.
Surety
Gross premiums written for the surety segment were up $10.2 million for the first nine months of 2022. Contract surety benefited from new construction opportunities and larger contract values, driven by the inflation of material prices. The growth in miscellaneous surety is broad based and has been supported by our focus on customer experience and technology. The expansion of existing accounts and new business resulted in increased premium for commercial surety.
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Underwriting Income
For the Nine Months
Ended September 30,
2022
2021
Underwriting Income (Loss) (in thousands)
Casualty
$
60,418
$
74,254
Property
40,273
(8,684)
Surety
23,539
14,662
Total
$
124,230
$
80,232
Combined Ratio
Casualty
88.6
84.1
Property
81.9
105.2
Surety
74.4
83.1
Total
85.3
88.9
Casualty
The casualty segment recorded underwriting income of $60.4 million in the first nine months of 2022, compared to $74.3 million for the same period last year. Reserve releases reduced loss and settlement expenses for the casualty segment by $72.9 million, primarily on accident years 2018 through 2021. Favorable development was widespread, with notable amounts from general liability, professional services, transportation, executive products and commercial excess. In comparison, $83.6 million of reserves were released in the first nine months of 2021. General liability, transportation, professional services, small commercial, commercial excess and personal umbrella were drivers of the favorable development. Offsetting the favorable development, hurricane and storm losses on casualty-oriented package policies that include property coverage resulted in $7.5 million of losses in 2022 and $4.0 million of losses in 2021.
The combined ratio for the casualty segment was 88.6 in 2022, compared to 84.1 in 2021. The segment’s loss ratio was 52.8 in 2022, up from 48.9 in 2021. Lower levels of reserve releases on prior accident years and larger storm losses resulted in the higher loss ratio in 2022, while current accident year attritional losses were slightly improved. The expense ratio for the casualty segment was 35.8, up from 35.2 for the same period last year.
Property
The property segment recorded underwriting income of $40.3 million for the first nine months of 2022, compared to $8.7 million of underwriting loss for the same period last year. Underwriting results for 2022 included $20.8 million of favorable development on prior years’ loss and catastrophe reserves across all products, $33.0 million of hurricane losses and $4.5 million of other storm losses. Comparatively, the 2021 underwriting results included $10.8 million of favorable development on prior years’ loss and catastrophe reserves, $32.6 million of hurricane losses and $22.3 million of other storm losses.
Underwriting results for the first nine months of 2022 translated into a combined ratio of 81.9, compared to 105.2 for the same period last year. The segment’s loss ratio was 44.9 in 2022, down from 66.3 in 2021, due to lower levels of storm losses and larger reserve releases. The segment’s expense ratio decreased to 37.0 in 2022 from 38.9 in the prior year, with 2022 benefiting from a larger earned premium base.
Surety
The surety segment recorded underwriting income of $23.5 million for the first nine months of 2022, compared to $14.7 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 2022 included favorable development on prior accident years’ reserves, which decreased loss and settlement expenses for the segment by $9.3 million. Comparatively, 2021 results included favorable development on prior accident years’ loss reserves, which decreased the segment’s loss and settlement expenses by $2.6 million.
The combined ratio for the surety segment totaled 74.4 for the first nine months of 2022, compared to 83.1 for the same period in 2021. The segment’s loss ratio was 10.4 in 2022, down from 17.4 in 2021 due to larger reserve releases. The expense ratio was 64.0, down from 65.7 in the prior year, as 2022 had a higher earned premium base.
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Investment Income
Our investment portfolio generated net investment income of $57.6 million during the first nine months of 2022, an increase of 13.1 percent from that reported for the same period in 2021. The increase in investment income was due to higher interest rates as well as an increased average asset base relative to the prior year.
