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, surety 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, 2022 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, casualty and surety products through major subsidiaries. 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 2022, we achieved our 27th consecutive year of underwriting profitability. Over the 27-year period, we averaged an 88.2 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 either 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 limit our net aggregate exposure to a catastrophic event by managing 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 medium-sized contract surety coverages, including payment and performance bonds. We offer a variety of commercial surety bonds for medium to large-sized businesses across a broad spectrum of industries, including the financial, healthcare as well as on and offshore energy, petrochemical and refining industries. We also offer miscellaneous bonds including license and permit, notary and court bonds. Often, our surety coverages involve a statutory requirement for bonds. While these bonds typically maintain a relatively low loss ratio, losses may fluctuate due to adverse economic conditions affecting the financial viability of our insureds. The contract surety product guarantees the construction work of a commercial contractor for a specific project. Generally, losses occur due to the deterioration of a contractor’s financial condition. This line has historically produced marginally higher loss ratios than other surety lines during economic downturns.
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.
Key Performance Measures
The following is a list of key performance 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 2022 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 Six Months
Ended June 30,
Ended June 30,
(in thousands)
2023
2022
2023
2022
Net earnings (loss)
$
77,652
$
(2,239)
$
176,463
$
45,684
Income tax expense (benefit)
18,379
(4,315)
42,359
6,287
Earnings (loss) before income taxes
$
96,031
$
(6,554)
$
218,822
$
51,971
Equity in earnings of unconsolidated investees
(1,514)
(11,654)
(5,437)
(20,413)
General corporate expenses
4,219
2,435
8,433
5,798
Interest expense on debt
2,047
2,011
4,055
4,021
Net unrealized (gains) losses on equity securities
(25,214)
100,994
(40,710)
128,804
Net realized gains
(5,580)
(12,804)
(20,200)
(18,392)
Net investment income
(28,788)
(18,472)
(55,872)
(36,355)
Net underwriting income
$
41,201
$
55,956
$
109,091
$
115,434
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 2022 Annual Report on Form 10-K.
There have been no significant changes to critical accounting policies during the year.
RESULTS OF OPERATIONS
Six Months Ended June 30, 2023 Compared to Six Months Ended June 30, 2022
Net premiums earned increased 14 percent, driven by growth from our property and casualty segments. Positive market performance resulted in $41 million of unrealized gains on equity securities in the first six months of 2023, while overall market declines resulted in $129 million of unrealized losses in our equity portfolio in 2022. Investment income was up 54 percent, due to an increased average asset base and higher interest rates relative to the prior year. Realized gains during the first six months of 2023 were comprised of $9 million of realized gains on equity securities, primarily due to rebalancing within our equity strategies, $3 million of realized losses on the fixed income portfolio and $14 million of realized gains from the payout of the working capital escrow from our sale of Maui Jim, Inc. (Maui Jim). This compares to $19 million of realized gains on the equity portfolio and $1 million of realized losses on the fixed income portfolio in the previous year.
For the Six Months
Ended June 30,
Consolidated Revenues (in thousands)
2023
2022
Net premiums earned
$
630,003
$
551,962
Net investment income
55,872
36,355
Net realized gains
20,200
18,392
Net unrealized gains (losses) on equity securities
40,710
(128,804)
Total consolidated revenue
$
746,785
$
477,905
Net earnings for the first six months of 2023 totaled $176 million, compared to $46 million for the same period in 2022. The increase for 2023 was largely attributed to the $39 million of net after-tax realized and unrealized gains on equity securities, compared to $87 million of after-tax realized and unrealized losses in 2022. Underwriting results for 2023 were impacted by $22 million of pretax storm losses, compared to $5 million of pretax storm losses in the first six months of 2022. Results for each period benefited from favorable development on prior years’ loss reserves, which provided additional pretax earnings of $72 million in the first six months of 2023, compared to $70 million in 2022.
