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 management liability 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 in Hawaii. 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 onshore and offshore energy, petrochemical and refining industries. We also offer a variety of miscellaneous bonds including, but not limited to: 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 commercial contractors’ contractual obligations for a specific construction 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 7 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 Nine Months
Ended September 30,
Ended September 30,
(in thousands)
2023
2022
2023
2022
Net earnings
$
13,536
$
439,893
$
189,999
$
485,577
Income tax expense
1,483
114,809
43,842
121,096
Earnings before income taxes
$
15,019
$
554,702
$
233,841
$
606,673
Equity in (earnings) loss of unconsolidated investees
(1,732)
17,352
(7,169)
(3,061)
General corporate expenses
2,372
2,755
10,805
8,553
Interest expense on debt
1,873
2,013
5,928
6,034
Net unrealized (gains) losses on equity securities
25,236
26,414
(15,474)
155,218
Net realized gains
(6,558)
(573,170)
(26,758)
(591,562)
Net investment income
(31,963)
(21,270)
(87,835)
(57,625)
Net underwriting income
$
4,247
$
8,796
$
113,338
$
124,230
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, 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
Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022
Net premiums earned increased 12 percent, with all segments contributing to the growth. Positive market performance resulted in $15 million of unrealized gains on equity securities in the first nine months of 2023, while overall market declines resulted in $155 million of unrealized losses in 2022. Investment income was up 52 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 2023 were comprised of $16 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 $20 million of realized gains on the equity portfolio, $3 million of realized losses on the fixed income portfolio and $574 million of realized gains from the sale of our investment in Maui Jim in the previous year.
For the Nine Months
Ended September 30,
Consolidated Revenues (in thousands)
2023
2022
Net premiums earned
$
948,412
$
843,430
Net investment income
87,835
57,625
Net realized gains
26,758
591,562
Net unrealized gains (losses) on equity securities
15,474
(155,218)
Total consolidated revenue
$
1,078,479
$
1,337,399
Net earnings for the first nine months of 2023 totaled $190 million, compared to $486 million for the same period in 2022. The decrease for 2023 was primarily attributed to the $437.7 million of after-tax earnings recognized from the sale of our equity method investment in Maui Jim in 2022. The impact was partially offset by the $25 million of net after-tax realized and unrealized gains on equity securities, compared to $107 million of after-tax realized and unrealized losses in 2022. Underwriting results for 2023 were impacted by $52 million of pretax losses and $14 million of reinstatement premium from the Hawaiian wildfires, as well as $27 million of storm losses. Comparatively, 2022 included $40 million of pretax hurricane losses and $5 million of pretax storm losses. Results for each period benefited from favorable development on prior years’ loss reserves, which provided additional pretax earnings of $94 million in the first nine months of 2023, compared to $103 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 $113 million on an 88.0 combined ratio for the first nine months of 2023, compared to $124 million on an 85.3 combined ratio in the same period of 2022. The loss ratio increased to 48.3 from 46.1, due to higher levels of catastrophe losses in 2023. The expense ratio increased to 39.7 from 39.2, as improved year to date metrics 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 experiences and drive efficiencies, which impacted all segments.
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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 nine months of 2023, we recognized $7 million of investee earnings from Prime. Comparatively, the first nine months of 2022 reflected $9 million of investee earnings from Prime and $3 million of investee losses for Maui Jim, primarily due to transaction related expenses from the sale of Maui Jim in the third quarter of 2022.
Comprehensive earnings totaled $151 million for the first nine months of 2023, compared to $191 million for the first nine months of 2022. Other comprehensive earnings (loss) primarily included net after-tax unrealized losses from the fixed income portfolio. Other comprehensive loss of $39 million in the first nine months of 2023 was attributable to higher interest rates, which decreased the fair value of securities held in the fixed income portfolio. Comparatively, $294 million of other comprehensive loss was recognized in 2022, as interest rates increased.
Premiums
Gross premiums written increased $191 million for the first nine 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 $105 million, driven by products in our property and casualty segments.