Yields on our fixed income investments for the first nine months of 2022 and 2021 were as follows:
2022
2021
Pretax Yield
Taxable
2.82
%
2.78
%
Tax-Exempt
2.67
%
2.63
%
After-Tax Yield
Taxable
2.23
%
2.20
%
Tax-Exempt
2.53
%
2.49
%
The following table depicts the composition of our investment portfolio at September 30, 2022 as compared to December 31, 2021:
(in thousands)
September 30, 2022
December 31, 2021
Fixed income
$
2,452,039
66.5
%
$
2,409,887
76.2
%
Equity securities
462,988
12.6
%
613,776
19.4
%
Other invested assets
48,837
1.3
%
50,501
1.6
%
Cash
723,511
19.6
%
88,804
2.8
%
Total investments and cash
$
3,687,375
100.0
%
$
3,162,968
100.0
%
We believe our overall asset allocation supports our strategy to preserve capital for policyholders, provide sufficient income to support insurance operations and effectively grow book value over a long-term investment horizon.
The fixed income portfolio increased by $42.2 million in the first nine months of 2022. Positive operating cash flows were used to purchase fixed income securities, which offset fair value declines resulting from higher interest rates. Average fixed income duration was 4.7 years at September 30, 2022, reflecting our current liability structure and sound capital position. The equity portfolio decreased by $150.8 million during the first nine months of 2022, as we reduced our risk asset profile and equity markets declined over the first nine months of the year.
Income Taxes
Our effective tax rate for the first nine months of 2022 was 20.0 percent, compared to 19.0 percent for the same period in 2021. Effective rates are dependent upon components of pretax earnings or losses and the related tax effects. The effective rate was higher for the first nine months of 2022, as higher pretax income, resulting from the gain on our sale of Maui Jim, decreased the percentage impact of tax-favored adjustments.
Three Months Ended September 30, 2022 Compared to Three Months Ended September 30, 2021
Net premiums earned for the Group increased 15 percent, driven by growth from our property and casualty segments. Overall market declines resulted in $26.4 million of unrealized losses on equity securities in the third quarter of 2022, compared to $2.6 million of unrealized losses during the same period in 2021. Investment income was up 19 percent, due to an increased asset base and higher interest rates relative to the prior year. Realized gains during the third quarter of 2022 were comprised of $0.6 million of realized gains on equity securities, primarily due to rebalancing within our equity strategies, $1.9 million of realized losses on the fixed income portfolio and a $574.5 million gain from the sale of equity method investment in Maui Jim. This compares to $1.7 million of realized gains on the equity portfolio, $0.2 million of realized gains on the fixed income portfolio and $0.1 million of other realized losses for the same period in 2021.
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For the Three Months
Ended September 30,
Consolidated Revenues (in thousands)
2022
2021
Net premiums earned
$
291,468
$
253,389
Net investment income
21,270
17,844
Net realized gains
573,170
1,829
Net unrealized gains (losses) on equity securities
(26,414)
(2,592)
Total consolidated revenue
$
859,494
$
270,470
Net earnings for the third quarter of 2022 totaled $439.9 million, compared to $29.2 million for the same period in 2021. The increase for 2022 was primarily attributed to the $437.7 million after tax earnings recognized from the sale of our equity method investment in Maui Jim. This gain was partially offset by $20.4 million of net after-tax realized and unrealized losses on equity securities, compared to $0.7 million of after-tax realized and unrealized losses in 2021. Underwriting results for 2022 were impacted by $40.0 million of pretax hurricane losses. Underwriting results for 2021 were impacted by $34.0 million of pretax hurricane losses and $1.0 million of pretax losses from other storms. Results for each period benefited from favorable development on prior years’ loss reserves, which provided additional pretax earnings of $33.3 million in the third quarter of 2022, compared to $29.5 million in 2021.
Bonus and profit-sharing amounts earned by executives, managers and associates are predominantly influenced by corporate performance, including operating earnings, combined ratio and return on capital. Favorable development and other drivers of growth in book value will increase bonus and profit-sharing expenses, while catastrophe losses, adverse development and decreased investment portfolio returns would lead to expense reductions. These performance-related expenses affect policy acquisition, insurance operating and general corporate expenses.