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 $109 million on an 82.7 combined ratio for the first six months of 2023, compared to $115 million on a 79.1 combined ratio in the same period of 2022. The loss ratio increased to 42.6 from 40.5, due to higher levels of storm losses in 2023. The expense ratio increased to 40.1 from 38.6, as higher net earnings and growth in book value led to larger levels of bonus and profit-sharing expenses in 2023. We also increased investments in our people and technology to support growth, improve customer experience and drive efficiencies, which impacted all segments.
Our equity in earnings of unconsolidated investees primarily relates to our investment in Prime Holdings Insurance Services, Inc. (Prime), a specialty insurance company. In the first six months of 2023, we recognized $6 million of investee earnings from Prime. Comparatively, the first six months of 2022 reflected investee earnings of $6 million from Prime and $15 million from Maui Jim. Our interest in Maui Jim was sold in the third quarter of 2022.
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Comprehensive earnings totaled $194 million for the first six months of 2023, compared to $167 million of comprehensive loss for the first six months of 2022. Other comprehensive earnings (loss) primarily included net after-tax unrealized gains and losses from the fixed income portfolio. Other comprehensive earnings of $18 million in the first six months of 2023 was attributable to modestly tighter credit spreads while interest rates remained relatively flat, which increased the fair value of securities held in the fixed income portfolio. Comparatively, $213 million of other comprehensive loss was recognized in 2022, as interest rates increased.
Premiums
Gross premiums written increased $145 million for the first six months of 2023, compared to the same period of 2022. Growth was achieved in all three segments, though the increase was largely driven by products in the property segment. Net premiums earned increased $78 million, driven by products in our property and casualty segments.
Gross Premiums Written
Net Premiums Earned
For the Six Months
For the Six Months
Ended June 30,
Ended June 30,
(in thousands)
2023
2022
% Change
2023
2022
% Change
Casualty
Commercial excess and personal umbrella
$
176,840
$
163,298
8
%
$
136,843
$
122,535
12
%
General liability
55,612
59,192
(6)
%
51,916
48,846
6
%
Commercial transportation
58,715
60,592
(3)
%
50,630
47,569
6
%
Professional services
55,282
52,390
6
%
48,959
47,416
3
%
Small commercial
40,246
36,937
9
%
36,396
33,458
9
%
Executive products
40,345
45,622
(12)
%
12,506
13,652
(8)
%
Other casualty
41,851
46,105
(9)
%
35,829
35,403
1
%
Total
$
468,891
$
464,136
1
%
$
373,079
$
348,879
7
%
Property
Commercial property
$
284,945
$
162,148
76
%
$
109,481
$
72,218
52
%
Marine
74,970
64,996
15
%
63,048
54,907
15
%
Other property
20,820
18,302
14
%
18,079
15,005
20
%
Total
$
380,735
$
245,446
55
%
$
190,608
$
142,130
34
%
Surety
Commercial
$
27,039
$
25,230
7
%
$
24,923
$
23,366
7
%
Miscellaneous
25,821
25,814
0
%
23,934
22,940
4
%
Contract
20,490
17,322
18
%
17,459
14,647
19
%
Total
$
73,350
$
68,366
7
%
$
66,316
$
60,953
9
%
Grand Total
$
922,976
$
777,948
19
%
$
630,003
$
551,962
14
%
Casualty
Gross premiums written for the casualty segment were up $5 million in the first six months of 2023. Continued growth within our personal umbrella distribution base and positive rate movement across a large portion of our casualty segment offset challenging conditions some lines experienced during the first six months. As we mentioned in prior filings, we are running off our excess energy liability business, which resulted in a $9 million decrease within the commercial excess product and negatively impacted the production of our primary energy liability business within the general liability product. Increased competition led to a further reduction in commercial excess business. Additionally, executive products premium decreased as a result of a more competitive market, particularly with public directors and officers coverages. However, the benefit of our diversified book of business is that select products can work through challenges they may encounter while the success of other products allows us to achieve positive overall results.
