The following is selected financial data of RLI Corp. and Subsidiaries for the 5 years ended December 31, 2014.
million and $146.7 million for 2013, 2012, 2011 and 2010, respectively. The special dividends produced corresponding decreases to book value per share and our stock price.
The foundation of our overall business strategy is to underwrite for profit in all market conditions and we achieved this for the 19th consecutive year in 2014, averaging an 87.4 combined ratio over that period of time. This foundation drives our ability to provide shareholder returns in three different ways: the underwriting income itself, net investment income from our investment portfolio and long-term appreciation in our equity portfolio. Our investment strategy is based on preservation of capital as the first priority, with a secondary focus on generating total return. The fixed income portfolio consists primarily of highly-rated, diversified, liquid, investment-grade securities. Consistent underwriting income allows a portion of our shareholders’ equity to be invested in equity securities. Our equity portfolio consists of a core stock portfolio weighted toward dividend-paying stocks, as well as exchange traded funds (ETFs). Our minority equity ownership interests in Maui Jim, Inc. (Maui Jim), a manufacturer of high-quality sunglasses, and Prime, a specialty E&S insurance company, has also enhanced overall returns. We have a diversified investment portfolio and closely monitor our investment risks. Despite periodic fluctuations in market value, our equity portfolio is part of a long-term asset allocation strategy and has contributed significantly to our historic growth in book value.
While rates generally improved over the past few years, many coverages experienced flat or declining prices during 2014. Excess capital in the market impacted the rate environment, and 2014 represented the second consecutive year without a natural catastrophe significant to the industry. As a result, the insurance marketplace remains very competitive. Despite these challenges, we believe that our business model is geared to create underwriting income by focusing on sound risk selection and discipline. Our primary focus will continue to be on underwriting profitability, with a secondary focus on premium growth where we believe underwriting profit exists, as opposed to general premium growth or market share measurements.
On February 5, 2014, we invested $5.3 million for a 20 percent equity ownership interest in Prime, an Illinois domiciled insurance carrier based in Salt Lake City, Utah. Prime is a privately-held excess and surplus lines insurance company that distributes its products through a network of wholesale brokers and specializes in hard-to-place risks.
A more detailed discussion of the impact of these acquisitions is provided in the results of operations and segment highlights, as well as in note 13 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.
Throughout this annual report, we present our operations in the way we believe will be most meaningful, useful and transparent to anyone using this financial information to evaluate our performance. In addition to the generally accepted accounting principles in the United States of America (GAAP) presentation of net income, we show certain statutory reporting information and other non-GAAP financial measures that we believe are valuable in managing our business and drawing comparisons to our peers. These non-GAAP measures are underwriting income, combined ratios and net unpaid loss and settlement expenses.
Following is a list of non-GAAP measures found throughout this report with their definitions, relationships to GAAP measures and explanations of their importance to our operations.
All decisions regarding our best estimate of ultimate loss and LAE reserves are made by our Loss Reserve Committee (LRC). The LRC is made up of various members of the management team including the chief executive officer, chief operating officer, chief financial officer, chief actuary, 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 overall reserve levels at December 31, 2014, make a reasonable provision to meet our future obligations.
The initial loss and ALAE ratios that are applied to earned premium are reviewed at least semi-annually. Prospective estimates are made based on historical loss experience adjusted for exposure mix, price change and loss cost trends. The initial loss and ALAE ratios also reflect our judgment as to estimation risk. We consider estimation risk by product and coverage within product, if applicable. A product with greater overall volatility and uncertainty has greater estimation risk. Products or coverages with higher estimation risk include, but are not limited to, the following characteristics:
A new business or one experiencing significant growth and/or high turnover,
Small volume or lacking internal data requiring significant utilization of external data,
A full analysis of our loss reserves takes place at least semi-annually. The purpose of this analysis is to provide validation of our carried loss reserves. Estimates of the expected value of the unpaid loss and LAE are derived using actuarial methodologies. These estimates are then compared to the carried loss reserves to determine the appropriateness of the current reserve balance.
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.