Gross Premiums Written
Net Premiums Earned
For the Nine Months
For the Nine Months
Ended September 30,
Ended September 30,
(in thousands)
2023
2022
% Change
2023
2022
% Change
Casualty
Commercial excess and personal umbrella
$
276,592
$
247,750
12
%
$
209,402
$
187,666
12
%
General liability
80,160
84,405
(5)
%
77,166
74,130
4
%
Commercial transportation
96,156
98,691
(3)
%
76,473
71,774
7
%
Professional services
83,634
79,406
5
%
73,841
71,590
3
%
Small commercial
59,655
55,529
7
%
54,492
50,463
8
%
Executive products
66,581
73,307
(9)
%
18,449
20,208
(9)
%
Other casualty
60,420
65,414
(8)
%
52,561
52,663
(0)
%
Total
$
723,198
$
704,502
3
%
$
562,384
$
528,494
6
%
Property
Commercial property
$
395,979
$
241,800
64
%
$
173,264
$
115,419
50
%
Marine
111,205
100,923
10
%
96,484
84,499
14
%
Other property
32,141
28,806
12
%
15,848
23,056
(31)
%
Total
$
539,325
$
371,529
45
%
$
285,596
$
222,974
28
%
Surety
Commercial
$
40,968
$
39,560
4
%
$
37,576
$
35,423
6
%
Miscellaneous
38,554
38,394
0
%
35,900
33,691
7
%
Contract
30,255
27,713
9
%
26,956
22,848
18
%
Total
$
109,777
$
105,667
4
%
$
100,432
$
91,962
9
%
Grand Total
$
1,372,300
$
1,181,698
16
%
$
948,412
$
843,430
12
%
Casualty
Gross premiums written for the casualty segment increased $19 million in the first nine months of 2023. Continued new business growth across our personal umbrella and small commercial distribution channels, as well as positive rate movement across a large portion of our casualty segment, offset challenging conditions some lines experienced during the first nine months. We are running off our energy liability business, which resulted in a $19 million decrease within the commercial excess and general liability products. Executive products premium decreased as a result of a more competitive market, particularly with public directors and officers coverages. Additionally, commercial transportation premium decreased, as trucking companies’ revenues are down compared to last year and there is some consolidation underway in the bus industry. 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.
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Property
Gross premiums written for the property segment increased $168 million in the first nine months of 2023. Our commercial property business was up $154 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.
Surety
Gross premiums written for the surety segment increased $4 million for the first nine 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 Nine Months
Ended September 30,
2023
2022
Underwriting Income (in thousands)
Casualty
$
57,478
$
60,418
Property
33,589
40,273
Surety
22,271
23,539
Total
$
113,338
$
124,230
Combined Ratio
Casualty
89.8
88.6
Property
88.2
81.9
Surety
77.8
74.4
Total
88.0
85.3
Casualty
The casualty segment recorded underwriting income of $57 million in the first nine months of 2023, compared to $60 million for the same period last year. Prior accident years’ reserve releases reduced loss and settlement expenses for the casualty segment by $69 million, primarily on accident years 2015 through 2018 and 2020 through 2022. Favorable development was widespread, with notable amounts from commercial excess, executive products, general liability, personal umbrella and professional services. In comparison, $73 million of prior accident years’ reserves were released in the first nine months of 2022. General liability, professional services, transportation, executive products and commercial excess were drivers of the favorable development in 2022. Offsetting the favorable development, storm losses on casualty-oriented package policies that include property coverage resulted in $2 million of losses in 2023 and $8 million of losses in 2022.
The combined ratio for the casualty segment was 89.8 in 2023, compared to 88.6 in 2022. The segment’s loss ratio was 52.7 in 2023, down from 52.8 in 2022. The expense ratio for the casualty segment was 37.1, up from 35.8 for the same period last year. The increase in expense ratio was the result of continued investments in technology and people to support growth and improve customer experiences.
Property
The property segment recorded underwriting income of $34 million for the first nine months of 2023, compared to $40 million for the same period last year. Underwriting results for 2023 included $17 million of favorable development on prior years’ loss and catastrophe reserves, $25 million of storm losses, as well as $52 million of losses and $14 million of reinstatement premium from the Hawaiian wildfires. Comparatively, the 2022 underwriting results included $21 million of favorable development on prior years’ loss and catastrophe reserves, $33 million of hurricane losses and $5 million of other storm losses.