Property
Gross premiums written for the property segment were up $135 million in the first six months of 2023. Our commercial property business was up $123 million, as wind rates continued to increase and limited exposure growth was experienced. Rate increases and new opportunities led to $10 million of premium growth for our marine product.
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Surety
Gross premiums written for the surety segment were up $5 million for the first six months of 2023. Contract surety benefited from new agency relationships and new construction projects. The expansion of existing accounts and new business resulted in increased premium for commercial surety.
Underwriting Income
For the Six Months
Ended June 30,
2023
2022
Underwriting Income (in thousands)
Casualty
$
38,808
$
49,089
Property
54,260
48,581
Surety
16,023
17,764
Total
$
109,091
$
115,434
Combined Ratio
Casualty
89.6
85.9
Property
71.5
65.8
Surety
75.8
70.9
Total
82.7
79.1
Casualty
The casualty segment recorded underwriting income of $39 million in the first six months of 2023, compared to $49 million for the same period last year. Prior accident years’ reserve releases reduced loss and settlement expenses for the casualty segment by $47 million, primarily on accident years 2018 through 2022. Favorable development was widespread, with notable amounts from commercial excess, professional services, general liability and personal umbrella. In comparison, $45 million of prior accident years’ reserves were released in the first six months of 2022. General liability, professional services and transportation were drivers of the favorable development. Offsetting the favorable development, storm losses on casualty-oriented package policies that include property coverage resulted in $1.7 million of losses in 2023 and $0.5 million of losses in 2022.
The combined ratio for the casualty segment was 89.6 in 2023, compared to 85.9 in 2022. The segment’s loss ratio was 52.2 in 2023, up from 51.0 in 2022. A higher earned premium base, which reduced the loss ratio impact of favorable prior years’ reserve development, and an increased level of storm losses resulted in the higher loss ratio in 2023. The expense ratio for the casualty segment was 37.4, up from 34.9 for the same period last year. Higher net earnings and growth in book value led to larger levels of bonus and profit-sharing expenses in 2023 for all segments.
Property
The property segment recorded underwriting income of $54 million for the first six months of 2023, compared to $49 million for the same period last year. Underwriting results for 2023 included $17 million of favorable development on prior years’ loss and catastrophe reserves and $20 million of storm losses. Comparatively, the 2022 underwriting results included $17 million of favorable development on prior years’ loss and catastrophe reserves and $5 million of storm losses.
Underwriting results for the first six months of 2023 translated into a combined ratio of 71.5, compared to 65.8 for the same period last year. The segment’s loss ratio was 35.5 in 2023, up from 28.7 in 2022, due to an increase in storm losses. The segment’s expense ratio decreased to 36.0 in 2023 from 37.1 in the prior year, as the growth in the earned premium base exceeded the growth in expense.
Surety
The surety segment recorded underwriting income of $16 million for the first six months of 2023, compared to $18 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 2023 included favorable development on prior
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accident years’ reserves, which decreased loss and settlement expenses for the segment by $7.5 million. Results for 2022 also included $7.5 million of favorable development on prior accident years’ reserves.
The combined ratio for the surety segment totaled 75.8 for the first six months of 2023, compared to 70.9 for the same period in 2022. The segment’s loss ratio increased to 9.0 in 2023, up from 7.4 in 2022, as a higher earned premium base reduced the loss ratio impact of favorable prior accident years’ reserve development. The expense ratio was 66.8, up from 63.5 in the prior year.