Operational or internal processes affecting the timing of loss and LAE transactions,
Upon completion of our full loss and LAE estimation analysis, the results are discussed with the LRC. As part of this discussion, the analysis supporting the actuarial central estimate of the IBNR reserve by product is reviewed. The actuaries also
As a predominantly excess and surplus lines and specialty insurer serving niche markets, we believe there are several reasons to carry, on an overall basis, reserves above the actuarial central estimate. We believe we are subject to above-average variation in estimates and that this variation is not symmetrical around the actuarial central estimate.
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 pricing categories that are used to classify fair value.
We regularly evaluate our fixed income and equity securities using both quantitative and qualitative criteria to determine impairment losses for other-than-temporary declines in the fair value of the investments. The following are some of the key factors we consider for determining if a security is other-than-temporarily impaired:
Changes in technology that may impair the earnings potential of the investment,
Consolidated revenue increased 10 percent in 2014, following 7 percent increases in 2013 and 2012. Premiums earned from insurance operations improved for each of the past three years, while investment income also increased during 2014, reversing a trend of moderate declines seen in recent periods. Net premiums earned increased 9 percent in 2014, after advancing 9 percent and 7 percent in 2013 and 2012, respectively. Increased retentions and reduced reinsurance costs have each contributed to the improved results. Premium growth for 2014 was driven by a number of products across our portfolio, as newer product initiatives continued to gain scale and certain established product lines also posted increases. From a segment standpoint, the bulk of the growth during the year was attributable to our casualty segment, where investments in expansion made during recent years has made the most notable impact. With regard to pricing, rates were flat for 2014 on an overall basis. The first half of the year was marked by excess capital in the marketplace, driven by an absence of significant natural catastrophes in 2013 and an influx of alternative capital. This led to reduced reinsurance prices, which resulted in cost savings as we renewed our major property and casualty reinsurance treaties in early 2014. The pressure on reinsurance rates ultimately impacted primary market pricing as well. As a result, positive momentum that existed early in the year gave way to flattening prices as the year progressed. Rates related to catastrophe-exposed coverages in our property segment, however, declined significantly as 2014 represented the second consecutive year of abnormally low natural catastrophe activity. Investment income increased by 5 percent in 2014. The increase was primarily due to a larger invested asset base for most of the year. Additionally, an allocation to higher yielding fixed income securities contributed modestly to the increase. 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 activities were the result of normal portfolio rebalancing, as well as raising cash to support special dividends paid in each of the last three years.
Net earnings increased for the second consecutive year in 2014, after declining in 2012. Results for 2014 reflected both positive underwriting results for the current accident year and favorable loss reserve development on prior accident years. Much like in 2013, a benign catastrophe season and an absence of significant hurricane activity benefited earnings. Catastrophe losses in 2014 and 2013 related primarily to spring storm activity and totaled $7.2 million and $10.0 million, respectively. By comparison, 2012 included a much greater impact from catastrophes, as losses related to Hurricane Sandy, Hurricane Isaac and spring storms amounted to $35.0 million. In total, underwriting income was $107.0 million in 2014, compared to $106.8 million in 2013 and $63.6 million in 2012. Our ability to continue to produce underwriting income, at levels which have consistently outperformed the broader industry, is a testament to our underwriters’ discipline throughout the insurance cycle and our continued commitment to underwriting for a profit. We believe our underwriting discipline can differentiate us from the broader insurance market by ensuring appropriate risk selection and pricing of both new and renewal business and can
Equity in earnings of unconsolidated investees totaled $12.3 million in 2014, increasing for the third consecutive year. This amount includes $12.0 million from Maui Jim, which posted increased sales volume in each of the last three years as a result of continued investments in their business. The combination of increased sales and improved margins resulted in a 10 percent increase in earnings for 2014. The remaining $0.3 million of equity in earnings of unconsolidated investees relates to Prime, a specialty E&S insurance company. Our equity investment in Prime occurred in the first quarter of 2014. Further discussion of the investment in Prime can be found in note 13 to the consolidated financial statements with Item 8, Financial Statement and Supplementary Data.
