UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2003

 

or

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                                          to

 

Commission File Number 0-6612

 

RLI CORP.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code  (309) 692-1000

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:  NONE

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

ý  Yes  o  No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

ý  Yes  o  No

 

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2003, based upon the closing sale price of the Common Stock on June 30, 2003 as reported on the New York Stock Exchange, was $826,524,064.  Shares of Common Stock held directly or indirectly by each officer and director along with shares held by the Company ESOP have been excluded in that such persons may be deemed to be affiliates.  This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

The number of shares outstanding of the Registrant’s Common Stock, $1.00 par value, on February 12, 2004 was 25,176,980.

 

DOCUMENTS INCORPORATED BY REFERENCE.

Portions of the Annual Report to Shareholders for the past year ended December 31, 2003, are incorporated by reference into Parts I and II of this document.

 

Portions of the Registrant’s definitive Proxy Statement for the 2004 annual meeting of security holders to be held May 6, 2004, are incorporated herein by reference into Part III of this document.

 

Exhibit index is located on pages 39-40 of this document.

 

 

PART I

 

Item 1.  Business

 

We are a holding company that underwrites selected property and casualty insurance through our insurance subsidiaries. We are an Illinois corporation that was organized in 1965. We conduct operations principally through three insurance companies. RLI Insurance Company, our principal subsidiary, writes multiple lines insurance on an admitted basis in all 50 states, the District of Columbia and Puerto Rico. Mt. Hawley Insurance Company, a subsidiary of RLI Insurance Company, writes surplus lines insurance in all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam. RLI Indemnity Company (formerly known as Planet Indemnity Company), a subsidiary of Mt. Hawley, has authority to write multiple lines insurance on an admitted basis in 48 states and the District of Columbia.  Other companies in our group include: Replacement Lens Inc., RLI Insurance Agency, Ltd., RLI Insurance Ltd., Underwriters Indemnity General Agency, Inc. and Safe Fleet Insurance Services, Inc.

 

We maintain an Internet website at http://www.rlicorp.com. We make available free of charge on our website our annual report on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

 

As a “niche” company, we offer specialty insurance products designed to meet specific insurance needs of targeted insured groups. A niche company underwrites a particular type of coverage for certain markets that are underserved by the insurance industry, such as our commercial earthquake coverage and oil and gas surety bonds. A niche company also provides a type of product not generally offered by other companies, such as our personal umbrella policy. The excess and surplus market provides an alternative market for customers with hard-to-place risks and risks that admitted insurers specifically refuse to write. When we underwrite within the surplus lines market, we are selective in the line of business and type of risks we choose to write. Often the development of these specialty insurance products is generated through proposals brought to us by an agent or broker seeking coverage for a specific group of clients. Once a proposal is submitted, underwriters determine whether a proposal would be a viable product in keeping with our business objectives.

 

Since 1977, when we first began underwriting specialty property and casualty coverages for commercial risks, highly cyclical market conditions and a number of other factors have influenced our growth and underwriting profits. From 1987 to 2001, the industry experienced generally soft market conditions featuring intensified competition for admitted and surplus lines insurers, resulting in rate decreases. We continually monitored our rates and controlled our costs in an effort to maximize profits during this entrenched soft market condition. As a result of catastrophic losses, such as Hurricane Andrew and the Northridge Earthquake, in the mid-1990’s, property rates hardened in California, Florida and the wind belt, but remained soft in other areas of the country. During this period, rates hardened and premium growth was achieved in the commercial property book of business. Otherwise, rates for property and casualty lines continued to decline over time. To maintain profitability, underwriters tightened selection criteria, broadened their focus to other market segments and gave up business where rates fell below our tolerance.

 

Beginning at the end of 1999, a trend of price firming emerged in many of the markets in which we participate. Likewise, since early in 2001, a return to conservative underwriting took place in the industry for most of the products we write. For the most part, this pattern continued throughout the first half of 2003 and is still in place for most of the casualty segment. However, for property business, rates are now beginning to flatten and, for superior risks, are actually starting to decrease. Nevertheless, we believe that a climate of rate adequacy for our core business continues to exist as a result of the following influences:

 

•                                          low interest rates;

 

•                                          the downgrading or close monitoring of many insurers and reinsurers by rating agencies;

 

•                                          new corporate governance requirements; and

 

•                                          recognition of the devastating effect that many years of having under-priced business has had on much of the industry.

