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RLI Corp RLI
January 26, 2009 - 9:03am EST by
renegade978
2009 2010
Price: 56.80 EPS $4.74 $4.25
Shares Out. (in M): 22 P/E 12.0x 14.2x
Market Cap (in $M): 1,244 P/FCF 7.3x 10.3x
Net Debt (in $M): 100 EBIT 161 131
TEV (in $M): 1,344 TEV/EBIT 8.4x 10.3x

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Description

 

Description: RLI is a market leader in the specialty insurance business that is trading +20% off its 52 week high in a period when the insurance markets are starting to harden.  RLI's stock has held up better than peers due to the conservative nature of their underwriting as well as their strong balance sheet and conservative investment portfolio.  They are in a better position than any of their peers with an under-leveraged and conservative balance sheet (Premium / Surplus of 69% compared to a target of 110%; Debt / capital of 12%).  Also, the market turmoil with RLI's biggest competitor in the E&S space, AIG, will work to their benefit since they have an A+ rating and one of the lowest debt / capital (12%) of their peers.  Clients' greater focus on diversification of carriers and RLI's high quality and high rated company will provide lots of opportunity to take share. 

     
Current Price    
Price (local currency): $56.80  
Shares Outstanding (in M): 21.9  
Market Cap (in $M): $1,243.5  
     
     
     
Current Valuation 2008 2009
EarningsPerShare: $4.74 $4.00
P/E: 12.0 x 14.2 x
     
Summary B/S    
Cash & Investments $1.8  
Reinsurance assets 0.4  
Other 0.3  
Total Assets $2.5  
     
Policy Reserves $1.5  
Total Debt 0.1  
Other 0.2  
Total liabilities $1.8  
     
Common Equity $0.7  
Total liab. & SE $2.5  
     
BVPS $32.84  
     
Multiple on Ins Business 1.75 x  
Value of Ins Business $57.46  
     
Plus: excess reserve 4.57  
Value of Maui Jim's 6.67  
Total value $68.70  
Discount (17.3%)  
     

 

 Business description:

  • RLI underwrites selected P&C insurance in all 50 states, DC and PR
  • RLI operates in the excess and surplus insurance market and the specialty admitted insurance market
  • o 53% of RLI premiums (395.4mm) are in the excess and surplus market
  • o The entire excess and surplus market is ~30bn or 6% of the 499bn domestic property and casualty industry
  • o 47% of RLI premiums (343.9mm) are in the specialty admitted insurance market

 

Segment Overview:

  • Casualty Segment
  • o General Liability: consists of coverage for third party liability of commercial insureds including manufacturers, contractors, apartments and mercantile
  • § Net premiums totaled 167.9mm (26%)
  • o Commercial & Personal Umbrella Liability: the commercial umbrella coverage is principally written in excess of primary liability insurance provided by other carriers and, to a modest degree, in excess of primary liability written by RLI
  • § The personal umbrella coverage is written in excess of the homeowners and automobile liability coverage provided by other carriers
  • § Net premiums earned were 66.3mm or 10% of total
  • o Executive products: D&O liability insurance and other miscellaneous professional liability coverages
  • § Target accounts include publicly traded companies with market capitalizations below $5bn
  • § Net premiums earned were 12.0mm or 2% of total
  • o Specialty program business: program coverages include commercial property, general liability, inland marine, and crime
  • § Net premiums earned were 29.4mm or 5% of total
  • o Commercial Transportation: the facility in Atlanta provides automobile liability and physical damage insurance to local, intermediate and long haul truckers, public transportation risks and equipment dealers
  • § Net premiums earned were 49.1mm or 8% of total
  • o Other: smaller programs including dedutible buy-back, at-home business and employer's excess indemnity
  • § Net premiums earned were 18.7mm or 3% of total

 

  • Property Segment
  • o Commercial: consists of excess and surplus lines and specialty insurance such as fire, earthquake and "difference in conditions"
  • § RLI provides insurance for a wide range of industrial risks such as office buildings, apartments, condos and certain industrial and mercantile structures
  • § Net premiums totaled 92.6mm or 14% of total
  • o Marine: Launched in 2005, the focus includes "brown water" ocean marine (near shore, river and Great Lakes) coverages including hull, cargo and protection indemnity and inland marine coverages including builders risks, contractors equipment and other "floater" type coverages
  • § Net premiums were 32.9mm or 5% of total
  • o Other: smaller programs including homeowners and dwelling fire insurance in Hawaii
  • § Net premiums were 12.9mm or 2% of total

 

  • Surety Segment
  • o Specializes in provided coverage for individuals, contractors, small business owners, small to large corporations and businesses operating in the energy, petrochemical and refining industries
  • o RLI also offers miscellaneous and contract surety bonds, including fidelity and court sureties
  • o Net premiums were 62.7mm or 10% of total

 

Distribution channels

RLI distributes coverage primarily through branch offices throughout the country that market to wholesale and retail brokers and through independent agents

  • Broker business: the largest volume of broker-generated premium is in RLI's commercial property, general liability, commercial surety, commercial umbrella and commercial automobile coverages.  This business is produced through wholesale and retail brokers who are not affiliated with RLI
  • Independent Agent business: The surety segment offers its business through a variety of IA's.  Additionally RLI writes program business such as at-home business and personal umbrella
  • Underwriting Agents: RLI contracts with certain underwriting agencies who have limited authority to bind or underwrite business on RLI's behalf
  • E-commerce: RLI actively employs e-commerce to produce and efficiently process and service business, including package policies for limited service motel/hotel operations, restaurant/bar/tavern operations and at-home businesses, small commercial and personal umbrella risks and surety bonding

 

 

Underwriting: RLI has demonstrated its ability to profitably underwrite in hard and soft markets over the past 10 years.  RLI's conservative underwriting and consistent reserve strategy has led to an understated book value and balance sheet strength that is not appreciated by the market and will allow them to take advantage of the coming hard market and AIG mishaps.