The industry again benefited from a very light catastrophe year in 2014. Pricing momentum slowed during 2014, a contrast from steady improvements experienced in recent years, with rates generally flat on an overall basis. While flat overall, the direction and magnitude of rate changes has varied across our product portfolio. The most noteworthy pricing movements related to catastrophe exposed coverages in our property segment, which sustained double-digit declines in response to competitive pressures in this market. Abnormally low natural catastrophe activity over the past two years and an abundance of capital in the market have been the primary drivers of declining prices for these coverages. Positive pricing trends have been experienced for certain product lines elsewhere in our product portfolio, including umbrella, marine, transportation and specialty personal coverages. In our surety segment, rates remained flat in 2014 as competitive pressures persist in this market. Despite challenging market conditions in 2014, we have managed to grow our top line. Expansion efforts and new product initiatives over the past several years, including our crop reinsurance program, have played a significant role in overall premium production, totaling approximately $250 million, $220 million and $190 million in gross premiums written in 2014, 2013 and 2012, respectively. Excluding premiums from crop, newer initiatives have accounted for approximately 20 percent of gross premiums written in each of the past three years. The top line impact of crop is noteworthy as our crop reinsurance relationship will expire over the next year due to the acquisition of the cedant. While we expect gross premiums written from crop business to decrease from approximately $50 million in 2014 to $10 million in 2015, the impact on underwriting income is expected to be minimal. Gross premiums written, as reflected in the table that follows, increased 2 percent in 2014 after advancing 7 percent in 2013 and 12 percent in 2012. On a net basis, premiums increased 6 percent in 2014 and outpaced growth in gross premiums written due to cost savings realized on our 2014 reinsurance renewals. During the first half of 2014, we renewed all material reinsurance treaties which resulted in over $16.0 million of annual savings. Net premium growth outpaced gross premiums written growth in 2013 as well, as we increased retentions on certain casualty products where pricing trends were positive.
On an overall basis, pricing for many casualty coverages was less favorable in 2014, as positive rate momentum slowed during the year. For our more mature product offerings, in particular, this made top line growth challenging. Umbrella premiums declined 2 percent in 2014, following consecutive years of solid growth in 2013 and 2012. Rates for commercial umbrella, which were up nearly 15 percent on average during those periods of growth, leveled off during 2014. Transportation premiums also decreased slightly during the year, down 1 percent to $71.7 million. The decline in transportation follows a 56 percent increase achieved during 2013 and a 16 percent increase in 2012. Prior to 2012, this book sustained several consecutive years of decline in response to competitive pressures and weak economic conditions, which reduced the revenues upon which insured premiums are based. Premiums from executive products totaled $50.3 million, slightly improved from prior year, despite a 1 percent decline in rates for these coverages during 2014. In 2013 and 2012, executive products premiums advanced 4 percent and 9 percent, respectively. For general liability, historically our largest product in this segment, gross premiums were flat at $83.0 million in 2014, after declining 11 percent in 2013 and increasing 4 percent in 2012. While premiums during
this three year period were favorably impacted by modest price increases, re-underwriting efforts on habitational business, particularly in 2013, negatively impacted the top line. During 2012 and 2013, the habitational component of the general liability book sustained adverse loss experience. Re-underwriting efforts in 2013 led to non-renewal of certain policies and rate increases on others. Prior to re-underwriting, the habitational component represented nearly 50 percent of general liability revenue in 2012. By the end of 2013, this percentage had declined to nearly 25 percent. The increased rates and improved mix of business has resulted in improved current accident year underwriting results in each of the past two years.
Gross premiums written in the property segment decreased by 4 percent in 2014 after decreasing 3 percent in 2013 and increasing 4 percent in 2012. Property segment premiums have been pressured by increased competition and re-underwriting actions taken during recent years, which have combined to cause declines for many property coverages. Certain products, however, have provided top-line growth, which partially offset the overall decline seen in 2014. The largest increase was from our recreational vehicle product, which we launched late in the fourth quarter of 2012. Gross written premiums from this book increased $4.6 million, or 40 percent from 2013, the first full year of operations. Property coverages that experienced premium decreases in 2014 included our marine, commercial property and reinsurance products. Gross premiums written for marine declined in each of the past two years, down 10 percent in 2014 and 7 percent in 2013, after increasing 2 percent in 2012. The decline in marine is due to re-underwriting efforts on the cargo and inland marine books, which included exiting certain unprofitable accounts and increasing rates on others. Overall, these efforts were successful, as marine achieved rate increases of 5 percent and 9 percent in 2014 and 2013, respectively. While premium declined on a full year basis for 2014, production improved in the latter part of the year, reversing the trend of declines seen in recent periods. The re-underwriting of marine business was completed in the second half of 2014.