Investment Income
Our investment portfolio generated net investment income of $56 million during the first six months of 2023, an increase of 54 percent from that reported for the same period in 2022. 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 six months of 2023 and 2022 were as follows:
2023
2022
Pretax Yield
Taxable
3.40
%
2.75
%
Tax-Exempt
2.78
%
2.66
%
After-Tax Yield
Taxable
2.69
%
2.17
%
Tax-Exempt
2.63
%
2.52
%
The following table depicts the composition of our investment portfolio at June, 2023 as compared to December 31, 2022:
(in thousands)
June 30, 2023
December 31, 2022
Fixed income
$
2,689,100
74.9
%
$
2,666,950
81.5
%
Equity securities
552,566
15.4
%
498,382
15.2
%
Short-term investments
271,296
7.5
%
36,229
1.1
%
Other invested assets
60,907
1.7
%
47,922
1.5
%
Cash
16,707
0.5
%
22,818
0.7
%
Total investments and cash
$
3,590,576
100.0
%
$
3,272,301
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 $22 million in the first six months of 2023. Average fixed income duration was 4.6 years at June 30, 2023, reflecting our liability structure and sound capital position. The equity portfolio increased by $54 million during the first six months of 2023, due to the positive performance of equity markets. Short-term investments increased by $235 million, as improved yields made AAA-rated government money market funds an investable asset class that also allowed us to maximize liquidity for events in the second half of the year.
Income Taxes
Our effective tax rate for the first six months of 2023 was 19.4 percent, compared to 12.1 percent for the same period in 2022. Effective rates are dependent upon components of pretax earnings or losses and the related tax effects. The effective tax rate was higher for the six-month period in 2023, as higher pretax income decreased the percentage impact of tax-favored adjustments, such as tax credits and excess tax benefits on share-based compensation.
Three Months Ended June 30, 2023 Compared to Three Months Ended June 30, 2022
Net premiums earned increased 14 percent, driven by growth from our property and casualty segments. Positive market performance resulted in $25 million of unrealized gains on equity securities in the second quarter of 2023, while overall market declines resulted in $101 million of unrealized losses in our equity portfolio in the second quarter of 2022. Investment income was up 56 percent, due to an increased average asset base and higher interest rates relative to the prior year. Realized gains
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during the second quarter of 2023 were comprised of $6 million of realized gains on equity securities, primarily due to rebalancing within our equity strategies, and less than $1 million of realized losses on the fixed income portfolio. This compares to $13 million of realized gains on the equity portfolio and less than $1 million of realized losses on the fixed income portfolio in the same period of 2022.
For the Three Months
Ended June 30,
Consolidated Revenues (in thousands)
2023
2022
Net premiums earned
$
322,280
$
282,810
Net investment income
28,788
18,472
Net realized gains
5,580
12,804
Net unrealized gains (losses) on equity securities
25,214
(100,994)
Total consolidated revenue
$
381,862
$
213,092
Net earnings for the second quarter of 2023 totaled $78 million, compared to a net loss of $2 million for the same period in 2022. The increase for 2023 was largely attributed to the $25 million of net after-tax realized and unrealized gains on equity securities, compared to $69 million of after-tax realized and unrealized losses in the second quarter of 2022. Underwriting results for 2023 were impacted by $18 million of pretax storm losses, compared to $3 million of pretax storm losses in the second quarter of 2022. Results for each period benefited from favorable development on prior years’ loss reserves, which provided additional pretax earnings of $20 million in the second quarter of 2023, compared to $24 million in 2022.
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 $41 million on an 87.2 combined ratio for the second quarter of 2023, compared to $56 million on an 80.2 combined ratio in the same period of 2022. The loss ratio increased to 47.8 from 41.7, due to higher storm losses and lower levels of favorable development on prior years’ loss reserves in 2023. The expense ratio increased to 39.4 from 38.5, as higher net earnings and growth in book value led to larger levels of bonus and profit-sharing expenses in 2023. We also increased investments in our people and technology to support growth, improve customer experience and drive efficiencies, which impacted all segments.
In the second quarter of 2023, we recognized $2 million of investee earnings from Prime. Comparatively, the second quarter of 2022 reflected investee earnings of $4 million from Prime and $9 million from Maui Jim. Our interest in Maui Jim was sold in the third quarter of 2022.