Underwriting Analysis
  1999Y 2000Y 2001Y 2002Y 2003Y 2004Y 2005Y 2006Y 2007Y
                   
Consolidated                  
Current Year                  
Loss ratio 51.7% 54.5% 53.8% 54.5% 59.9% 62.0% 63.8% 56.6% 54.4%
Expense ratio 41.8% 41.0% 40.1% 37.2% 31.8% 32.3% 34.9% 35.7% 36.3%
  -------- -------- -------- -------- -------- -------- -------- -------- --------
Combined Ratio--CY 93.6% 95.5% 93.9% 91.6%

91.6%

 94.3% 98.7% 92.3% 90.7%

Loss Triangles depict the conservative nature of RLI's underwriting and the excessive redundancy leading to an understated book value.

  1997                    
  & Prior 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Net liability for unpaid losses and settlement expenses at end of the year 248,552 247,262 274,914 300,054 327,250 391,952 531,393 668,419 738,657 793,106 774,928
Paid cumulative as of:                      
1 year later 54,927 53,892 65,216 92,788 98,953 94,465 129,899 137,870 154,446 162,448  
2 years later 98,188 88,567 113,693 155,790 159,501 182,742 212,166 239,734 270,210    
3 years later 120,994 114,465 149,989 192,630 211,075 234,231 273,019 324,281      
4 years later 136,896 132,796 172,443 222,870 238,972 269,446 322,050        
5 years later 149,324 145,888 191,229 237,464 260,618 300,238          
6 years later 159,048 159,153 200,610 250,092 281,775            
7 years later 168,984 165,277 209,288 261,612              
8 years later 173,367 171,709 216,934                
9 years later 178,528 176,310                  
10 years later 182,423                    
                       
Liability re-estimated as of:                      
1 year later 245,150 243,270 273,230 309,021 340,775 393,347 520,576 605,946 695,254 687,927  
2 years later 248,762 233,041 263,122 301,172 335,772 394,297 485,146 577,709 636,356    
3 years later 232,774 229,750 263,639 314,401 344,668 397,772 478,113 566,181      
4 years later 220,128 217,476 262,156 319,923 355,997 409,597 490,022        
5 years later 218,888 207,571 264,383 323,698 359,161 424,809          
6 years later 209,884 205,563 264,569 323,642 377,264            
7 years later 210,843 204,002 264,305 340,498              
8 years later 213,095 204,597 280,666                
9 years later 214,226 219,304                  
10 years later 227,575                    
                       
Net cumulative redundancy (deficiency) 20,977 27,958 (5,752) (40,444) (50,014) (32,857) 41,371 102,238 102,301 105,179  
Sequential reserve development 3,402 3,992 1,684 (8,967) (13,525) (1,395) 10,817 62,473 43,403 105,179  
                       
Gross liability  404,263 415,523 520,494 539,750 604,505 732,838 903,441 1,132,599 1,331,866 1,318,777 1,192,178
Re-insurance recoverable (155,711) (168,261) (245,580) (239,696) (277,255) (340,886) (372,048) (464,180) (593,209) (525,671) (417,250)
  -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net liability 248,552 247,262 274,914 300,054 327,250 391,952 531,393 668,419 738,657 793,106 774,928
                       
Gross re-estimated liability 449,495 398,698 641,835 787,421 797,785 895,140 946,529 1,013,661 1,131,957 1,104,226  
Re-estimated recoverable (221,920) (179,394) (361,169) (446,923) (420,521) (470,331) (456,507) (447,480) (495,601) (416,299)  
  -------- -------- -------- -------- -------- -------- -------- -------- -------- --------  
Net re-estimated liability 227,575 219,304 280,666 340,498 377,264 424,809 490,022 566,181 636,356 687,927  
                       
Gross cumulative redundancy (deficiency) (45,232) 16,825 (121,341) (247,671) (193,280) (162,302) (43,088) 118,938 199,909 214,551  
                       

Investment Portfolio: RLI has a conservative investment Portfolio that is under leveraged compared to peers. Invested assets to shareholders equity of 248% compared to WR Berkley at 378%, Markel at 301% and ACE at 272%.  No sub-prime, Alt-A, CDO or CMO exposure and very little ABS exposure (3% of port).  RLI has no Level III assets in their portfolio and low corporate bond exposure.  Over 50% of their assets are invested in US govt and Municipal securities.  At 9.30.08 RLI had a net unrealized gain position in their investment portfolio.

Pros

  • Strong balance sheet
  • Underleveraged premium:surplus
  • Conservative underwriting
  • Strong insider ownership
  • Top notch management team

Cons

  • Stock trades in the middle of its 52 week high/low and has multiple compression downside potential in the short run
  • Market may not harden or management may not take full advantage of the hard market due to their conservative nature

Conclusion: RLI's management team has positioned the company to take advantage of current market turmoil (a la AIG and peer investment portfolio issues) in the coming hard market.  They will be able to take market share, leverage their conservative balance sheet and increase premium and profitability and a substantially higher rate than the market predicts.  Management has a proven track record of consistent profitability and book value per share growth that provides substantial downside protection and the company has huge upside potential if 1) the market hardens or 2) they take market share from AIG or 3) they leverage their premium and generate higher earnings utilizing their current excess capital position.

Catalyst

continued fallout from aig

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