 

These factors should contribute to continued demand for our specialty products.

 

2

 

While we anticipate a steady growth in market share, we do not anticipate any increase that would warrant disclosure of a material impact. We expect the demand for specialty products to increase in the areas of primary casualty business and directors and officers insurance, particularly as increased reinsurance costs limit new companies from entering these lines of business. We also expect that our personal umbrella policy will grow as we are one of the few insurers that write this coverage without also writing the underlying auto and homeowners insurance.

 

We initially wrote specialty property and casualty insurance through independent underwriting agents. We opened our first branch office in 1984, and began to shift from independent underwriting agents to wholly-owned branch offices that market to wholesale producers. We also market certain products to retail producers from several of our Casualty, Surety and Property Divisions. We produce a limited amount of business under agreements with underwriting general agents under the auspices of our product vice presidents. The majority of business is marketed through our branch offices located in Los Angeles, California; Oakland, California; Glastonbury, Connecticut; Sarasota, Florida; Atlanta, Georgia; Alpharetta, Georgia; Honolulu, Hawaii; Chicago, Illinois; Peoria, Illinois; Boston, Massachusetts; Summit, New Jersey; Cleveland, Ohio; Philadelphia, Pennsylvania; Dallas, Texas; Houston, Texas; and Seattle, Washington.

 

For the year ended December 31, 2003, the following table provides the geographic distribution of our risks insured as represented by direct premiums earned for all product lines. For the year ended December 31, 2003, no other state accounted for more than 1.5% of total direct premiums earned for all product lines.

 

 

In the ordinary course of business, we rely on other insurance companies as business partners to share risks through reinsurance. A large portion of the reinsurance is put into effect under contracts known as treaties and, in some instances, by negotiation on each individual risk, known as facultative placements. We have quota share, excess of loss and catastrophe reinsurance contracts that protect against losses over stipulated amounts arising from any one occurrence or event. The arrangements provide greater diversification of business and serve to limit the maximum net loss on catastrophes and large and unusually hazardous risks. Reinsurance is subject to certain risks, specifically market risk, which affects the cost of, and the ability to secure, these contracts, and collection risk, which is the risk that our reinsurers may not pay on losses in a timely fashion or at all. The following table illustrates, through premium volume, the degree to which we utilize reinsurance. For an expanded discussion of the impact of reinsurance on our operations, see Note 5 to our consolidated financial statements included in our Annual Report to Shareholders for the year ended December 31, 2003, attached as Exhibit 13.

 

Premiums Written (in thousands)		Year Ended December 31,
		2003			2002			2001
Direct & Assumed		$	742,477		$	707,453		$	511,985
Reinsurance ceded		(268,383		)	(293,815		)	(196,772		)
Net		$	474,094		$	413,638		$	315,213

 

3

 

Specialty Insurance Market Overview

 

The specialty insurance market differs significantly from the standard market. In the standard market, insurance rates and forms are highly regulated, products and coverages are largely uniform with relatively predictable exposures, and companies tend to compete for customers on the basis of price. In contrast, the specialty market provides coverage for risks that do not fit the underwriting criteria of the standard carriers. Competition tends to focus less on price and more on availability, service and other value-based considerations. While specialty market exposures may have higher insurance risks than their standard market counterparts, we manage these risks to achieve higher financial returns. To reach our financial and operational goals we must have extensive knowledge and expertise in our markets. Most of our risks are considered on an individual basis and restricted limits, deductibles, exclusions and surcharges are employed in order to respond to distinctive risk characteristics.

 

We operate in the excess and surplus market and the specialty admitted market.

 

Excess and Surplus Market

 

The excess and surplus market focuses on hard-to-place risks and risks that admitted insurers specifically refuse to write. Excess and surplus eligibility allows our insurance subsidiaries to underwrite nonstandard market risks with more flexible policy forms and unregulated premium rates. This typically results in coverages that are more restrictive and more expensive than in the standard admitted market. The excess and surplus market represented approximately $25.6 billion, or 6.3%, of the entire $407 billion domestic property and casualty industry, as measured by direct premiums written. For 2003, our excess and surplus units had gross premiums written of $356.0 million representing approximately 47.9% of our total gross written premium for the period.

