We own five commercial buildings on our 23 acre corporate campus in Peoria, Illinois. Our primary building is a two-story 84,000 square foot office building, which serves as our corporate headquarters. Located on the same campus is a 24,000 square foot building, which is used by two branch offices of RLI Ins., and is being replaced by a 41,000 square foot building currently in the course of construction and projected to be completed in the third quarter of 2016. In addition, we own a 15,000 square foot office building, a 26,000 square foot multi-story building used for record storage and a 12,000 square foot building used for furniture and equipment storage.
Ratios and surplus information are presented on a statutory basis. As discussed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, statutory accounting principles differ from GAAP and are generally based on a solvency concept. Further discussion is included in note 9 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data. Reporting of statutory surplus is a required disclosure under GAAP.
On October 2, 2013, we successfully completed a public debt offering, issuing $150.0 million in senior notes maturing September 15, 2023. This offering generated proceeds, net of discount and commission, of $148.6 million. In December 2013, we redeemed $100.0 million in senior notes that were issued in 2003 and were set to mature in January 2014.
Operating cash flow for 2011 includes a $50.0 million cash deposit that we received from a commercial surety customer in lieu of credit. The return of this $50.0 million deposit is reflected in operating cash flow for 2012.
The casualty portion of our business consists largely of general liability, personal umbrella, transportation, executive products and commercial umbrella coverages, as well as package business and other specialty coverages, such as professional liability and workers compensation for office-based professionals. We offer fidelity and crime coverage for commercial insureds and select financial institutions and recently expanded our casualty offerings to include medical and healthcare professional liability coverage in the excess and surplus market. We also assume select casualty business for excess and surplus accounts through our quota share reinsurance agreement with Prime. 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, marine and facultative and treaty reinsurance including crop. We also offer select personal lines policies, such as recreational vehicle, jewelry and Hawaii homeowners coverages. While our marine and facultative reinsurance coverages are predominantly domestic risks, these portfolios do contain a relatively small portion of foreign risks. Property insurance and reinsurance results are subject to the variability introduced by perils such as earthquakes, fires and hurricanes. Our major catastrophe exposure is to losses caused by earthquakes, primarily on the West Coast. Our second largest catastrophe exposure is to losses caused by wind storms to commercial properties throughout the Gulf and East Coast, as well as to homes we insure in Hawaii. We limit
On November 3, 2015, we completed the sale of RLI Indemnity Company (RIC) to Clear Blue Financial Holdings, LLC for net sale proceeds of $7.5 million, primarily generated from the transfer of insurance licenses. RIC was sold as a “shell,” with all business and cash flows from the company being retained by RLI Insurance Group. At the time of the sale, RIC had minimal assets and written premium and was transferring all premium and loss cash flows to RLI Ins. through a 100 percent quota share reinsurance agreement. RLI Ins. will continue to reinsure all RIC bond and insurance liabilities that existed at the date of sale, adjust claims and service the remaining in-force polices and bonds until they terminate or are moved into RLI Ins.
The process of estimating loss reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both internal and external events, such as changes in claims handling procedures, claim personnel, economic inflation, legal trends and legislative changes, among others. The impact of many of these items on ultimate costs for loss and LAE is difficult to estimate. Loss reserve estimations also differ significantly by coverage due to differences in claim complexity, the volume of claims, the policy limits written, the terms and conditions of the underlying policies, the potential severity of individual claims, the determination of occurrence date for a claim and reporting lags (the time between the occurrence of the policyholder event and when it is actually reported to the insurer). Informed judgment is applied throughout the process. We continually refine our loss reserve estimates as historical loss experience develops and additional claims are
Our best estimate of ultimate loss and LAE reserves are proposed by our lead reserving actuary and approved by our Loss Reserve Committee (LRC). The LRC is made up of various members of the management team including the lead reserving actuary, chief executive officer, chief operating officer, chief financial officer, general counsel and other selected executives. We do not use discounting (recognition of the time value of money) in reporting our estimated reserves for losses and settlement expenses. Based on current assumptions used in calculating reserves, we believe that our reserve levels at December 31, 2015, make a reasonable provision to meet our future obligations.
We do not reserve for natural or man-made catastrophes until an event has occurred. Shortly after such occurrence, we review insured locations exposed to the event, catastrophe model loss estimates based on our own exposures and industry loss estimates of the event. We also consider our knowledge of frequency and severity from early claim reports to determine an appropriate reserve for the catastrophe. These reserves are reviewed frequently to consider actual losses reported and appropriate changes to our estimates are made to reflect the new information.
and both settlement and payment pattern consistency. We use this data to determine historical claim reporting and payment patterns, which are used in the analysis of ultimate claim liabilities. For portions of the business without sufficiently large numbers of policies or that have not accumulated sufficient historical statistics, our own data is supplemented with external or industry average data as available and when appropriate. For our newer products such as crop reinsurance, as well as for executive products, professional services and marine, we utilize external data extensively.
We use historical development patterns, expected loss ratios and standard actuarial methods to derive an estimate of the ultimate level of loss and LAE payments necessary to settle all the claims occurring as of the end of the evaluation period.
Loss reserve estimates are subject to a high degree of variability due to the inherent uncertainty of ultimate settlement values. Periodic adjustments to these estimates will likely occur as the actual loss emergence reveals itself over time. Our loss reserving processes reflect accepted actuarial practices and our methodologies result in a reasonable provision for reserves as of December 31, 2015.
net of deferred income taxes. During 2014, we sold our remaining debt securities classified as held-to-maturity. During 2013, we sold our remaining debt securities classified as trading.
The occurrence of a discrete credit event resulting in the issuer defaulting on a material obligation, the issuer seeking protection from creditors under the bankruptcy laws, or the issuer proposing a voluntary reorganization under which creditors are asked to exchange their claims for cash or securities having a fair value substantially lower than par value of their claims,
Under current accounting standards, an OTTI write-down of debt securities, where fair value is below amortized cost, is triggered by circumstances where (1) an entity has the intent to sell a security, (2) it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis or (3) the entity does not expect to recover the entire amortized cost basis of the security. If an entity intends to sell a security or if it is more likely than not the entity will be required to sell the security before recovery, an OTTI write-down is recognized in earnings equal to the difference between the
security’s amortized cost and its fair value. If an entity does not intend to sell the security or it is not more likely than not that it will be required to sell the security before recovery, the OTTI write-down is separated into an amount representing the credit loss, which is recognized in earnings, and the amount related to all other factors, which is recognized in other comprehensive income.
