RLI Corp. (RLI)

RLI 
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RLI Corp. (RLI)

Q2 2009 Earnings Call Transcript

July 21, 2009 11:00 am ET

Executives

John Robison – Treasurer

Mike Stone – President and COO

Jon Michael – President and CEO

Joe Dondanville – SVP and CFO

Analysts

DeForest Hinman – Walthausen & Co.

Meyer Shields – Stifel Nicolaus

Mike Grasher – Piper Jaffray

Ron Bobman – Capital Returns

Bijan Moazami – FBR Capital Markets

Michael Nannizzi – Oppenheimer

Doug Mewhirter – RBC Capital Markets

Presentation

Jon Michael

[Starts abruptly] Joining me for today's call are Jon Michael, President and CEO of RLI Corp., Joe Dondanville, Senior Vice President and Chief Financial Officer, and Mike Stone, President And Chief Operating Officer of RLI Insurance Company.

We will conduct this call as we have in past quarters. I will give a brief review of the financial highlights and discuss the investment portfolio. Mike Stone will talk about the quarter's operations, then we will open the call to questions and Jon Michael will finish up with some closing comments.

Our second quarter operating earnings were $1.32 per share. Included in this quarter's earnings are $16.4 million in pretax favorable development and prior year's loss reserves. The favorable development came from our casualty book of business. The combined ratio for the second quarter was 79.5 resulting in underwriting income of roughly 25 million. Gross written premiums were down 3% versus the second quarter of 2008 and down 5% through the first six months of 2009. As we have demonstrated over time, we are an underwriting company focused on underwriting profits in hard and soft markets. We will grow when margins are acceptable and contract when we are not being compensated for the risks we are taking.

Turning to the investment portfolio, as of June 30, our overall allocation was 78% in fixed income, 12% in equities, and 10% in short-term investments. This allocation has not significantly changed from the first quarter. While the fixed income and equity markets rallied in the second quarter, we still believe the economy is fragile and have opted to slowly reinvest our cash positions. In my opinion, the first quarter exhibited an excess of pessimism while the second quarter exhibited an excess of optimism. We still have concerns over economic growth, significant deficit spending, unemployment, and the potential for inflation down the road, just to name a few. Again, we remain cautious, but have started to invest our cash balances.

We certainly benefited from the market really in the second quarter. Book value increased 7% from year-end to $35.32 per share. Many of our securities have improved significantly from the first quarter of 2009 as credit spreads tightened and equity securities posted one of the largest quarterly returns in recent history. We continue to monitor all of our holdings but believe our high-quality portfolio will continue to perform well in this challenging environment.

Within the fixed income arena, our exposure to commercial mortgage is less than 50 million, all are rated AAA and have made all contractual payments. Our exposure to credit cards and auto paper is less than 10 million and all are rated AAA. We do not own any California municipal securities and we do not own any securities rated below investment grade.

Our fixed income portfolio has an overall rating of AA with a duration of roughly 5 years. The tax equivalent book yield on our fixed income portfolio is approximately 5.3%. Investment income declined 16% for the quarter and 12% year-to-date. In addition to the lower interest rate environment, this decline is primarily due to our eliminating the more volatile asset classes, including positions in the high yield muni bond fund, REITs, preferred stocks, and the DOW Dividend Select ETF. These securities carried yields north of 7% and the proceeds are now sitting in short-term investments.

Net realized gains on investment securities were roughly 6 million this quarter. We realized approximately 12 million in investment gains from selling securities that were previously deemed other than temporarily impaired. We've recognized the tax laws but had a book value gain as these securities improved during the second quarter. These gains were offset by roughly 6 million in securities that were deemed other than temporarily impairment this quarter, the majority of which came from our equity portfolio. As of April 1, we adopted a new financial accounting standards 115-2 and 124-2. These new standards apply to fixed income securities, specifically any credit related impairment the company does not plan to sell and not likely to be required to sell is recognized in operating earnings, with the non-credit related impairment recognized in comprehensive earnings.

Based on our analysis, our fixed income portfolio is of a high credit quality and it is not probable that contractual cash flows will not be collected. The fixed income unrealized losses can primarily be attributed to changes in interest rates and not related to credit issues. As a result, this mandatory accounting change had no impact on our reporting. Our total return for the portfolio was 3.6% for the quarter with equities returning 14.1% and our fixed income reporting 2.4%. Our investment portfolio has returned 3.1% year-to-date.

Comprehensive earnings which include after-tax unrealized gains and losses from the investment portfolio were nearly 57 million for the quarter, up from 13.3 million over the same period in 2008. Shareholders equity increased to 767 million and statutory surplus stands at just under 700 million. Once again, from an investment portfolio perspective, it was a good quarter in terms of a market recovery. We are proceeding in a cautiously conservative manner making sure our portfolio remains high quality. We have started to invest our cash balances into shorter duration high-quality fixed-income securities. I would not expect to see our 12% equity allocation to significantly change in the near term.

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