Comprehensive earnings totaled $58 million for the second quarter of 2023, compared to $100 million of comprehensive loss for the second quarter of 2022. Other comprehensive earnings (loss) primarily included net after-tax unrealized gains and losses from the fixed income portfolio. Other comprehensive loss of $20 million in the second quarter of 2023 was attributable to higher interest rates, which decreased the fair value of securities held in the fixed income portfolio. Comparatively, $98 million of other comprehensive loss was recognized in 2022, as interest rates increased.
Premiums
Gross premiums written increased $89 million for the second quarter of 2023, compared to the same period of 2022. Growth was achieved in all three segments, though the increase was largely driven by products in the property segment. Net premiums earned increased $39 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 June 30,
Ended June 30,
(in thousands)
2023
2022
% Change
2023
2022
% Change
Casualty
Commercial excess and personal umbrella
$
95,409
$
85,512
12
%
$
69,261
$
62,463
11
%
General liability
30,823
31,298
(2)
%
26,016
25,106
4
%
Commercial transportation
35,842
38,291
(6)
%
25,398
23,941
6
%
Professional services
29,093
27,880
4
%
24,602
23,861
3
%
Small commercial
20,287
18,799
8
%
18,455
16,813
10
%
Executive products
22,518
24,941
(10)
%
6,153
7,075
(13)
%
Other casualty
17,085
21,594
(21)
%
17,163
17,864
(4)
%
Total
$
251,057
$
248,315
1
%
$
187,048
$
177,123
6
%
Property
Commercial property
$
173,006
$
93,068
86
%
$
60,219
$
38,929
55
%
Marine
37,781
32,913
15
%
32,412
28,178
15
%
Other property
11,102
9,867
13
%
9,210
7,583
21
%
Total
$
221,889
$
135,848
63
%
$
101,841
$
74,690
36
%
Surety
Commercial
$
11,943
$
12,567
(5)
%
$
12,505
$
11,663
7
%
Miscellaneous
12,474
12,452
0
%
11,887
11,587
3
%
Contract
10,601
9,607
10
%
8,999
7,747
16
%
Total
$
35,018
$
34,626
1
%
$
33,391
$
30,997
8
%
Grand Total
$
507,964
$
418,789
21
%
$
322,280
$
282,810
14
%
Casualty
Gross premiums written for the casualty segment were up $3 million in the second quarter of 2023. Continued momentum with our personal umbrella distribution base offset challenging conditions some lines experienced during the second quarter. The runoff of our excess energy liability business resulted in a $5 million decrease within the commercial excess product for the quarter and negatively impacted the production of our primary energy liability business within the general liability product. Commercial transportation was down, as the trucking market continues to be highly competitive and trucking companies’ revenues are down compared to last year. Additionally, executive products premium decreased as a result of a more competitive market, particularly with directors and officers coverages.
Property
Gross premiums written for the property segment were up $86 million in the second quarter of 2023. Our commercial property business was up $80 million. Continued rate increases on wind exposures has allowed us to achieve this result with limited exposure growth, while also strengthening terms and conditions. Rate increases and new opportunities led to $5 million of premium growth for our marine product.
Surety
Gross premiums written for the surety segment were up $0.4 million for the second quarter of 2023. The growth in contract surety was driven by new agency relationships, while the decline in commercial surety was due to accounts having non-recurring activity within select accounts that bolstered premium in 2022.