Consolidated revenue increased 3 percent in 2015, following a 10 percent increase in 2014 and a 7 percent increase in 2013. Premiums earned from insurance operations improved for each of the past three years, while investment income declined slightly during 2015, after posting a 5 percent increase in the prior year. Net premiums earned increased 2 percent in 2015, after advancing 9 percent in both 2014 and 2013. Excluding the impact of our exit from crop, net premiums earned increased 5 percent in 2015. Increased retentions and reduced reinsurance costs have each contributed to the improved results. We have a diverse portfolio of products, and a number of those have contributed to the growth in premium. Growth has been balanced between more mature product lines with a longstanding presence in our portfolio and newer product initiatives which have been rolled out in recent years. The bulk of the growth during 2015 was attributable to our casualty and surety segments. On an overall basis, our businesses continue to operate in challenging market conditions. Excess capital remained in the marketplace during 2015, and yet another year of light catastrophe activity translated into lower rates and increased competition, in particular for excess and surplus (E&S) catastrophe coverages. While the pressure on pricing for primary coverages has challenged top line production, we have been able to offset this somewhat during our annual reinsurance renewals, through cost savings realized on all major casualty and property reinsurance treaties in each of the past three years. From an investment income perspective, revenues decreased by 2 percent in 2015. The decrease was primarily due to a smaller invested asset base for most of the year. Additionally, an increased allocation to municipal securities contributed to the decline. While yields are lower on a pretax basis, municipals often exhibit higher after-tax yields versus taxable alternatives. We recorded net realized investment gains on our investment portfolio in each of the past three years. The majority of gains realized over this period related to sales activities versus calls or maturities. Sales activity was largely due to normal portfolio rebalancing, as well as raising cash to support special dividends paid in each of the last three years. Realized gains for 2015 also reflect a $6.7 million gain related to the sale of RIC, which occurred in the fourth quarter.
Bonus and profit-sharing amounts earned by executives, managers and associates are predominately influenced by corporate performance including operating earnings, combined ratio and return on capital. Operating earnings refers to net earnings excluding after-tax net realized gains. Return on capital measures components of comprehensive earnings against a minimum required return on capital. Return on capital is the primary measure of executive bonus achievement and a significant component of manager and associate bonus targets. Bonus and profit sharing-related expenses attributable to the favorable reserve developments totaled $11.0 million, $10.6 million and $11.2 million for 2015, 2014 and 2013, respectively. These performance-related expenses impact policy acquisition, insurance operating and general corporate expenses line items in the financial statements. Partially offsetting the 2015, 2014 and 2013 increases were $1.9 million, $1.1 million and $1.2 million, respectively, in reductions to bonus and profit-sharing earned due to losses associated with natural catastrophe activity.
The insurance marketplace remains competitive across all of our segments. Excess capital continues to exist in our industry, whether from insurance carriers holding additional surplus, or non-traditional investors entering the marketplace. In 2015, the desire to deploy that capital led to a rise in merger and acquisition (M&A) activity in the insurance space. While the full impact of the recent M&A deals and consolidation within the industry will become evident over a longer horizon, the shorter term impact of excess capital has translated to increased competition for business. Another year without significant catastrophe activity in the U.S. has only added to these competitive pressures. On an overall basis, prices within our portfolio were flat in 2015, similar to the largely flat pricing trends seen in 2014. While relatively unchanged, the direction and magnitude of rate change has varied across our product portfolio. The most noteworthy pricing movements related to catastrophe exposed coverages in our property segment, which again experienced double-digit declines. Prices for these coverages continue to be impacted by abnormally low natural catastrophe activity and an abundance of capital in the market. We have experienced positive pricing trends for certain product lines elsewhere in our product portfolio, including transportation, marine and specialty personal coverages. Our top line declined 1 percent overall in 2015, largely due to our previously announced exit from crop reinsurance. Excluding the impact of crop, gross premiums written advanced 4 percent. The top line impact of crop is noteworthy as our crop reinsurance relationship was reduced for and ultimately ended with the 2015 crop year due to the acquisition of the cedant, though the impact on underwriting income was minimal. As expected, premiums from crop dropped to $9.4 million in 2015, from $50.3 million in 2014. Growth achieved during the year was balanced between mature lines in our portfolio, such as transportation and surety, and newer product initiatives, such as P&C package and our professional services group offerings. Expansion efforts and newer product initiatives over the past several years continued to play a significant role in premium production, and have accounted for approximately 20 percent of gross premiums written in each of the past three years. On a net basis, total premiums written increased 3 percent in 2015 and outpaced growth in gross premiums written largely due to cost savings realized on our 2015 reinsurance renewals. During the first half of 2015, we renewed all material reinsurance treaties which resulted in an $8.5 million reduction in ceded premiums from improved reinsurance rates, while some coverages were expanded. Excluding the impact of crop, net premiums written increased 6 percent. Net premium growth outpaced gross premiums written growth in 2014 and 2013, as well. In 2014 this result was also largely driven by cost savings realized on our annual reinsurance renewals, while the 2013 result was driven by increased retentions on certain casualty products where pricing trends were positive.
The following table further summarizes revenues by major coverage type within each segment:
Casualty gross premiums written of $519.7 million were up 8 percent in 2015, following an increase of 6 percent in 2014 and 17 percent in 2013. The majority of products within the segment posted top line growth, driven by a combination of rate and exposure changes. Growth was led by transportation, which advanced 27 percent to $91.2 million, following a 1 percent decline in 2014 and 56 percent growth in 2013. Transportation capitalized on increased opportunities to write new and returning business in 2015. Several former transportation accounts, which had previously left RLI in search of low cost carriers, returned in 2015 in favor of our service and claim handling capabilities. Improved pricing also benefited most transportation coverages, most notably for the public transportation class, which increased 8 percent. Our P&C package business and professional services group also made significant contributions to overall growth. P&C package premiums increased 14 percent in 2015, the third consecutive year of double digit growth. Pricing for these coverages was flat during 2015, after declining 4 percent in the prior year. Total gross premiums from this business were $47.9 million, $42.0 million and $37.0 million in 2015, 2014 and 2013, respectively. Our professional services group posted $80.2 million in gross premiums written, up 8 percent from the prior year. This follows significant growth achieved in both 2014 and 2013, which totaled 24 percent and 38 percent, respectively.
Gross premiums written in the property segment decreased by 21 percent ($54.1 million) in 2015 after decreasing 4 percent in 2014 and 3 percent in 2013. The majority of this decrease related to our crop reinsurance business, which declined $40.9 million. As noted in previous filings, we expected reduced premiums as our crop reinsurance share was reduced for 2015 and expired at the end of the 2015 crop year due to the acquisition of the cedant. Excluding the impact of crop, gross premiums written in the property segment declined 6 percent. Increased competition and alternative capital continued to impact this segment, in particular for our E&S property coverages. Our commercial property business, which includes our fire and difference in conditions (DIC) products, declined for the third consecutive year as both primary and reinsurance pricing for these coverages continued to fall. We experienced double digit rate decreases for wind and earthquake exposed catastrophe coverages for the second consecutive year during 2015. Fire and DIC premiums for 2015 decreased 9 percent and 10 percent, respectively. Slightly offsetting this was an increase in gross premiums written from marine, which delivered modest top line growth after experiencing declines in each of the past two years. Improved pricing contributed to the growth in marine, as rates increased 2 percent. The premium declines in 2014 and 2013 were due to re-underwriting efforts on the cargo and inland marine lines, which included exiting certain unprofitable accounts and increasing rates on others. These efforts were successful, as marine achieved rate increases on retained business of 5 percent and 9 percent in 2014 and 2013, respectively. On an overall basis, marine premiums written in 2014 and 2013 were down 10 percent and 7 percent, respectively.