 

Specialty Admitted Market

 

We also write business in the specialty admitted market. Most of these risks are unique and hard to place in the standard market, but for marketing and regulatory reasons, they must remain with an admitted insurance company. The specialty admitted market is subject to greater state regulation than the excess and surplus market, particularly with regard to rate and form filing requirements, restrictions on the ability to exit lines of business, premium tax payments and membership in various state associations, such as state guaranty funds and assigned risk plans. For 2003, our specialty admitted units had gross premiums written of $386.5 million representing approximately 52.1% of our total gross written premium for the year.

 

Business Overview

 

We presently underwrite selected property and casualty insurance across three distinct business segments: casualty, property and surety. See Note 11 to our consolidated financial statements included in our Annual Report to Shareholders for the year ended December 31, 2003, attached as Exhibit 13.

 

Casualty Segment

 

General Liability

 

Our general liability business consists primarily of coverage for third party liability of commercial insureds including manufacturers, contractors, apartments and mercantile risks. Net earned premiums totaled $131.9 million, $75.9 million and $47.7 million, or 25%, 20% and 15% of consolidated net revenues for the years 2003, 2002 and 2001, respectively.

 

Commercial and Personal Umbrella Liability

 

Our commercial umbrella coverage is principally written in excess of primary liability insurance provided by other carriers and, to a small degree, in excess of primary liability written by us. The personal umbrella coverage, which is produced through the Specialty Markets Division, is written in excess of the homeowners and automobile liability coverage provided by other carriers, except in Hawaii, where some underlying homeowners is written by us. Net earned premiums totaled $42.8 million, $33.8 million and $56.3 million, or 8%, 9% and 18% of consolidated net revenues for the years 2003, 2002 and 2001, respectively.

 

4

 

Executive Products

 

We sell financial products such as directors’ and officers’, or D&O, liability and other miscellaneous professional liability for a variety of low to moderate classes of risks. Events affecting the economy over the past few years have resulted in several insurers ceasing to write D&O coverage, which created an opportunity to raise rates significantly and reduce exposures. This situation is now starting to slow as rates appear to be more adequate. The package of coverages offered has been expanded to include a variety of coverages of interest to corporations and executives, such as employment practices liability and fiduciary liability. This is designed to give the product broader appeal. Net earned premiums totaled $13.9 million, $8.4 million and $4.5 million, or 3%, 2% and 1% of consolidated net revenues for the years 2003, 2002 and 2001, respectively.

 

Specialty Program Business

 

We began writing program business in 1998 through a broker in New Jersey. During 2001, we improved our infrastructure to streamline processing through automation and utilization of new technologies that shorten the time required to launch new products and programs. We continue to develop new programs for a variety of affinity groups. Coverages offered include: commercial property, general liability, inland marine, and crime. Often, these coverages are combined into a package or portfolio policy. We have recently moved to a strategy of bringing most risk underwriting “in house” while continuing to rely upon program administrators for policy servicing and sales. Net earned premiums totaled $50.8 million, $28.5 million and $8.5 million for 2003, 2002 and 2001, respectively. These amounts represent 10%, 7% and 3% of consolidated net revenues for 2003, 2002 and 2001, respectively.

 

Commercial Transportation

 

In 1997, we opened a transportation insurance facility in Atlanta to offer automobile liability and physical damage insurance to local, intermediate and long haul truckers, public transportation risks and equipment dealers. We also offer incidental, related insurance coverages, including general liability, commercial umbrella and excess liability, and motor truck cargo. The facility is staffed by highly experienced transportation underwriters who produce business through independent agents and brokers nationwide. Net earned premiums totaled $50.6 million, $44.2 million and $23.5 million, or 10%, 12% and 8% of consolidated net revenues for 2003, 2002 and 2001, respectively.

 

Other

 

We offer a variety of other smaller programs, including deductible buy-back, in-home business, and employer’s excess indemnity. Net earned premiums from these lines totaled $19.5 million, $17.3 million and $16.4 million, or 4%, 5% and 5% of consolidated net revenues for the years 2003, 2002 and 2001, respectively.

