RLI CORP - 10-K Annual Report

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, 2004

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)

Illinois		37-0889946
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

9025 North Lindbergh Drive, Peoria, Illinois		61615
(Address of principal executive offices)		(Zip Code)

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

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

Title of each class		Name of each exchange on which registered
Common Stock $1.00 par value		New York Stock Exchange

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. Yes ý No o

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). Yes ý No o

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2004, based upon the closing sale price of the Common Stock on June 30, 2004 as reported on the New York Stock Exchange, was $920,389,621. 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 10, 2005 was 25,399,227.

DOCUMENTS INCORPORATED BY REFERENCE.

Portions of the 2004 Financial Report to Shareholders for the past year ended December 31, 2004, are incorporated by reference into Parts I and II of this document.

Portions of the Registrant’s definitive Proxy Statement for the 2005 annual meeting of security holders to be held May 5, 2005, 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, 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: RLI Underwriting Services, 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. Beginning early in 2001, a return to conservative underwriting took place in the industry for virtually all of the products we write. For property business, this pattern continued until the second half of 2003, when rates first plateaued, and then slowly began to decline. This moderate decline continued throughout much of 2004, with some stabilization seen after the October Hurricanes in Florida. For casualty business, rates remained firm throughout 2003 and stabilized in 2004. No significant decline in rate levels has been seen. Consequently, we believe that a climate of rate adequacy for our core business continues to exist, as a result of the following influences:

• relatively 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.

While we anticipate moderate growth, 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, transportation, and small surety bonds. We also expect that our personal umbrella business will continue to grow, as we remain 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 Phoenix, Arizona; Los Angeles, California; Oakland, California; Glastonbury, Connecticut; Sarasota, Florida; Atlanta, Georgia; Alpharetta, Georgia; Honolulu, Hawaii; Chicago, Illinois; Peoria, Illinois; Indianapolis, Indiana; Boston, Massachusetts; Lincoln, Nebraska; Summit, New Jersey; Saratoga Springs, New York; Cleveland, Ohio; Philadelphia, Pennsylvania; Pittsburgh, Pennsylvania; Dallas, Texas; Houston, Texas; and Seattle, Washington.

For the year ended December 31, 2004, 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, 2004, no other state accounted for more than 1.5% of total direct premiums earned for all product lines.

State	Direct Premiums Earned		Percent of Total
	(in thousands)
California	$	165,896	22.3
Texas	87,573		11.8
New York	85,697		11.5
Florida	71,439		9.6
Illinois	26,300		3.5
New Jersey	25,530		3.4
Pennsylvania	19,227		2.6
Georgia	16,685		2.2
Ohio	14,683		2.0
Washington	14,479		1.9
Massachusetts	13,994		1.9
Tennessee	12,472		1.7
Hawaii	11,795		1.6
Michigan	11,287		1.5
Missouri	10,993		1.5
All Other	156,546		21.0

Total direct premiums	$	744,596	100.0	%

In the ordinary course of business, we rely on other insurance companies 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 allow us to pursue greater diversification of business and serve to limit the maximum net loss on catastrophes and large 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 2004 Financial Report to Shareholders, attached as Exhibit 13.

Premiums Written	Year Ended December 31,
(in thousands)	2004			2003			2002
Direct & Assumed	$	752,588		$	742,477		$	707,453
Reinsurance ceded	(241,376		)	(268,383		)	(293,815		)
Net	$	511,212		$	474,094		$	413,638

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 coverage 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 $33 billion, or 7%, of the entire $456 billion domestic property and casualty industry, as measured by direct premiums written. For 2004, our excess and surplus operation wrote gross premiums written of $390.2 million representing approximately 52% 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 2004, our specialty admitted operations wrote gross premiums written of $362.4 million representing approximately 48% 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 2004 Financial Report to Shareholders, 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. Net earned premiums totaled $175.0 million, $131.9 million and $75.9 million, or 30%, 25% and 20% of consolidated net revenues for the years 2004, 2003 and 2002, 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 is written in excess of the homeowners and automobile liability coverage provided by other carriers, except in Hawaii, where some underlying homeowners coverage is written by us. Net earned premiums totaled $53.5 million, $42.8 million and $33.8 million, or 9%, 8% and 9% of consolidated net revenues for the years 2004, 2003 and 2002, respectively.

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 resulted in several insurers ceasing to write D&O coverage, which created an opportunity to raise rates significantly and reduce exposures. This situation rapidly changed in early 2004 with the return of price competition, particularly in the large account sector. As a consequence, we have shifted our focus to smaller risks and not-for-profit organizations. This shift largely limited our writings in the large account market to a very conservative new D&O policy coverage. Net earned premiums totaled $13.1 million, $13.9 million and $8.4 million, or 2%, 3% and 2% of consolidated net revenues for the years 2004, 2003 and 2002, respectively.

Specialty Program Business

We began writing program business in 1998 through a broker in New Jersey. We have 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 $47.1 million, $50.8 million and $28.5 million for 2004, 2003 and 2002, respectively. These amounts represent 8%, 10% and 7% of consolidated net revenues for 2004, 2003 and 2002, respectively.

Commercial Transportation

In 1997, we opened a transportation insurance facility in Atlanta to provide automobile liability and physical damage insurance to local, intermediate and long haul truckers, public transportation risks and equipment dealers. In early 2005, we expanded our focus to include other types of commercial automobile risks. 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 $56.0 million, $50.6 million and $44.2 million, or 10%, 10% and 12% of consolidated net revenues for 2004, 2003, and 2002, respectively.

Other

We offer a variety of other smaller programs, including deductible buy-back, at-home business, and employer’s excess indemnity. Net earned premiums from these lines totaled $20.9 million, $19.5 million and $17.3 million, or 4%, 4% and 5% of consolidated net revenues for the years 2004, 2003 and 2002, respectively.

Property Segment

Commercial Property

Our commercial property coverage consists primarily of excess and surplus lines and specialty insurance such as fire, earthquake and “difference in conditions,” which includes earthquake, wind, flood and collapse coverages written in the United States. We provide insurance 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 2004, 2003, and 2002, net earned premiums totaled $90.8 million, $100.6 million and $82.2 million, or 16%, 19%, and 22%, 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 $7.2 million, $7.1 million and $7.0 million, or 1%, 1% and 2% of consolidated net revenues for 2004, 2003 and 2002, respectively.

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 $47.7 million, $46.4 million, and $50.7 million, or 8%, 9% and 13% of consolidated net revenues for 2004, 2003 and 2002, 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 2,400 companies, both stock and mutual, actively market property and casualty products. Our primary competitors in our casualty segment include AIG, St. Paul/Travelers, 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/Travelers 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

STRONG

A++, A+

Superior

AAA

Extremely strong

Aaa

Exceptional

A,A-

Excellent

Very strong

Excellent

B++, B+

Very good

Strong

Good

BBB

Good

Baa

Adequate

VULNERABLE

WEAK

B,B-

Fair

Marginal

Questionable

C++,C+

Marginal

Weak

Poor

C,C-

Weak