Other products which contributed to the premium decline in the property segment included our recreational vehicles product (RV) and our other property reinsurance program. Premiums from RV were down 16 percent in 2015 to $13.4 million. Since its launch at the end of 2012, gross premiums written from recreational vehicles were $16.1 million in 2014 and $11.5 million in 2013. The decrease in this book was due to re-underwriting efforts initiated in the latter part of 2014 in response to heightened loss activity. Re-underwriting efforts have included filed rate changes and implementation of coverage restrictions, as well as termination of some producers. As a result of these efforts, we obtained a 14 percent rate increase on retained business. For other property reinsurance programs, excluding crop reinsurance, gross premiums declined slightly to $12.8 million, down from $13.1 million in 2014 and $16.1 million in 2013. A majority of business assumed in our other property reinsurance program is catastrophe exposed and is viewed as complementary and diversifying for our catastrophe strategy employed within our commercial property product. Where experience is adverse or pricing is deemed inadequate, as occurred
Underwriting income was $29.0 million in 2015, compared to $32.9 million in 2014 and $27.6 million in 2013. The segment’s results translated into combined ratios of 83.1, 83.4 and 86.2 for 2015, 2014 and 2013, respectively. These results reflect relatively small amounts of catastrophe losses, as no significant hurricane or earthquake activity has occurred during the past three years. Each of these periods were impacted, however, by seasonal storm losses. Results for 2015 included $11.8 million in losses from winter and spring storms, and favorable development on prior accident years’ reserves, mainly from marine, which served to offset these losses. Favorable development improved underwriting results for the segment by $11.8 million. Positive underwriting performance from a current accident year standpoint is reflected in 2015 results, due in part to continued improvement from marine. The exit from crop did not have a significant impact from an underwriting income standpoint.
Results for 2014 included $4.7 million in spring storm losses and $0.3 million in losses related to earthquake activity in Napa Valley. Favorable development on prior accident years’ reserves, primarily from marine, partially offset these losses and improved underwriting results for the segment by $1.1 million. Results were positive from a current accident year standpoint, as re-underwriting efforts on marine and other assumed coverages led to a nearly 3 point improvement in the current accident year loss ratio. Results for 2013 included $9.9 million in losses from spring storms, but were devoid of hurricane losses. In addition, results for 2013 were negatively impacted by increased loss activity on marine property coverages, specifically cargo and inland marine. Underwriting actions were taken to increase rates across both coverages, as well as exiting certain underperforming accounts. These adverse items were partially offset by $7.3 million of favorable development on prior accident years’ reserves and lower losses from our commercial fire business. Approximately half of the favorable development related to reductions in prior years’ hurricane reserves, with the remainder attributed to continued positive emergence on marine coverages.
The segment’s loss ratio was 40.9 in 2015 compared to 45.3 in 2014 and 48.1 in 2013. The improved result for 2015 related to the increased benefit from favorable development on prior years’ reserves. Results for 2014 reflected the aforementioned 3 point improvement in the current accident year loss ratio. The expense ratio for the property segment was 42.2 in 2015 compared to 38.1 in 2014 and 2013. The increased expense ratio for 2015 was driven largely by shifts in product mix within the segment, specifically with regard to crop, which carries a very low acquisition expense rate. The overall decline in earned premium also contributed to the higher expense ratio in 2015.
Underwriting income totaled $33.3 million in 2015, compared to $28.2 million in 2014 and $23.6 million in 2013. The segment’s results translated into combined ratios of 71.5, 73.8 and 77.9 for 2015, 2014 and 2013, respectively. Underwriting performance for each of these years reflects a combination of positive current accident year results and favorable development in prior accident years’ loss reserves. From a current accident year standpoint this segment has continued to deliver strong performance. Excluding the impact of favorable development in prior years’ reserves, the combined ratio for each of the past three years has been in the low 80s.
The segment’s loss ratio was 9.2 in 2015, compared to 7.3 in 2014 and 13.8 in 2013. While all three years benefited from favorable development in prior years’ reserves, the amount in 2015 was $3.0 million lower than in 2014. This decrease drove the slightly higher loss ratio in 2015. Similarly, the higher loss ratio in 2013 also reflected a smaller amount of favorable prior
The after-tax yield reflects the different tax rates applicable to each category of investment. Our taxable fixed income securities are subject to our corporate tax rate of 35.0 percent, our tax-exempt municipal securities are subject to a tax rate of 5.3 percent and our dividend income is generally subject to a tax rate of 14.2 percent. During 2015, the average after-tax yield on the taxable fixed income portfolio declined to 2.2 percent from 2.3 percent in 2014, while the average after-tax yield on the tax-exempt portfolio decreased slightly.
During 2015, our equity portfolio experienced net realized gains of $22.1 million and ended 2015 with net unrealized gains of $173.0 million. The total return for the year on the equity portfolio was -2.6 percent.
Key components to our OTTI procedures are discussed in our critical accounting policy on investment valuation and OTTI and in note 2 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data. Based on our analysis, we have concluded that the securities in an unrealized loss position were not other-than-temporarily impaired at December 31, 2015.
We determined the fair value of certain financial instruments based on their underlying characteristics and relevant transactions in the marketplace. GAAP guidance requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance also describes three levels of inputs that may be used to measure fair value. For additional information, see notes 1 and 2 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.
As of December 31, 2015, our investment portfolio had the following asset allocation breakdown:
Fixed income represented 79 percent of our total 2015 portfolio compared to 76 percent in 2014. As of December 31, 2015, the fair value of our fixed income portfolio consisted of 34 percent AAA-rated securities, 31 percent AA-rated securities, 17 percent A-rated securities, 12 percent BBB-rated securities and 6 percent non-investment grade or non-rated securities. This compares to 17 percent AAA-rated securities, 45 percent AA-rated securities, 22 percent A-rated securities, 10 percent BBB-rated securities and 6 percent non-investment grade or non-rated securities in 2014.
An asset-backed security (ABS) or commercial mortgage-backed security (CMBS) is a securitization collateralized by the cash flows from a specific pool of underlying assets. These asset pools can include items such as credit card payments, auto loans and residential or commercial mortgages. As of December 31, 2015, ABS/CMBS investments were $91.9 million (6 percent) of the fixed income portfolio, compared to $135.3 million (9 percent) as of December 31, 2014. All but one security in the ABS/CMBS portfolio was rated AAA as of December 31, 2015. We believe that ABS/CMBS investments add diversification and additional yield to the portfolio while often adding superior cash flow stability over mortgage pass-throughs or CMOs.
When making investments in MBS/ABS/CMBS, we evaluate the quality of the underlying collateral, the structure of the transaction (which dictates how any losses in the underlying collateral will be distributed) and prepayment risks. All of our collateralized securities carry the highest credit rating by one or more major rating agency and continue to pay according to contractual terms. We had $2.2 million in unrealized losses in these asset classes as of December 31, 2015.
As of December 31, 2015, municipal bonds totaled $610.4 million (40 percent) of our fixed income portfolio, compared to $481.4 million (32 percent) as of December 31, 2014. We actively increased our holdings in the sector upon completion of a strategic asset allocation review in the middle part of the year. We believe municipal fixed income securities can provide
As of December 31, 2015, approximately 47 percent of the municipal fixed income securities in the investment portfolio were GO and the remaining 53 percent were revenue based. Ninety-two percent of our municipal fixed income securities were rated AA or better, while 99 percent were rated A or better.
As of December 31, 2015, our corporate debt portfolio totaled $517.1 million (34 percent) of the fixed income portfolio compared to $562.7 million (38 percent) as of December 31, 2014. Our allocation to the corporate debt portfolio decreased during the year as we rotated toward municipals. The corporate allocation includes 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 corporate debt portfolio has an overall quality rating of BBB+, diversified among 499 issues.