Underwriting income was $8.8 million on a 97.0 combined ratio for the third quarter of 2022, compared to $13.7 million on a 94.6 combined ratio in the same period of 2021. The loss ratio decreased to 56.6 from 56.7, due to larger amounts of favorable development on prior years’ loss reserves and a higher earned premium base, which offset the impact of larger catastrophe loss during the third quarter. The Group’s expense ratio increased to 40.4 from 37.9. Improved year to date results led to higher levels of bonus and profit-sharing expense. Additionally, a one-time bonus related to the sale of our investment in Maui Jim was accrued for in the third quarter.
In the third quarter of 2022, $18.0 million of investee losses were recorded for Maui Jim, primarily due to transaction related expenses from the sale of the company, and $2.9 million of investee earnings were recorded for Prime. Comparatively, the third quarter of 2021 reflected investee earnings of $5.4 million and $4.4 million from Maui Jim and Prime, respectively.
Comprehensive earnings totaled $358.6 million for the third quarter of 2022, compared to $17.0 million for the same period in 2021. Other comprehensive earnings (loss) primarily included net after-tax unrealized gains and losses from the fixed income portfolio. Other comprehensive loss of $81.2 million in the third quarter of 2022 was attributable to higher interest rates, which decreased the fair value of securities held in the fixed income portfolio. Comparatively, $12.2 million of other comprehensive loss was recognized in 2021 as interest rates increased.
Premiums
Gross premiums written for the Group increased $47.5 million for the third quarter of 2022 when compared to the same period of 2021. Growth was achieved in all three segments, though the increase was largely driven by the property segment. Net premiums earned increased $38.1 million, driven by products in our property and casualty segments.
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Gross Premiums Written
Net Premiums Earned
For the Three Months
For the Three Months
Ended September 30,
Ended September 30,
(in thousands)
2022
2021
% Change
2022
2021
% Change
Casualty
Commercial excess and personal umbrella
$
84,452
$
73,477
15
%
$
65,131
$
56,285
16
%
General liability
25,213
21,573
17
%
25,284
23,156
9
%
Commercial transportation
38,099
34,586
10
%
24,205
22,571
7
%
Professional services
27,016
25,516
6
%
24,174
22,401
8
%
Small commercial
18,592
17,573
6
%
17,005
16,301
4
%
Executive products
27,685
40,113
(31)
%
6,556
5,461
20
%
Other casualty
19,309
19,958
(3)
%
17,260
16,677
3
%
Total
$
240,366
$
232,796
3
%
$
179,615
$
162,852
10
%
Property
Commercial property
$
79,652
$
53,023
50
%
$
43,201
$
28,683
51
%
Marine
35,927
28,618
26
%
29,592
25,416
16
%
Specialty personal
7,517
6,447
17
%
6,409
5,462
17
%
Other property
2,987
2,060
45
%
1,642
1,325
24
%
Total
$
126,083
$
90,148
40
%
$
80,844
$
60,886
33
%
Surety
Commercial
$
14,330
$
13,605
5
%
$
12,057
$
11,541
4
%
Miscellaneous
12,580
11,899
6
%
10,751
11,124
(3)
%
Contract
10,391
7,798
33
%
8,201
6,986
17
%
Total
$
37,301
$
33,302
12
%
$
31,009
$
29,651
5
%
Grand Total
$
403,750
$
356,246
13
%
$
291,468
$
253,389
15
%
Casualty
Gross premiums written for the casualty segment were up $7.6 million in the third quarter of 2022. Gross premiums from commercial excess and personal umbrella increased $11.0 million, due to rate increases and an expanded distribution base. Increases in new construction projects led to the increase in general liability. Commercial transportation premium increased by $3.5 million, driven by our public transportation line, where customers put vehicles back in service on policies that were suspended throughout the first two years of the pandemic. Executive products premium was down as a result of a more competitive market and the exit from our large account cyber and representations and warranties programs.
Property
Gross premiums written for the property segment were up $35.9 million in the third quarter of 2022. Our commercial property business was up $26.6 million, as rates on wind exposures continued to increase, building valuations rose and market disruption provided an opportunity to grow while strengthening terms and conditions. Rate increases and new opportunities in the inland marine space led to $7.3 million of premium growth for our marine product.