 

Property Segment

 

Commercial Property

 

Our commercial property coverage consists primarily of excess and surplus lines and specialty insurance such as fire and earthquake and “difference in conditions,” which includes earthquake, wind, flood and collapse coverages written in the United States. We write coverage for a wide range of commercial and industrial risks such as office buildings, apartments, condominiums, certain industrial and mercantile structures, buildings under construction and movable equipment. We also write boiler and machinery coverage under the same management as commercial property. In 2003, 2002, and 2001, net earned premiums totaled $100.6 million, $82.2 million and $62.9 million, or 19%, 22% and 20%, respectively, of our consolidated net revenues.

 

Homeowners/Residential Property

 

In 1997, we acquired a book of homeowners and dwelling fire business for Hawaii homeowners from the Hawaii Property Insurance Association. In the aftermath of Hurricane Iniki in 1992, this business was available at reasonable rates and terms. Net earned premiums totaled $7.1 million, $7.0 million and $7.9 million, or 1%, 2% and 3% of consolidated net revenues for 2003, 2002 and 2001, respectively.

 

5

 

Surety Segment

 

Our surety segment specializes in writing small to large commercial and small contract surety products, as well as those for the energy (plugging and abandonment), petrochemical and refining industries. These bonds are written through independent agencies, regional and national brokers. Net earned premium totaled $46.4 million, $50.7 million, and $45.3 million, or 9%, 13% and 15% of consolidated net revenues for 2003, 2002 and 2001, respectively.

 

Competition

 

Our specialty property and casualty insurance subsidiaries are part of an extremely competitive industry that is cyclical and historically characterized by periods of high premium rates and shortages of underwriting capacity followed by periods of severe competition and excess underwriting capacity. Within the United States alone, approximately 3,100 companies, both stock and mutual, actively market property and casualty products. Our primary competitors in our casualty segment include AIG, St. Paul, Scottsdale Insurance, General Star, CNA, Chubb, Great West Casualty, and others. Our primary competitors in our property segment include Lexington Insurance Company, ARCH Insurance Co., General Star, Markel, St. Paul Surplus and others. Our primary competitors in our surety segment include North American Specialty Insurance Co., CNA Insurance Companies, and St. Paul Companies. The combination of products, service, pricing and other methods of competition vary from line to line. Our principal methods of meeting this competition are innovative products, marketing structure and quality service to the agents and policyholders at a fair price. We compete favorably in part because of our sound financial base and reputation, as well as our broad geographic penetration into all 50 states, the District of Columbia, Puerto Rico, the Virgin Islands and Guam. In the property and casualty area, we have acquired experienced underwriting specialists in our branch and home offices. We have continued to maintain our underwriting and marketing standards by not seeking market share at the expense of earnings. New products and new programs are offered where the opportunity exists to provide needed insurance coverage with exceptional service on a profitable basis.

 

Ratings

 

A.M. Best ratings for the industry range from ‘‘A++’’ (Superior) to ‘‘F’’ (In Liquidation) with some companies not being rated. Standard & Poor’s ratings for the industry range from ‘‘AAA’’ (Superior) to ‘‘R’’ (Regulatory Action). Moody’s ratings for the industry range from “Aaa” (Exceptional) to “C” (Lowest).  The following table illustrates the range of ratings assigned by each of the three major rating companies that has issued a financial strength rating on our insurance companies:

 

A.M. Best				Standard & Poor’s				Moody’s
SECURE				SECURE				STRONG
A++, A+		Superior		AAA		Extremely strong		Aaa		Exceptional
A, A-		Excellent		AA		Very strong		Aa		Excellent
B++, B+		Very good		A		Strong		A		Good
				BBB		Good		Baa		Adequate
VULNERABLE				VULNERABLE				WEAK
B, B-		Fair		BB		Marginal		Ba		Questionable
C++, C+		Marginal		B		Weak		B		Poor
C, C-		Weak		CCC		Very weak		Caa		Very poor
D		Poor		CC		Extremely weak		Ca		Extremely poor
E		Under regulatory supervision		R		Regulatory action		C		Lowest