The following table illustrates our corporate debt exposure to the financial and non-financial sectors as of December 31, 2015, including fair value, cost basis and unrealized gains and losses:
The amortized cost and fair value of fixed income securities at December 31, 2015, by contractual maturity, are shown as follows:
As of December 31, 2015, our equity portfolio totaled $375.4 million (19 percent) of the investment portfolio, compared to $410.6 million (21 percent) as of December 31, 2014. Our common stock portfolio decreased through some minor rebalancing into fixed income but in large part to the decline in equity prices over the course of the year. The securities within the equity portfolio remain primarily invested in large-cap issues with a focus on dividend income. In addition, we have investments in three broadly diversified, exchange traded funds (ETFs) that represent market indexes similar to the Russell
We maintain a 40 percent equity interest in Maui Jim, a manufacturer of high-quality sunglasses. Maui Jim’s chief executive officer owns a controlling majority of the outstanding shares of Maui Jim. Maui Jim is a private company, and as such, the market for its stock is limited. Our investment in Maui Jim is carried at the holding company, RLI Corp., level as it is not core to our insurance operations. As a minority shareholder, we are subject to the decisions of the controlling shareholder, which may impact the value of our investment. In 2015, we recorded $9.9 million in earnings from this investment compared to $12.0 million in 2014 and $10.9 million in 2013. Sunglass sales were down 2 percent in 2015, after increasing 14 percent in 2014 and 6 percent in 2013. A loss on the sale of an asset and unfavorable foreign exchange results also led to Maui Jim’s decrease in earnings for 2015 compared to 2014.
In 2014 and 2013, we received dividends from Maui Jim. Dividends from Maui Jim have been irregular in nature and while they provide added liquidity when received, we do not rely on those dividends to meet our liquidity needs. While these dividends do not flow through the investee earnings line, they do result in the recognition of a tax benefit, which is discussed in the income tax section that follows.
Our effective tax rates were 30.1 percent, 28.5 percent and 28.1 percent for 2015, 2014 and 2013, respectively. Effective rates are dependent upon components of pretax earnings and the related tax effects. The effective rate was higher in 2015 due largely to reduced tax benefits associated with dividends paid to our Employee Stock Ownership Plan (ESOP) and received from our unconsolidated investees.
Dividends paid to our Employee Stock Ownership Plan (ESOP) result in a tax deduction. Special dividends paid to the ESOP in 2015, 2014 and 2013 resulted in tax benefits of $2.5 million, $3.6 million and $1.7 million, respectively. These tax benefits reduced the effective tax rate for 2015, 2014 and 2013 by 1.2 percent, 1.9 percent and 1.0 percent, respectively.
The liability can be split into two parts: (1) case reserves representing estimates of losses and settlement expenses on known claims and (2) IBNR reserves representing estimates of losses and settlement expenses on claims that have occurred but have not yet been reported to us. Our gross liability for both case and IBNR reserves is reduced by reinsurance balances recoverable on unpaid losses and settlement expenses to calculate our net reserve balance. This net reserve balance increased to $805.9 million at December 31, 2015, from $785.9 million as of December 31, 2014. This reflects incurred losses of $299.0 million in 2015 offset by paid losses of $279.0 million compared to incurred losses of $296.6 million offset by $285.2 million paid in 2014. The overall increase in our net loss and LAE reserves between 2015 and 2014 was small, but there were changes by segment as discussed in note 6 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.
We have three primary types of cash flows: (1) operating cash flows, which consist mainly of cash generated by our underwriting operations and income earned on our investment portfolio, (2) investing cash flows related to the purchase, sale and maturity of investments and (3) financing cash flows that impact our capital structure, such as changes in debt and shares outstanding. The following table summarizes these three cash flows over the last three years.
We have posted positive operating cash flow in each of the last three years. Variations in operating cash flow between periods are largely driven by the volume and timing of premium receipt, claim payments, reinsurance and taxes. In addition, fluctuations in insurance operating expenses impact operating cash flow. During 2015, the majority of cash flows were used in financing activities, due largely to the payment of special dividends. Financing cash flows noted in the above table include special dividends totaling $87.1 million, $129.3 million and $64.5 million for 2015, 2014 and 2013, respectively. In 2013, cash flows also reflect a net financing cash inflow related to our public debt offering.
We have entered into certain contractual obligations that require us to make recurring payments. The following table summarizes our contractual obligations as of December 31, 2015.
The next largest contractual obligation relates to long-term debt outstanding. On October 2, 2013, we completed a public debt offering of $150.0 million in senior notes maturing September 15, 2023, (a 10-year maturity) and paying interest semi-annually at the rate of 4.875 percent. The notes were issued at a discount resulting in proceeds, net of discount and commission, of $148.6 million. We are not party to any off-balance sheet arrangements.
Our primary objective in managing our capital is to preserve and grow shareholders’ equity and statutory surplus to improve our competitive position and allow for expansion of our insurance operations. Our insurance subsidiaries must maintain certain minimum capital levels in order to meet the requirements of the states in which we are regulated. Our insurance companies are also evaluated by rating agencies that assign financial strength ratings that measure our ability to meet our obligations to policyholders over an extended period of time.
At December 31, 2015, we had cash, short-term investments and other investments maturing within one year of approximately $27.0 million and an additional $276.1 million of investments maturing between 1 to 5 years. We maintain a revolving line of credit with JP Morgan Chase Bank N.A., which permits us to borrow up to an aggregate principal amount of $40.0 million. This facility was entered into during the second quarter of 2014 and replaced the previous $25.0 million facility which expired on May 31, 2014. Under certain conditions, the line may be increased up to an aggregate principal amount of $65.0 million. The facility has a four-year term that expires on May 28, 2018. As of and during the year ended December 31, 2015, no amounts were outstanding on the revolving line of credit.
We believe that cash generated by operations, cash generated by investments and cash available from financing activities will provide sufficient sources of liquidity to meet our anticipated needs over the next 12 to 24 months. We have generated positive operating cash flow for more than 30 consecutive years. The primary factor in our ability to generate positive operating cash flow is underwriting profitability, which we have achieved for 20 consecutive years.
Our capital structure is comprised of equity and debt obligations. As of December 31, 2015, our capital structure consisted of $149.7 million in 10-year maturity senior notes (long-term debt) and $823.5 million of shareholders’ equity. Debt outstanding comprised 15 percent of total capital as of December 31, 2015.
The insurance and reinsurance industry is poised to record an underwriting profit in 2015 for the third consecutive year, benefitting from low catastrophe activity, continued favorable reserve releases and generally benign loss cost trends. This profitability has attracted capital to the industry from traditional carriers looking to deploy capital generated from their businesses and from newer sources such as pension funds. These alternative capital providers are attracted to the industry’s current margins as well as the perceived diversification of returns relative to traditional investments. We believe that economic conditions and market dynamics the insurance industry experienced in 2015 will largely continue in 2016.
Broader economic conditions are expected to have varied impacts on RLI and the market in 2016. The economy has been growing at a slow pace over the last several years, a trend largely forecasted to continue. Mediocre economic growth will temper the ability of the industry to grow premium volume. Particular subsets of the economy are poised to benefit from recent trends such as an increase in miles driven as a result of an improving economy and lower gas prices, or continued growth in construction activity. On the other hand, the energy sector is being negatively impacted by the decline in oil prices. Given our varied exposure to multiple areas of the U.S. economy, including customers in the transportation, construction and energy industries, we expect growth to be challenging.