Surety
Gross premiums written for the surety segment were up $4.0 million for the third quarter of 2022. Contract surety benefited from new construction opportunities and larger contract values, driven by the inflation of material prices. Commercial surety premium increased as a result of new business and the expansion of existing accounts.
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Underwriting Income
For the Three Months
Ended September 30,
2022
2021
Underwriting Income (Loss) (in thousands)
Casualty
$
11,329
$
22,949
Property
(8,308)
(16,558)
Surety
5,775
7,333
Total
$
8,796
$
13,724
Combined Ratio
Casualty
93.7
85.9
Property
110.3
127.2
Surety
81.4
75.3
Total
97.0
94.6
Casualty
The casualty segment recorded underwriting income of $11.3 million in the third quarter of 2022, compared to $22.9 million for the same period last year. Reserve releases reduced loss and settlement expenses for the casualty segment by $28.0 million, primarily on accident years 2016 through 2021. Products which generated the majority of the favorable development included general liability, commercial excess and executive products. In comparison, $26.0 million of reserves were released in the third quarter of 2021. Transportation, general liability and commercial excess were drivers of the favorable development. Offsetting the favorable development, hurricane and storm losses on casualty-oriented package policies that include property coverage resulted in $7.0 million of losses in 2022 and $1.6 million of losses in 2021.
The combined ratio for the casualty segment was 93.7 in 2022, compared to 85.9 in 2021. The segment’s loss ratio was 56.1 in 2022, up from 51.7 in 2021. Larger hurricane losses resulted in the higher loss ratio in 2022. The expense ratio for the casualty segment was 37.6, up from 34.2 for the same period last year, primarily due to larger bonus accruals associated with improved year to date metrics and the Maui Jim sale.
Property
The property segment recorded underwriting loss of $8.3 million for the third quarter of 2022, compared to $16.6 million of underwriting loss for the same period last year. Underwriting results for 2022 included $3.5 million of favorable development on prior years’ loss and catastrophe reserves and $33.0 million of hurricane losses. Comparatively, the 2021 underwriting results included $0.9 million of favorable development on prior years’ loss and catastrophe reserves, $32.6 million of hurricane losses and $0.7 million of storm losses.
Underwriting results for the third quarter of 2022 translated into a combined ratio of 110.3, compared to 127.2 for the same period last year. The segment’s loss ratio was 73.4 in 2022, down from 91.5 in 2021, due to larger levels of favorable development on prior years’ reserves and a higher earned premium base, which helped to offset the impact of catastrophe losses. The segment’s expense ratio increased to 36.9 in 2022 from 35.7 in the prior year.
Surety
The surety segment recorded underwriting income of $5.8 million for the third quarter of 2022, compared to $7.3 million for the same period last year. Both periods reflected positive current accident year underwriting performance. Results for 2022 included favorable development on prior accident years’ reserves, which decreased loss and settlement expenses for the segment by $1.8 million. Comparatively, 2021 results included $2.5 million of favorable development on prior accident years’ loss reserves.
The combined ratio for the surety segment totaled 81.4 for the third quarter of 2022, compared to 75.3 for the same period in 2021. The segment’s loss ratio was 16.2 in 2022, up from 12.9 in 2021 due to differences in prior accident year reserve development. The expense ratio was 65.2, up from 62.4 in the prior year.
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Investment Income
Our investment portfolio generated net investment income of $21.3 million during the third quarter of 2022, an increase of 19.2 percent from that reported for the same period in 2021. The increase in investment income was largely due to an increased asset base and higher interest rates relative to the prior year.
Yields on our fixed income investments for the third quarter of 2022 and 2021 were as follows:
2022
2021
Pretax Yield
Taxable
2.91
%
2.70
%
Tax-Exempt
2.69
%
2.64
%
After-Tax Yield
Taxable
2.30
%
2.13
%
Tax-Exempt
2.55
%
2.50
%
Income Taxes
Our effective tax rate for the third quarter of 2022 was 20.7 percent, compared to 17.5 percent for the same period in 2021. Effective rates are dependent upon components of pretax earnings or losses and the related tax effects. The effective rate was higher for the third quarter of 2022, as higher pretax income, resulting from the gain on our sale of Maui Jim, decreased the percentage impact of tax-favored adjustments.