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Underwriting Income
For the Three Months
Ended June 30,
2023
2022
Underwriting Income (in thousands)
Casualty
$
6,977
$
21,442
Property
25,877
26,105
Surety
8,347
8,409
Total
$
41,201
$
55,956
Combined Ratio
Casualty
96.3
87.9
Property
74.6
65.0
Surety
75.0
72.9
Total
87.2
80.2
Casualty
The casualty segment recorded underwriting income of $7 million in the second quarter of 2023, compared to $21 million for the same period last year. Prior accident years’ reserve releases reduced loss and settlement expenses for the casualty segment by $11 million, primarily on accident years 2020 through 2022. Favorable development was widespread, with notable amounts from small commercial, commercial excess and personal umbrella. In comparison, $17 million of prior accident years’ reserves were released in the second quarter of 2022. General liability, professional services and transportation were drivers of the favorable development. Storm losses on casualty-oriented package policies that include property coverage offset the favorable development and resulted in $1.3 million of losses in 2023 and $0.5 million of losses in 2022.
The combined ratio for the casualty segment was 96.3 in 2023, compared to 87.9 in 2022. The segment’s loss ratio was 58.9 in 2023, up from 53.2 in 2022. The increase in loss ratio was attributable to lower levels of reserve releases on prior accident years, as well as increased storm losses and modest additions to the current accident year for energy casualty. The expense ratio for the casualty segment was 37.4, up from 34.7 for the same period last year. Higher net earnings and growth in book value led to larger levels of bonus and profit-sharing expenses in 2023 for all segments.
Property
The property segment recorded underwriting income of $26 million for the second quarter of 2023 and 2022. Underwriting results for 2023 included $4 million of favorable development on prior years’ loss and catastrophe reserves and $17 million of storm losses. Comparatively, the 2022 underwriting results included $4 million of favorable development on prior years’ loss and catastrophe reserves and $3 million of storm losses.
Underwriting results for the second quarter of 2023 translated into a combined ratio of 74.6, compared to 65.0 for the same period last year. The segment’s loss ratio was 40.4 in 2023, up from 27.4 in 2022, due to the increase in storm losses. The segment’s expense ratio decreased to 34.2 in 2023 from 37.6 in the prior year, as the growth in the earned premium base exceeded the growth in expense.
Surety
The surety segment recorded underwriting income of $8 million for the second quarter of 2023 and 2022. Both periods reflected positive current accident year underwriting performance and benefited from favorable development on prior years’ loss reserves. Results for 2023 included favorable development on prior accident years’ reserves, which decreased loss and settlement expenses for the segment by $4 million, compared to $3 million in 2022.
The combined ratio for the surety segment totaled 75.0 for the second quarter of 2023, compared to 72.9 for the same period in 2022. The segment’s loss ratio was 7.8 in 2023, down from 10.3 in 2022, due to higher levels of prior accident year reserve releases. The expense ratio was 67.2, up from 62.6 in the prior year.
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Investment Income
Our investment portfolio generated net investment income of $29 million during the second quarter of 2023, an increase of 56 percent from that reported for the same period in 2022. 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 second quarter of 2023 and 2022 were as follows:
2023
2022
Pretax Yield
Taxable
3.41
%
2.79
%
Tax-Exempt
2.79
%
2.69
%
After-Tax Yield
Taxable
2.69
%
2.20
%
Tax-Exempt
2.64
%
2.55
%
Income Taxes
Our effective tax rate for the second quarter of 2023 was 19.1 percent, compared to 65.8 percent for the same period in 2022. Effective rates are dependent upon components of pretax earnings or losses and the related tax effects. Tax-favored adjustments acting on pretax income decreased the effective tax rate in 2023, whereas tax-favored adjustments acting on pretax loss increased the effective tax rate in 2022.
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 six-month periods ended June 30, 2023 and 2022:
(in thousands)
2023
2022
Operating cash flows
$
243,595
$
170,645
Investing cash flows
(226,116)
(124,946)
Financing cash flows
(23,590)
(21,459)
Total
$
(6,111)
$
24,240
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 six months of 2023 benefited from increased premium receipts relative to the first six months of 2022.
We have $200 million in debt outstanding. On October 2, 2013, we completed a public debt offering, issuing $150 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 $149 million. The estimated fair value for the senior notes at June 30, 2023 was $150 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 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 prior to maturity. Interest is paid monthly at an annualized rate of 0.84 percent.