We expect some overall growth from the casualty segment. This segment includes a number of diverse products that are subject to unique market conditions and changing profit opportunities, so growth rates among products will vary. While we do not expect transportation to grow at the same pace as 2015, some growth is likely to occur as we focus on superior underwriting and claim services. The E&S excess casualty book has benefited from decreased competition over the last couple of years, a trend we do not expect to last. With carriers and managing general agencies reentering the market in search of premium, individually underwritten standalone casualty business will be pressured to relax underwriting standards. We recently added underwriters to focus on additional classes of business in the E&S casualty group, but expect measured growth from these opportunities. Package business has the potential for growth as we expand certain products and classes geographically. Growth in these products will be slow in 2016 as we begin to establish new relationships across the country and customize coverages. Rate change was flat for the casualty segment in 2015, and we see no signs of improvement in 2016.
We should continue to achieve positive rate in our commercial auto business as industry trends allow, but our construction based business will be more pressured for rate decreases due to a higher level of competition. Overall moderate growth is expected for the segment.
The property segment will have another challenging year in 2016. With no material catastrophe losses in the industry, rates on those exposures will continue to decrease while terms and conditions will be under pressure. In marine, recent re-underwriting efforts were completed in 2015, positioning this business to achieve profitable growth in 2016. Although some marine classes have recorded five consecutive years of slight rate increases, ongoing rate increases in 2016 will be challenging. We continue to adjust the recreational vehicle book to attain profitability. Since we implemented a rate increase and revised our claim handling processes, we have seen premium shrink and this trend will likely continue. Finally, gross written premium of $9.4 million of crop reinsurance and $3.5 million of facultative reinsurance in 2015 will not be available given the previously discussed termination of these businesses. While the top line will likely decrease for all of these reasons, the overall property segment should remain profitable, assuming normal catastrophe experience.
Although the surety segment remains very competitive, we believe this segment will experience modest growth in 2016. Continued investments in technology and expansion of marketing initiatives will drive continued organic growth, while modest economic growth will provide a slight tailwind. The recent decline in oil prices could potentially hamper these trends, which increases underwriting risk as well as pressure on our energy surety customers. Although overall economic growth trends have been favorable, there is a chance that premium growth will be hampered by slowing conditions. There is also a risk that certain credit-related exposures related to our commercial and contract surety business will become more challenging under such circumstances.
Global macroeconomic influences brought higher levels of volatility to U.S. capital markets in 2015. A stronger U.S. dollar and the commodity complex in decline were central themes of the year and had a widespread impact on the global economy. Monetary policy in the U.S. was partly responsible for relative currency weakness abroad as the Federal Reserve began a process to tighten policy and raise rates in the fourth quarter of the year. While much anticipated, the move to lift the Fed Funds target rate has created some uncertainty around the sustainability of the domestic recovery, which stands as one of the shallowest on record. Despite GDP growth of around 2 percent, the labor market has continued to heal with recent reports outlining positive additions to payrolls and an unemployment rate nearing a full reading. Slow growth and low inflation were major influences on Treasury yields that continue to underperform the expectations for higher rates. The bellwether 10 year Treasury yield ended 2015 at 2.27 percent, up 0.10 percent from year end 2014. Stocks and corporate bonds struggled in the second half of the year and exhibited greater volatility than in recent memory. High yield bonds have been trading at recession-like levels and were highly levered to the price of oil in 2015. The current environment has the potential to derail the Federal Reserve’s monetary policy plan for a higher Fed Funds rate in 2016 although we have anticipated a slower process for policy to normalize for some time. We believe that lower input and gasoline prices can be stimulative and that a consistently positive jobs report offers a constructive backdrop for the U.S. to lead world growth in the near term.
Our investment focus remains on supporting year-to-year operations through current income and contributing to long-term growth in book value in surplus assigned strategies like equities. We do not expect the yield environment to change significantly in the first half of 2016 and any potential for higher levels of investment income will be most acutely influenced by a larger invested asset base over the course of the year.
Prospective accounting standards are those which we have not implemented because the implementation date has not yet occurred. For a discussion of relevant prospective accounting standards, see note 1.D. to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.
As no effective Accounting Standards Updates (ASUs) impact our financial statements, there are no new adopted accounting standards to report.
Net incurred and paid claims development information by accident year for the number of years for which claims incurred typically remain outstanding, but need not exceed 10 years;
This ASU is effective for annual and interim reporting periods beginning after December 15, 2018. Early adoption is permitted. Upon adoption, leases will be recognized and measured at the beginning of the earliest period presented using a modified retrospective approach. We have not yet completed the analysis of how adopting this ASU will affect our financial statements. See note 10 for more information on our current lease expenses and obligations.
Debt securities that we have the positive intent and ability to hold to maturity are classified as held-to-maturity and carried at amortized cost. Except for declines that are other-than-temporary, changes in the fair value of these securities are not reflected in the financial statements. During 2014, we sold our remaining debt security classified as held-to-maturity.
Quantitative criteria considered during this process include, but are not limited to: the degree and duration of current fair value as compared to the cost (amortized, in certain cases) of the security, degree and duration of the security’s fair value being below cost and, for fixed maturities, whether the issuer is in compliance with terms and covenants of the security. Qualitative criteria include the credit quality, current economic conditions, the anticipated speed of cost recovery, the financial health of and specific prospects for the issuer, as well as our absence of intent to sell or requirement to sell fixed income securities prior to maturity. In addition, we consider price declines of securities in our other-than-temporary impairment (OTTI) analysis, where such price declines provide evidence of declining credit quality, and we distinguish between price changes caused by credit deterioration, as opposed to rising interest rates. See note 2 for further discussion of OTTI.
Cash consists of uninvested balances in bank accounts. Short-term investments consist of investments with original maturities of 90 days or less, primarily AAA-rated prime and government money market funds. Short-term investments are carried at cost. We have not experienced losses on these instruments. Other invested assets includes an investment in two low income housing tax credit partnerships, carried at amortized cost, membership in the Federal Home Loan Bank of Chicago, carried at cost, and an investment in a real estate fund, carried at cost. Due to the nature of cash, short-term investments and other invested assets, their carrying amounts approximate fair value.
We maintain a 40 percent interest in the earnings of Maui Jim, Inc. (Maui Jim), a manufacturer of high-quality sunglasses, which is accounted for by the equity method. We also maintain a similar minority representation on their board of directors. Maui Jim’s chief executive officer owns a controlling majority of the outstanding shares of Maui Jim. We carry this investment at the holding company, RLI Corp., level as it is not core to our insurance operations. Our investment in Maui Jim was $62.7 million in 2015 and $54.3 million in 2014. In 2015, we recorded $9.9 million in investee earnings for Maui Jim, compared to $12.0 million in 2014 and $10.9 million in 2013. Maui Jim recorded net income of $23.7 million in 2015, $30.7 million in 2014 and $26.1 million in 2013. Additional summarized financial information for Maui Jim for 2015 and 2014 is outlined in the following table:
Approximately $52.0 million of undistributed earnings from Maui Jim are included in our retained earnings as of December 31, 2015. In 2014 and 2013, we received dividends of $6.6 million and $13.2 million, respectively, from Maui Jim. No dividends were received in 2015.