LIQUIDITY AND CAPITAL RESOURCES
We have three primary types of cash flows: (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 nine-month periods ended September 30, 2022 and 2021:
(in thousands)
2022
2021
Operating cash flows
$
282,886
$
280,441
Investing cash flows
384,536
(220,265)
Financing cash flows
(32,715)
(32,775)
Total
$
634,707
$
27,401
Our largest source of cash is premiums received from customers and our largest cash outflow is claim payments on insured losses. 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 nine months of 2022 benefited from increased premium receipts relative to the first nine months of 2021, but were partially offset by increased levels of loss and settlement expense payments. Investing cash flows reflects the cash received from the sale of our investment in Maui Jim at the end of the third quarter.
We have $199.8 million in debt outstanding. On October 2, 2013, we completed a public debt offering, issuing $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 per annum. 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 notes at September 30, 2022 was $150.0 million. The fair value of our debt is estimated based on the limited observable prices that reflect thinly traded securities. Additionally, RLI Insurance Company borrowed $50.0 million from the Federal Home Loan Bank of Chicago (FHLBC) on November 10, 2021. The borrowing matures on November 10, 2023 and has an option to be paid off early on November 10, 2022. Interest is paid monthly at an annualized rate of 0.84 percent.
As of September 30, 2022, we had cash and other investments maturing within one year of approximately $929.9 million and an additional $851.5 million maturing between one to five years. The cash balance was elevated by the cash proceeds received from our sale of Maui Jim on September 30, 2022. Whereas our strategy is to be fully invested at all times, short-term
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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.
We also maintain a revolving line of credit with Bank of Montreal, Chicago Branch, which permits us to borrow up to an aggregate principal amount of $60.0 million. This facility was entered into during the first quarter of 2020 and replaced the previous $50.0 million facility with JP Morgan Chase Bank N.A., which was set to expire on May 24, 2020. Under certain conditions, the line may be increased up to an aggregate principal amount of $120.0 million. The facility has a three-year term that expires on March 27, 2023. As of and during the nine-month period ended September 30, 2022, no amounts were outstanding on either facility.
Additionally, two of our insurance companies, RLI Insurance Company (RLI Ins.) and Mt. Hawley Insurance Company, are members of the FHLBC. Membership in the Federal Home Loan Bank system provides both companies access to an additional source of liquidity via a secured lending facility. Our membership allows each insurance subsidiary to determine tenor and structure at the time of borrowing. As of September 30, 2022, $60.2 million of investments were pledged as collateral with the FHLBC to ensure timely access to the secured lending facility.
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. In the event they are not sufficient, we believe cash available from financing activities and other sources will provide sufficient additional liquidity.
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. Invested assets at September 30, 2022 have increased $524.4 million from December 31, 2021. As of September 30, 2022, our investment portfolio had the following asset allocation breakdown:
Cost or
Fair
Unrealized
% of Total
(in thousands)
Amortized Cost
Value
Gain/(Loss)
Fair Value
Quality*
U.S. government
$
349,419
$
340,442
$
(8,977)
9.2
%
AAA
U.S. agency
59,048
56,935
(2,113)
1.5
%
AAA
Non-U.S. government & agency
6,798
5,712
(1,086)
0.2
%
BBB+
Agency MBS
360,429
317,029
(43,400)
8.6
%
AAA
ABS/CMBS/MBS**
277,401
241,512
(35,889)
6.6
%
AA+
Corporate
1,067,473
963,869
(103,604)
26.1
%
BBB+
Municipal
633,063
526,540
(106,523)
14.3
%
AA
Total fixed income
$
2,753,631
$
2,452,039
$
(301,592)
66.5
%
AA-
Equity
327,964
462,988
135,024
12.6
%
Other invested assets
43,738
48,837
5,099
1.3
%
Cash
723,511
723,511
—
19.6
%
Total portfolio
$
3,848,844
$
3,687,375
$
(161,469)
100.0
%
*
Quality ratings provided by Moody’s, S&P and Fitch
**
Non-agency asset-backed, commercial mortgage-backed and mortgage-backed securities
Quality is an average of each bond’s credit rating, adjusted for its relative weighting in the portfolio. As of September 30, 2022, our fixed income portfolio had the following rating distribution:
AAA
40.5
%
AA
18.3
%
A
20.7
%
BBB
12.4
%
BB
3.1
%
B
2.2
%
CCC
0.0
%
NR
2.8
%
Total
100.0
%
As of September 30, 2022, our fixed income portfolio remained well diversified, with 1,639 individual issues.