Underwriting results for the first nine months of 2023 translated into a combined ratio of 88.2, compared to 81.9 for the same period last year. The segment’s loss ratio was 52.3 in 2023, up from 44.9 in 2022, due to an increase in catastrophe losses. The segment’s expense ratio decreased to 35.9 in 2023 from 37.0 in the prior year, as the growth in the earned premium base exceeded the growth in expense.
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Surety
The surety segment recorded underwriting income of $22 million for the first nine months of 2023, compared to $24 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 accident years’ reserves, which decreased loss and settlement expenses for the segment by $8 million. Results for 2022 included $9 million of favorable development on prior accident years’ reserves.
The combined ratio for the surety segment totaled 77.8 for the first nine months of 2023, compared to 74.4 for the same period in 2022. The segment’s loss ratio increased to 11.8 in 2023, up from 10.4 in 2022, due to lower levels of favorable prior accident years’ reserve development. The expense ratio was 66.0, up from 64.0 in the prior year.
Investment Income
Our investment portfolio generated net investment income of $88 million during the first nine months of 2023, an increase of 52 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 nine months of 2023 and 2022 were as follows:
2023
2022
Pretax Yield
Taxable
3.45
%
2.82
%
Tax-Exempt
2.79
%
2.67
%
After-Tax Yield
Taxable
2.73
%
2.23
%
Tax-Exempt
2.64
%
2.53
%
The following table depicts the composition of our investment portfolio at September 30, 2023 as compared to December 31, 2022:
(in thousands)
September 30, 2023
December 31, 2022
Fixed income
$
2,717,627
78.7
%
$
2,666,950
81.5
%
Equity securities
534,436
15.5
%
498,382
15.2
%
Short-term investments
125,032
3.6
%
36,229
1.1
%
Other invested assets
59,730
1.7
%
47,922
1.5
%
Cash
18,445
0.5
%
22,818
0.7
%
Total investments and cash
$
3,455,270
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 $51 million in the first nine months of 2023. Average fixed income duration was 4.6 years at September 30, 2023, reflecting our liability structure and sound capital position. The equity portfolio increased by $36 million during the first nine months of 2023, due to the positive performance of equity markets. Short-term investments increased by $89 million, as improved yields made AAA-rated government money market funds an investable asset class.
Income Taxes
Our effective tax rate for the first nine months of 2023 was 18.7 percent, compared to 20.0 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 lower for the nine-month period in 2023, as lower pretax income increased the percentage impact of tax-favored adjustments, such as tax credits and excess tax benefits on share-based compensation.
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Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022
Net premiums earned increased 9 percent, with all segments contributing to the growth. Overall equity market declines resulted in $25 million of unrealized losses on equity securities in the third quarter of 2023, compared to $26 million in the third quarter of 2022. Investment income was up 50 percent, due to an increased average asset base and higher interest rates relative to the prior year. Realized gains during the third quarter of 2023 were comprised of $7 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 less than $1 million of realized gains on the equity portfolio, $2 million of realized losses on the fixed income portfolio and a $574 million gain from the sale of Maui Jim in the same period of 2022.
For the Three Months
Ended September 30,
Consolidated Revenues (in thousands)
2023
2022
Net premiums earned
$
318,409
$
291,468
Net investment income
31,963
21,270
Net realized gains
6,558
573,170
Net unrealized gains (losses) on equity securities
(25,236)
(26,414)
Total consolidated revenue
$
331,694
$
859,494
Net earnings for the third quarter of 2023 totaled $14 million, compared to $440 million for the same period in 2022. The decrease for 2023 was primarily attributed to the $437.7 million of after-tax earnings recognized from the sale of our equity method investment in Maui Jim in 2022. Underwriting results for 2023 were impacted by $52 million of pretax losses and $14 million of reinstatement premium from the Hawaiian wildfires, as well as $5 million of storm losses. Comparatively, 2022 included $40 million of pretax hurricane losses. Results for each period benefited from favorable development on prior years’ loss reserves, which provided additional pretax earnings of $22 million in the third quarter of 2023, compared to $33 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 $4 million on a 98.7 combined ratio for the third quarter of 2023, compared to $9 million on a 97.0 combined ratio in the same period of 2022. The loss ratio increased to 59.5 from 56.6, due to higher net retained catastrophe losses and lower levels of favorable development on prior years’ loss reserves in 2023. The expense ratio decreased to 39.2 from 40.4, with 2023 benefiting from a larger earned premium base.