On February 5, 2014, we invested $5.3 million for a 20 percent equity ownership interest in Prime Holdings Insurance Services, Inc. (Prime). On March 4, 2015, we invested an additional $1.7 million, increasing our total equity ownership to 27 percent. Prime writes business through two Illinois domiciled insurance carriers, Prime Insurance Company, an excess and
In accordance with GAAP guidelines, the amortization of goodwill and indefinite-lived intangible assets is not permitted. Goodwill and indefinite-lived intangible assets remain on the balance sheet and are tested for impairment on an annual basis, or earlier if there is reason to suspect that their values may have been diminished or impaired. Goodwill and intangibles totaled $71.3 million at December 31, 2015 as detailed in the following table.
*Decrease from 2014 is due to the sale of RIC, which included $0.5 million of state licenses carried as an indefinite-lived intangible asset. See note 13 for further discussion on the sale of RIC.
The definite-lived intangible assets are amortized against future operating results based on their estimated useful lives. Amortization of intangible assets was $0.9 million, $0.9 million and $1.2 million for 2015, 2014 and 2013, respectively.
We file a consolidated federal income tax return. Federal income taxes are accounted for using the asset and liability method under which deferred income taxes are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities, operating losses and tax credit carry forwards. The effect on deferred taxes for a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that all or some of the deferred tax assets will not be realized.
Basic earnings per share (EPS) excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the dilution that could occur if securities or other contracts to issue common stock or common stock equivalents were exercised or converted into common stock. When inclusion of these items increases the earnings per share or reduces the loss per share, the effect on earnings is anti-dilutive. Under these circumstances, the diluted net earnings or net loss per share is computed excluding the these items.
The following represents a reconciliation of the numerator and denominator of the basic and diluted EPS computations contained in the consolidated financial statements.
Mortgage-backed Securities (MBS)/Collateralized Mortgage Obligations (CMO) and Asset-backed Securities (ABS): The pricing vendor evaluation methodology includes principally interest rate movements and new issue data. Evaluation of the tranches (non-volatile, volatile or credit sensitivity) is based on the pricing vendors’ interpretation of accepted modeling and pricing conventions. This information is then used to determine the cash flows for each tranche, benchmark yields, pre-payment assumptions and to incorporate collateral performance. To evaluate CMO volatility, an option adjusted spread model is used in combination with models that simulate interest rate paths to determine market price
Certain risks and uncertainties are inherent to our day-to-day operations and to the process of preparing our consolidated financial statements. The more significant risks and uncertainties, as well as our attempt to mitigate, quantify and minimize such risks, are presented below and throughout the notes to the consolidated financial statements.
In 2009, as an extension of our excess and surplus lines general liability product, we expanded our offerings into low to moderate environmental liability exposures for small contractors and asbestos and mold remediation specialists. The business unit also provides limited coverage for individually underwritten underground storage tanks. We attempted to mitigate the overall exposure by focusing on smaller risks with low to moderate exposures. A large portion of this business is also offered on a claims-made basis with relatively low limits. We avoid risks that have large-scale exposures including petrochemical, chemical, mining, manufacturers and other risks that might be exposed to superfund sites. This business is covered under our casualty ceded reinsurance treaties. Since 2009, we have written a total of $16.9 million of premium from this product extension with $3.9 million written in 2015.
The National Association of Insurance Commissioners (NAIC) has developed Property/Casualty Risk-Based Capital (RBC) standards that relate an insurer’s reported statutory surplus to the risks inherent in its overall operations. The RBC formula uses the statutory annual statement to calculate the minimum indicated capital level to support asset (investment and credit) risk and underwriting (loss reserves, premiums written and unearned premium) risk. The NAIC model law calls for various levels of regulatory action based on the magnitude of an indicated RBC capital deficiency, if any. We regularly monitor our subsidiaries’ internal capital requirements and the NAIC’s RBC developments. As of December 31, 2015, we determined that our capital levels are well in excess of the minimum capital requirements for all RBC action levels and that our capital levels are sufficient to support the level of risk inherent in our operations. See note 9 for further discussion of statutory information and related insurance regulatory restrictions.
*See note 13 for further discussion on the sale of RLI Indemnity Company.
Assets measured at fair value on a recurring basis as of December 31, 2014, are summarized below:
In addition, the following table is a schedule of amortized costs and estimated fair values of investments in fixed income and equity securities as of December 31, 2015 and 2014:
Gross unrealized losses in the collateralized securities bond portfolio increased to $2.2 million in 2015 as spreads widened during the year. All of our collateralized securities carry the highest credit rating by one or more major rating agencies and continue to pay according to contractual terms.
For all fixed income securities at a loss at December 31, 2015, we believe it is probable that we will receive all contractual payments in the form of principal and interest. In addition, we are not required to, nor do we intend to sell these investments prior to recovering the entire amortized cost basis of each security, which may be at maturity. We do not consider these investments to be other-than-temporarily impaired at December 31, 2015.
Gross unrealized losses in the corporate bond portfolio increased to $14.8 million in 2015 from $4.2 million at the end of 2014 as credit spreads widened during the year. While these unrealized losses are not due to credit-specific defaults, the energy and materials sectors continue to experience higher risk premiums due to declines in commodity prices. The corporate bond portfolio has an overall rating of BBB+.
As of December 31, 2015, municipal bonds totaled $610.4 million with gross unrealized losses of less than $0.1 million. As of December 31, 2015, approximately 47 percent of the municipal fixed income securities in the investment portfolio were general obligations of state and local governments and the remaining 53 percent were revenue based. Ninety-two percent of our municipal fixed income securities were rated AA or better while 99 percent were rated A or better.
Our equity portfolio consists of common stocks and exchange traded funds (ETF). Gross unrealized losses in the equity portfolio increased $0.5 million to $1.5 million in 2015. Given our intent to hold and expectation of recovery to cost within a reasonable period of time, we do not consider any of our equities to be other-than-temporarily impaired.
Under current accounting standards, an OTTI write-down of debt securities, where fair value is below amortized cost, is triggered by circumstances where (1) an entity has the intent to sell a security, (2) it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis or (3) the entity does not expect to recover the entire
As of December 31, 2015, we held six equity securities that were in unrealized loss positions. The total unrealized loss on these securities was $1.5 million. In considering both the significance and duration of the unrealized loss position, we have no equity securities in an unrealized loss position of greater than 20 percent for more than six consecutive months.
The fixed income portfolio contained 472 securities in an unrealized loss position as of December 31, 2015. Of these 472 securities, 44 have been in an unrealized loss position for 12 consecutive months or longer and represent $5.4 million in unrealized losses. All fixed income securities in the investment portfolio continue to pay the expected coupon payments under the contractual terms of the securities. Credit-related impairments on fixed income securities that we do not plan to sell, and for which we are not more likely than not to be required to sell, are recognized in net earnings. Any non-credit related impairment is recognized in comprehensive earnings. Based on our analysis, our fixed income portfolio is of a high credit quality and we believe we will recover the amortized cost basis of our fixed income securities. We continually monitor the credit quality of our fixed income investments to assess if it is probable that we will receive our contractual or estimated cash flows in the form of principal and interest. There were no OTTI losses recognized in other comprehensive earnings in the periods presented. Key factors that we consider in the evaluation of credit quality include:
As required by law, certain fixed maturity investments amounting to $25.4 million at December 31, 2015, were on deposit with either regulatory authorities or banks.
*Includes asset for value of business acquired (VOBA) in CBIC acquisition, which was fully amortized at the end of 2014.