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Our investment portfolio has limited exposure to structured asset-backed securities. As of September 30, 2022, we had $128.2 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 September 30, 2022, we had $113.4 million in commercial mortgage-backed securities and $317.0 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 6.6 percent of our investment portfolio at quarter end.
We had $963.9 million in corporate fixed income securities as of September 30, 2022, which includes $98.8 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.
The municipal portfolio includes approximately 52 percent taxable securities and 48 percent tax-exempt securities. Approximately 87 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.
Securities within the equity portfolio are well diversified and are primarily invested in broad index exchange traded funds (ETFs). Our actively managed equity strategy has a preference for dividend income and value oriented security selection with low turnover, which minimizes transaction costs and taxes throughout our long investment horizon.
As of September 30, 2022, our equity portfolio had a dividend yield of 2.5 percent, compared to 1.8 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. The equity portfolio is managed in a diversified and granular manner, with 92 individual securities and four ETF positions. No single company exposure in the equity portfolio represents more than 1 percent of invested assets.
Other invested assets include investments in low income housing tax credit partnerships, membership in the FHLBC and investments in private funds.
We had $58.1 million of investments in unconsolidated investees at September 30, 2022, compared to $171.3 million at December 31, 2021. At September 30, 2022 our investment in Prime was $47.0 million. During the third quarter, we completed the sale of our equity method investment in Maui Jim to Kering Eyewear for cash proceeds of $686.6 million. We recognized net realized gains of $574.5 million as a result of the sale. As always, our top priority is to ensure we have adequate capital to support our business. However, we have demonstrated discipline in returning capital to shareholders if it exceeds our near-term needs.
Our investment portfolio does not have any exposure to derivatives.
Our capital structure is comprised of equity and debt outstanding. As of September 30, 2022, our capital structure consisted of $199.8 million in long-term debt and $1.4 billion of shareholders’ equity. Debt outstanding comprised 12.5 percent of total capital as of September 30, 2022. Interest and fees on debt obligations totaled $6.0 million for the first nine months of 2022, compared to $5.7 million during the same period of 2021. We incurred interest expense on debt at an average annual interest rate of 3.89 percent during the first nine months of 2022, compared to 4.91 percent for the same time period during 2021.
We paid a regular quarterly cash dividend of $0.26 per share on September 20, 2022, the same amount as the prior quarter. We have increased dividends in each of the last 47 years.
Our three insurance companies are subsidiaries of RLI Corp, with RLI Ins. as the first-level, or principal, insurance company. At the holding company (RLI Corp.) level, we rely largely on dividends from our insurance 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 September 30, 2022, our holding company had $1.4 billion 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 $828.9 million in liquid assets, which was elevated by the cash proceeds received from the sale of Maui Jim at
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the end of the quarter. Unrestricted funds at the holding company are available to fund debt interest, general corporate obligations and 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. 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 nine months of 2022, RLI Ins. paid $13.0 million in ordinary dividends to RLI Corp. In 2021, our principal insurance subsidiary paid ordinary dividends totaling $70.0 million and extraordinary dividends totaling $110.0 million. As of September 30, 2022, $83.1 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. Because the limitations are based upon a rolling 12-month period, the amount and impact of these restrictions vary over time. 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.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.