In the third quarter of 2023, we recognized $2 million of investee earnings from Prime. Comparatively, the third quarter of 2022 reflected investee earnings of $3 million from Prime and $18 million of investee losses from Maui Jim, primarily due to transaction related expenses from the sale of the company in the third quarter of 2022.
Comprehensive loss totaled $43 million for the third quarter of 2023, compared to $359 million in comprehensive earnings for the same period of 2022. Other comprehensive earnings (loss) primarily included net after-tax unrealized losses from the fixed income portfolio. Other comprehensive loss of $57 million in the third quarter of 2023 was attributable to higher interest rates, which decreased the fair value of securities held in the fixed income portfolio. Comparatively, $81 million of other comprehensive loss was recognized in 2022, as interest rates increased.
Premiums
Gross premiums written increased $46 million for the third quarter of 2023, compared to the same period of 2022. Growth was achieved from the property and casualty segments. Net premiums earned increased $27 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)
2023
2022
% Change
2023
2022
% Change
Casualty
Commercial excess and personal umbrella
$
99,752
$
84,452
18
%
$
72,559
$
65,131
11
%
General liability
24,548
25,213
(3)
%
25,250
25,284
(0)
%
Commercial transportation
37,441
38,099
(2)
%
25,843
24,205
7
%
Professional services
28,352
27,016
5
%
24,882
24,174
3
%
Small commercial
19,409
18,592
4
%
18,096
17,005
6
%
Executive products
26,236
27,685
(5)
%
5,943
6,556
(9)
%
Other casualty
18,569
19,309
(4)
%
16,732
17,260
(3)
%
Total
$
254,307
$
240,366
6
%
$
189,305
$
179,615
5
%
Property
Commercial property
$
111,034
$
79,652
39
%
$
63,783
$
43,201
48
%
Marine
36,235
35,927
1
%
33,436
29,592
13
%
Other property
11,321
10,504
8
%
(2,231)
8,051
(128)
%
Total
$
158,590
$
126,083
26
%
$
94,988
$
80,844
17
%
Surety
Commercial
$
13,929
$
14,330
(3)
%
$
12,653
$
12,057
5
%
Miscellaneous
12,733
12,580
1
%
11,966
10,751
11
%
Contract
9,765
10,391
(6)
%
9,497
8,201
16
%
Total
$
36,427
$
37,301
(2)
%
$
34,116
$
31,009
10
%
Grand Total
$
449,324
$
403,750
11
%
$
318,409
$
291,468
9
%
Casualty
Gross premiums written for the casualty segment increased $14 million in the third quarter of 2023. Continued momentum with our personal umbrella distribution base offset challenging conditions some lines experienced during the third quarter. The runoff of our energy liability business resulted in a $5 million decrease within the commercial excess and general liability products for the quarter. 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 increased $33 million in the third quarter of 2023. Our commercial property business grew by $31 million. Continued rate increases on wind exposures has allowed us to achieve this result with limited exposure growth, while also strengthening terms and conditions. Net premiums earned are negative for other property in 2023, as a result of the $14 million of reinstatement premium recorded for Hawaiian wildfires.
Surety
Gross premiums written for the surety segment decreased $1 million for the third quarter of 2023. The decline in commercial surety was due to the timing of select renewals that shifted to the fourth quarter. While public sector construction appears to be holding steady, private sector construction has slowed, which led to declines in contract surety.