On October 2, 2013, we completed a public debt offering, issuing $150.0 million in senior notes maturing September 15, 2023, and paying interest semi-annually at the rate of 4.875 percent. The notes were issued at a discount resulting in proceeds, net of discount and commission, of $148.6 million. The amount of the discount is being charged to income over the life of the debt on an effective-yield basis. On December 12, 2013, a portion of the proceeds were used to redeem the $100.0 million in senior notes that were to mature on January 15, 2014, and the remaining proceeds were made available for general corporate purposes. The estimated fair value for the senior note is $158.7 million. The fair value of our long-term debt is estimated based on the limited observable prices that reflect thinly traded securities.
In 2015, 2014 and 2013, we incurred interest expense on our senior notes in the amounts of $7.4 million, $7.4 million and $8.1 million, respectively. The average rate on debt in 2015, 2014 and 2013 was 4.91 percent, 4.91 percent and 5.71 percent, respectively.
We maintain a revolving line of credit with JP Morgan Chase Bank N.A., which permits us to borrow up to an aggregate principal amount of $40.0 million. This facility was entered into during the second quarter of 2014 and replaced the previous $25.0 million facility which expired on May 31, 2014. Under certain conditions, the line may be increased up to an aggregate principal amount of $65.0 million. This facility has a four-year term that expires on May 28, 2018. As of and during the years ended December 31, 2015, 2014 and 2013, no amounts were outstanding on these facilities.
In the ordinary course of business, the insurance subsidiaries assume and cede premiums and selected insured risks with other insurance companies, known as 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 reinsurance). In addition, there are several types of treaties including 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 to a single event, such as a catastrophe. Through the quantification of exposed policy limits in each region and the extensive use of computer-assisted modeling techniques, we monitor the concentration of risks exposed to catastrophic events.
Our policy is to charge to earnings, in the form of an allowance, an estimate of unrecoverable amounts from reinsurers. This allowance is reviewed on an ongoing basis to ensure that the amount makes a reasonable provision for reinsurance balances that we may be unable to recover. Once regulatory action (such as receivership, finding of insolvency, order of conservation or order of liquidation) is taken against a reinsurer, the paid and unpaid recoverable for the reinsurer are specifically identified and written off through the use of our allowance for estimated unrecoverable amounts from reinsurers. When we write-off such a balance, it is done in full. We then re-evaluate the remaining allowance and determine whether the balance is sufficient as detailed above and if needed, an additional allowance is recognized and income charged. The amounts of allowances for uncollectible amounts on paid and unpaid recoverables were $14.0 million and $11.9 million, respectively, at December 31, 2015. At December 31, 2014, the amounts were $13.3 million and $13.1 million, respectively. We have no receivables with a due date that extends beyond one year that are not included in our allowance for uncollectible amounts.
The differences from our initial reserve estimates emerged as changes in our ultimate loss expectations as we performed our reserve analysis process. The recognition of the changes in initial reserve estimates occurred over time as claims were reported, initial case reserves were established, initial reserves were reviewed in light of additional information and ultimate payments were made on the collective set of claims incurred as of that evaluation date. The new information on the ultimate settlement value of claims is continually updated until all claims in a defined set are settled. As a small specialty insurer with a diversified product portfolio, our experience will ordinarily exhibit fluctuations from period to period. While we attempt to identify and react to
2015. We experienced favorable emergence relative to prior years’ reserve estimates in all of our segments during 2015. Development from the casualty segment totaled $45.7 million with the largest amounts coming from accident years 2010 through 2014. We continue to experience emergence that is generally better than previously estimated, but to a lesser degree in 2015 than in the previous two years. Frequency and severity trends have been favorable relative to initial estimates and we believe this is largely due to risk selection by our underwriters, which has been effective in offsetting loss cost trends and a competitive pricing environment. Our general liability product was the largest single contributor to this favorable development at $14.7 million. Although the habitational classes within this product produced adverse development, it was more than offset by favorable development from the construction classes. The second largest contributor was our commercial umbrella product at $10.7 million and we also had a favorable contribution of $5.4 million from our transportation product. In addition, our P&C package product had $6.6 million of favorable development. One business unit, the professional services product, experienced adverse development totaling $3.2 million in 2015. In addition, the casualty runoff business experienced $5.4 million of adverse development, with a large portion attributable to the 1983 accident year.
For the third year in a row, our marine product was the predominant driver of the favorable development in the property segment, accounting for $9.2 million of the $11.8 million total favorable development for the segment. The accident years making the largest contributions were 2010 through 2014. The inland marine and cargo coverages were responsible for the majority of the favorable loss experience. Our assumed property products contributed $4.9 million of favorable development with the majority of that coming from loss reductions on previous hurricanes and storms. Development on direct property products business was also favorable overall. Our recreational vehicle product experienced $1.3 million of adverse development, mostly due to auto physical damage coverages.
The surety segment experienced $7.9 million of favorable development. The majority of the favorable development came from the 2014 accident year, which served to offset the unfavorable development from accident years 2010 and 2013. Commercial, contract and energy surety contributed favorable development of $4.0 million, $2.2 million and $2.0 million, respectively. Miscellaneous surety experience adverse development totaling $0.3 million.
The unfavorable assumed property development was primarily attributable to 2012 spring storms on a treaty, covering mostly Texas homeowners, which was cancelled in early 2013.
The surety segment experienced favorable development of $3.4 million. The majority of the favorable development was from accident year 2012, which offset the unfavorable development from accident years 2009 to 2011. The adverse development coincided with the economic environment in those years. The majority of the adverse development was from the contract and miscellaneous surety products. Though accident year 2012 was favorable for all of surety combined, energy surety was unfavorable in accident year 2012.
The following table represents paid and unpaid environmental, asbestos and mass tort claims data (including incurred but not reported losses) as of December 31, 2015, 2014 and 2013:
Calendar year 2015 was fairly active in aggregate, with inception-to-date incurred losses increasing on a gross and net basis. The most significant change was an increase in the case reserves for a 1983 claim. The claim is reserved at the policy limit, with a gross increase of $2.5 million and a net increase of $2.4 million.
Our net earnings include equity in earnings of unconsolidated investees, Maui Jim and Prime. The investees do not have a policy or pattern of paying dividends. As a result, we record a deferred tax liability on the earnings at the corporate capital gains rate of 35 percent. In the fourth quarters of 2014 and 2013, we received a $6.6 million and $13.2 million dividend from Maui Jim, respectively. No dividend was received from any unconsolidated investee in 2015. In accordance with GAAP guidelines on income taxes, we recognized a $1.8 million and $3.7 million tax benefit for 2014 and 2013, respectively. The tax benefit is generated from applying the lower tax rate applicable to affiliated dividends (7 percent), as compared to the corporate capital gains rate on which the deferred tax liabilities were based. Standing alone the dividend resulted in a 1.0 percent and 2.1 percent reduction to the 2014 and 2013 effective tax rates, respectively. In determining the appropriate tax rate to apply, we anticipate recovering our investments through means other than the receipt of dividends, such as a sale.
During 2013, the Internal Revenue Service (IRS) completed an examination of the income tax returns for the years 2010 and 2011, which produced no material change to net earnings. Tax years 2012 through 2015 remain open and are subject to examination or re-examination.