As of June 30, 2023, we had cash and other investments maturing within one year of approximately $482 million and an additional $896 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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We also maintain a revolving line of credit with PNC Bank, N.A., which permits us to borrow up to an aggregate principal amount of $100 million. This facility was entered into during the first quarter of 2023 and replaced the previous $60 million facility with Bank of Montreal, Chicago Branch, which expired on March 27, 2023. Under certain conditions, the line may be increased up to an aggregate principal amount of $130 million. The facility has a three-year term that expires on May 29, 2026. As of and during the six-month period ended June 30, 2023, 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 June 30, 2023, $56 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 June 30, 2023 have increased $318 million from December 31, 2022. As of June 30, 2023, 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
$
325,893
$
315,976
$
(9,917)
8.8
%
AAA
U.S. agency
45,937
43,719
(2,218)
1.2
%
AAA
Non-U.S. government & agency
4,799
3,960
(839)
0.1
%
BBB+
Agency MBS
414,503
372,030
(42,473)
10.4
%
AAA
ABS/CMBS/MBS**
285,855
252,330
(33,525)
7.0
%
AA+
Corporate
1,227,628
1,147,504
(80,124)
32.0
%
A-
Municipal
642,305
553,581
(88,724)
15.4
%
AA
Total fixed income
$
2,946,920
$
2,689,100
$
(257,820)
74.9
%
AA-
Equity
340,184
552,566
212,382
15.4
%
Short-term investments
271,296
271,296
—
7.5
%
Other invested assets
58,275
60,907
2,632
1.7
%
Cash
16,707
16,707
—
0.5
%
Total portfolio
$
3,633,382
$
3,590,576
$
(42,806)
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 June 30, 2023, our fixed income portfolio had the following rating distribution:
AAA
38.2
%
AA
19.2
%
A
22.3
%
BBB
12.2
%
BB
2.8
%
B
2.3
%
CCC
0.1
%
D
0.0
%
NR
2.9
%
Total
100.0
%
As of June 30, 2023, our fixed income portfolio remained well diversified, with 1,751 individual issues.
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Our investment portfolio has limited exposure to structured asset-backed securities. As of June 30, 2023, we had $136 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, 2023, we had $116 million in commercial mortgage-backed securities and $372 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 7.0 percent of our investment portfolio at quarter end.
We had $1,148 million in corporate fixed income securities as of June 30, 2023, which includes $110 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 56 percent taxable securities and 44 percent tax-exempt securities. Approximately 90 percent of our municipal bond portfolio maintains an ‘AA’ or better rating, while 100 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 June 30, 2023, our equity portfolio had a dividend yield of 2.0 percent, compared to 1.5 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 85 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 and historic tax credit partnerships, membership in the FHLBC and investments in private funds.
We had $55 million of investments in unconsolidated investees at June 30, 2023, compared to $58 million at December 31, 2022.
Our investment portfolio does not have any exposure to derivatives.
Our capital structure is comprised of equity and debt outstanding. As of June 30, 2023, our capital structure consisted of $200 million in long-term debt and $1.4 billion of shareholders’ equity. Debt outstanding comprised 13 percent of total capital as of June 30, 2023. Interest and fees on debt obligations totaled $4 million for the first six months of 2023 and 2022. We incurred interest expense on debt at an average annual interest rate of 3.89 percent during the first six months of 2023 and 2022.
We paid a regular quarterly cash dividend of $0.27 per share on June 20, 2023, an increase of $0.01 from the prior quarter. We have increased dividends in each of the last 48 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 June 30, 2023, 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 $262 million in liquid assets, which was elevated by the cash proceeds received from the sale of Maui Jim. 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.
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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 six months of 2023, RLI Ins. paid $30 million in ordinary dividends to RLI Corp. In 2022, our principal insurance subsidiary paid ordinary dividends totaling $13 million. As of June 30, 2023, $120 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.