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Underwriting Income (Loss)
For the Three Months
Ended September 30,
2023
2022
Underwriting Income (Loss) (in thousands)
Casualty
$
18,670
$
11,329
Property
(20,671)
(8,308)
Surety
6,248
5,775
Total
$
4,247
$
8,796
Combined Ratio
Casualty
90.1
93.7
Property
121.8
110.3
Surety
81.7
81.4
Total
98.7
97.0
Casualty
The casualty segment recorded underwriting income of $19 million in the third quarter of 2023, compared to $11 million for the same period last year. Prior accident years’ reserve releases reduced loss and settlement expenses for the casualty segment by $22 million, primarily on accident years 2015 through 2017 and 2020 through 2022. Favorable development was widespread, with notable amounts from our executive products, commercial excess, general liability and personal umbrella products. In comparison, $28 million of prior accident years’ reserves were released in the third quarter of 2022. General liability, commercial excess and executive products were drivers of the favorable development in 2022. Storm losses on casualty-oriented package policies that include property coverage offset the favorable development and resulted in $0.5 million of losses in 2023 and $7.0 million of losses in 2022.
The combined ratio for the casualty segment was 90.1 in 2023, compared to 93.7 in 2022. The segment’s loss ratio was 53.7 in 2023, down from 56.1 in 2022. The decrease in loss ratio was attributable to improved results in the current accident year, which included lower levels of storm losses. The expense ratio for the casualty segment was 36.4, down from 37.6 for the same period last year, as the growth in the earned premium base exceeded the growth in expense for all segments.
Property
The property segment recorded $21 million of underwriting loss for the third quarter of 2023, compared to $8 million of underwriting loss for the same period last year. Underwriting results for 2023 included $0.4 million of unfavorable development on prior years’ loss and catastrophe reserves, $5 million of storm losses, as well as $52 million of losses and $14 million of reinstatement premium from the Hawaiian wildfires. Comparatively, the 2022 underwriting results included $3 million of favorable development on prior years’ loss and catastrophe reserves and $33 million of hurricane losses.
Underwriting results for the third quarter of 2023 translated into a combined ratio of 121.8, compared to 110.3 for the same period last year. The segment’s loss ratio was 86.3 in 2023, up from 73.4 in 2022, due to the increase in catastrophe losses. The segment’s expense ratio decreased to 35.5 in 2023 from 36.9 in the prior year.
Surety
The surety segment recorded underwriting income of $6 million for the third 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 $1 million, compared to $2 million in 2022.
The combined ratio for the surety segment totaled 81.7 for the third quarter of 2023, compared to 81.4 for the same period in 2022. The segment’s loss ratio was 17.2 in 2023, up from 16.2 in 2022, due to lower levels of prior accident year reserve releases. The expense ratio was 64.5, down from 65.2 in the prior year.
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Investment Income
Our investment portfolio generated net investment income of $32 million during the third quarter of 2023, an increase of 50 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 third quarter of 2023 and 2022 were as follows:
2023
2022
Pretax Yield
Taxable
3.54
%
2.91
%
Tax-Exempt
2.81
%
2.69
%
After-Tax Yield
Taxable
2.80
%
2.30
%
Tax-Exempt
2.66
%
2.55
%
Income Taxes
Our effective tax rate for the third quarter of 2023 was 9.9 percent, compared to 20.7 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 lower for the third quarter of 2023, as lower pretax income increased the percentage impact of tax-favored adjustments, such as tax credits and excess tax benefits on share-based compensation.
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, 2023 and 2022:
(in thousands)
2023
2022
Operating cash flows
$
342,192
$
282,886
Investing cash flows
(211,473)
384,536
Financing cash flows
(135,092)
(32,715)
Total
$
(4,373)
$
634,707
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 2023 benefited from increased premium receipts relative to the first nine months of 2022, but were also impacted by elevated levels of loss and settlement expense payments. Investing cash flows in 2022 reflect the cash received from the sale of our investment in Maui Jim at the end of the third quarter. Given proceeds from the sale were received on September 30, 2022, only a portion of the funds could be reinvested prior to the end of the quarter.