We maintain ESOP, 401(k) and bonus and incentive plans covering executives, managers and associates. Funding of these plans is primarily dependent upon reaching predetermined levels of operating return on equity, combined ratio and Market Value Potential (MVP). MVP is a compensation model that measures components of comprehensive earnings against a minimum required return on our capital. Bonuses are earned as we generate earnings in excess of this required return. While some management incentive plans may be affected somewhat by other performance factors, the larger influence of corporate performance ensures that the interests of our executives, managers and associates correspond with those of our shareholders.
Our ESOP and 401(k) cover all employees meeting eligibility requirements. ESOP and 401(k) profit-sharing contributions are determined annually by our board of directors and are expensed in the year earned. ESOP and 401(k)-related expenses (basic and profit-sharing) were $11.6 million, $14.1 million and $12.4 million, for 2015, 2014 and 2013, respectively.
Annual bonuses are awarded to executives, managers and associates through our incentive plans, provided certain financial and operational goals are met. Annual expenses for these incentive plans totaled $20.4 million, $23.1 million and $23.2 million for 2015, 2014 and 2013, respectively.
Under the 2015 LTIP, as under the 2010 LTIP and omnibus plan, we grant stock options for shares with an exercise price equal to the fair market value of the shares at the date of grant (subject to adjustments for changes in our capitalization, special dividends and other events as set forth in such plans). Options generally vest and become exercisable ratably over a five-year period.
Shares issued may be less than the number of shares actually exercised, as our plan allows net settlement to cover the option exercise price and taxes due upon option exercise. Shares netted are valued at the closing stock price at the time of option exercise. In these instances, the actual number of shares issued will be less than the options exercised and can result in a decrease to shareholders’ equity. Specifically, when options are exercised with significant intrinsic value (i.e. market value in excess of exercise price) and the exercise is facilitated via net settlement, amounts withheld for taxes result in a decrease in shareholders’ equity. During 2015, the aggregate intrinsic value of options exercised was $32.1 million. During 2013, the aggregate intrinsic value of options exercised was $22.4 million. A majority of these options were exercised via net settlement with taxes withheld at the statutory minimum rate. As shown in the consolidated statements of shareholders’ equity, the exercise of options in 2015 and 2013 resulted in a decrease to paid-in-capital, as the taxes withheld pursuant to net settlement exceeded amounts paid in for options that were exercised using cash. This was not the case in 2014 as the intrinsic value of the options exercised was not as significant ($6.2 million). Therefore, the exercise of options in 2014 resulted in an increase to paid-in-capital. In addition to settlement of the exercise, shareholders’ equity is impacted by corporate tax deductions allowed as a result of option exercises. The amount of the deduction is largely driven by the level of intrinsic value associated with
The following tables summarize option activity in 2015, 2014 and 2013:
The majority of our stock options are granted annually at our regular board meeting in May. In addition, options are approved at the May meeting for quarterly grants to certain retirement eligible employees. Since stock option grants to retirement eligible employees are fully expensed when issued, the approach allows for a more even expense distribution throughout the year.
In 2013, 632,700 options were granted with an average exercise price of $35.67 and an average fair value of $6.88. Of these grants, 472,700 were granted at the board meeting in May with a calculated fair value of $6.47. We recognized $3.8 million of expense during 2013 related to options vesting. Since options granted under our plan are non-qualified, we recorded a deferred tax benefit of $1.3 million related to this compensation expense. Total unrecognized compensation expense relating to outstanding and unvested options was $4.5 million, which will be recognized over the remainder of the vesting period.
The fair value of options were estimated using a Black-Scholes based option pricing model with the following weighted-average grant-date assumptions and weighted average fair values as of December 31:
The risk-free rate was determined based on U.S. treasury yields that most closely approximated the option’s expected life. The dividend yield was calculated based on the average annualized dividends paid during the most recent five-year period, exclusive of special dividends. In 2015 and 2014, the expected volatility was calculated based on the median of the rolling volatilities for the expected life of the options. In 2013, expected volatility was calculated based on the mean reversion of RLI’s stock. The expected option life was determined based on historical exercise behavior and the assumption that all outstanding options will be exercised at the midpoint of the current date and remaining contractual term, adjusted for the demographics of the current year’s grant.
In 2014 and 2013, each director received $10,000 worth of restricted common shares as part of annual director compensation. The shares were issued from the 2010 LTIP during the first quarter of each year. The shares were directly owned by each director on the date of issuance and included a one-year restriction on the sale or transfer of such shares. In the first quarter of 2014, we issued a total of 2,097 restricted shares and recognized $0.1 million of compensation expense. In the first quarter of 2013, we issued a total of 2,320 restricted shares and recognized $0.1 million of compensation expense. This restricted share program was terminated in 2014.
The NAIC has RBC requirements for insurance companies to calculate and report information under a risk-based formula, which measures statutory capital and surplus needs based upon a regulatory definition of risk relative to the company’s balance sheet and mix of products. As of December 31, 2015, each of our insurance subsidiaries had an RBC amount in excess of the authorized control level RBC, as defined by the NAIC. RLI Insurance Company (RLI Ins.), our principal insurance company subsidiary, had an authorized control level RBC of $123.6 million, $118.4 million and $90.6 million as of December 31, 2015, 2014 and 2013, respectively, compared to actual statutory capital and surplus of $865.3 million, $849.3 million and $859.2 million, respectively, for these same periods.
ordinary dividend limits is deemed extraordinary and requires prior approval from the Illinois Department of Insurance. No extraordinary dividends were paid in 2015, 2014 or 2013. As of December 31, 2015, $58.2 million of the net assets of our principal insurance subsidiary are not restricted and could be distributed to RLI Corp. as ordinary dividends. Because the limitations are based upon a rolling 12-month period, the presence, amount and impact of these restrictions vary over time.
The segments of our insurance operations include casualty, property and surety. The casualty portion of our business consists largely of commercial umbrella, personal umbrella, general liability, transportation, package business, executive products, medical professional liability and other specialty coverages, such as our professional liability for design professionals. We also offer fidelity and crime coverage for commercial insureds and select financial institutions. 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.
The surety segment specializes in writing small-to-large commercial and contract surety coverages, as well as those for the energy, petrochemical and refining industries. We also offer miscellaneous bonds including license and permit, notary and court bonds. Often, our surety coverages involve a statutory requirement for bonds. While these bonds typically maintain a
On February 5, 2014, we invested $5.3 million for a 20 percent equity ownership interest in Prime Holdings Insurance Services, Inc. (Prime). On March 4, 2015, we invested an additional $1.7 million, increasing our total equity ownership to 27 percent. Prime writes business through two Illinois domiciled insurance carriers, Prime Insurance Company, an excess and surplus lines company, and Prime Property and Casualty Insurance Inc., an admitted insurance company. The investment in Prime is reflected on our balance sheet as an investment in unconsolidated investee. Our investment in Prime was $8.1 million at December 31, 2015 and $5.7 million at December 31, 2014. Under the equity method of accounting we recognize our proportionate share of Prime’s income as equity in earnings of unconsolidated investees. Our share of Prime’s earnings amounted to $1.0 million during 2015, compared to $0.3 million during 2014.
We have audited the accompanying consolidated balance sheets of RLI Corp. and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of earnings and comprehensive earnings, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2015. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedules I - VI. We also have audited RLI Corp.’s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). RLI Corp.’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report on Controls and Procedures. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on RLI Corp.’s internal control over financial reporting based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of RLI Corp. and subsidiaries as of December 31, 2015 and 2014, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements, taken as a whole, present fairly, in all material respects, the information set forth therein. In our opinion, RLI Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).