As of September 30, 2023, we had $100 million in debt outstanding. On September 15, 2023, we retired $150 million in senior notes that were originally issued in 2013. Additionally, on September 15, 2023, we accessed $50 million from our revolving line of credit with PNC Bank, N.A. (PNC). The borrowing may be repaid at any time and carries a floating interest rate of 7.07 percent which will reset during the first quarter of 2024. The credit facility with PNC 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. The line of credit permits us to borrow up to an aggregate principal amount of $100 million, but may be increased up to an aggregate principal amount of $130 million under certain conditions. The facility has a three-year term that expires on May 29, 2026. Further, 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.
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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, 2023, $57 million of investments were pledged as collateral with the FHLBC to ensure timely access to the secured lending facility.
As of September 30, 2023, we had cash and other investments maturing within one year of approximately $318 million and an additional $892 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.
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, 2023 have increased $183 million from December 31, 2022. As of September 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
$
334,650
$
321,611
$
(13,039)
9.3
%
AA+
U.S. agency
51,477
48,368
(3,109)
1.4
%
AA+
Non-U.S. government & agency
4,800
3,811
(989)
0.1
%
BBB+
Agency MBS
457,496
399,381
(58,115)
11.6
%
AA+
ABS/CMBS/MBS**
302,659
265,779
(36,880)
7.7
%
AA+
Corporate
1,253,152
1,153,384
(99,768)
33.4
%
A-
Municipal
642,551
525,293
(117,258)
15.2
%
AA
Total fixed income
$
3,046,785
$
2,717,627
$
(329,158)
78.7
%
AA-
Equity
347,772
534,436
186,664
15.5
%
Short-term investments
125,032
125,032
—
3.6
%
Other invested assets
56,617
59,730
3,113
1.7
%
Cash
18,445
18,445
—
0.5
%
Total portfolio
$
3,594,651
$
3,455,270
$
(139,381)
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, 2023, our fixed income portfolio had the following rating distribution:
Below
Investment
AAA
AA
A
BBB
Grade
No Rating
Fair Value
U.S. government
-
321,611
-
-
-
-
321,611
U.S. agency
-
48,368
-
-
-
-
48,368
Non-U.S. government & agency
-
-
1,640
2,171
-
-
3,811
Agency MBS
-
399,381
-
-
-
-
399,381
ABS/CMBS/MBS*
169,828
23,651
53,831
-
-
18,469
265,779
Corporate
30,231
109,213
488,165
321,356
141,027
63,392
1,153,384
Municipal
132,118
340,260
52,915
-
-
-
525,293
Total
332,177
1,242,484
596,551
323,527
141,027
81,861
2,717,627
*
Non-agency asset-backed, commercial mortgage-backed and mortgage-backed securities
As of September 30, 2023, our fixed income portfolio remained well diversified, with 1,783 individual issues.
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Our investment portfolio has limited exposure to structured asset-backed securities. As of September 30, 2023, we had $146 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, 2023, we had $119 million in commercial and non-agency mortgage-backed securities and $399 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 7.7 percent of our investment portfolio at quarter end.
We had $1,153 million in corporate fixed income securities as of September 30, 2023, which includes $112 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 September 30, 2023, our equity portfolio had a dividend yield of 2.4 percent, compared to 1.6 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 84 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 $56 million of investments in unconsolidated investees at September 30, 2023, compared to $58 million at December 31, 2022.
Our investment portfolio does not have any exposure to derivatives.
As of September 30, 2023, our capital structure consisted of $100 million in debt and $1.3 billion of shareholders’ equity. Debt outstanding comprised 7 percent of total capital as of September 30, 2023. Interest and fees on debt obligations totaled $6 million for the first nine months of 2023 and 2022. We incurred interest expense on debt at an average annual interest rate of 3.90 percent during the first nine months of 2023, compared to 3.89 percent during the same period last year.
We paid a regular quarterly cash dividend of $0.27 per share on September 20, 2023, the same amount as 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 September 30, 2023, our holding company had $1.3 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 $156 million in liquid assets. 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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Table of Contents
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 2023, RLI Ins. paid $45 million in ordinary dividends to RLI Corp. In 2022, our principal insurance subsidiary paid ordinary dividends totaling $13 million. As of September 30, 2023, $105 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.