Commercial property declined 3 percent in 2014 and 2013 after increasing 4 percent in 2012. The 2014 results reflect significant rate declines during the year for catastrophe exposed coverages as an abundance of capital has impacted both reinsurance and primary pricing. Our crop reinsurance business declined 6 percent in 2014, posting premiums of $50.3 million, compared to $53.4 million in 2013 and $35.5 million in 2012. Gross premium growth was significant in 2013 as we increased our participation in the treaty with coverages concentrated in the Midwest. On a net basis, however, premium growth was less dramatic as two-thirds of the premium assumed under the second treaty was ceded to another reinsurance partner. As
Underwriting income was $32.9 million in 2014, compared to $27.6 million in 2013 and $11.7 million in 2012. The segment’s results translated into combined ratios of 83.4, 86.2 and 94.3 for 2014, 2013 and 2012, respectively. While all three periods were impacted by spring storm losses, the results for 2014 and 2013 reflected an absence of hurricane activity. Results for 2014 included $4.7 million in spring storm losses and $0.3 million in losses related to earthquake activity in Napa Valley, which occurred during the third quarter. 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 well 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. Partially offsetting these adverse impacts, commercial fire losses remained low and favorable development on prior accident years added $7.3 million to underwriting income. Approximately half of this benefit related to reductions in prior years’ hurricane reserves. The remainder can be attributed to continued positive emergence on marine liability and protection & indemnity coverages. For 2012, underwriting results included elevated natural catastrophe and weather-related losses that impacted our commercial property, marine, crop and other reinsurance coverages. Incurred losses from spring storms totaled $15.9 million in 2012, while losses and reinstatement premiums from Hurricanes Sandy and Isaac served to reduce income by an additional $18.1 million. In addition, widespread drought conditions across the United States resulted in our crop coverages posting $2.0 million in increased underwriting loss on the 2012 reinsurance contracts, when compared to the 2013 reinsurance contract. Partially offsetting these adverse impacts was $16.8 million in favorable development on prior accident years’ reserves. This benefit was due to $12.1 million in positive emergence on marine liability and protection & indemnity coverages. Reserves related to prior year hurricane and storm losses within commercial property and crop coverages also developed favorably in 2012 and accounted for the balance of favorable development within this segment.
The segment’s loss ratio was 45.3 in 2014 compared to 48.1 in 2013 and 57.2 in 2012. The improved result for 2014 related to the aforementioned 3 point decline in the current accident year loss ratio, while increased hurricane and storm activity accounted for the higher loss ratio in 2012. The expense ratio for the property segment was 38.1 in each of the last two years, compared to 37.1 in 2012. Over the three year period, expenses have trended upward slightly due to continued investment in expansion and marginal declines in net premiums earned.
During 2014, net investment income increased by 5 percent. The increase was primarily due to a larger invested asset base for most of the year. Additionally, an allocation to some higher yielding fixed income securities contributed modestly to the increase. The average annual yields on our investments were as follows for 2014, 2013 and 2012:
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 2014, the average after-tax yield on the taxable fixed income portfolio declined to 2.3 percent from 2.4 percent in 2013, while the average after-tax yield on the tax-exempt portfolio increased slightly.
We regularly evaluate the quality of our investment portfolio. When we determine that a specific security has suffered an other-than-temporary decline in value, the investment’s value is adjusted by reclassifying the decline from unrealized to realized losses. This has no impact on shareholders’ equity. We did not recognize any OTTI losses during 2014 or 2013. During 2012, we recognized $1.2 million in impairment losses. All losses were taken during the second quarter on equity securities we no longer had the intent to hold.
As of December 31, 2014, we held four securities in our equity portfolio that were in unrealized loss positions. The total unrealized loss on these securities was $1.0 million. With respect to both the significance and duration of the unrealized loss positions, 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 258 positions at an unrealized loss as of December 31, 2014. Of these 258 securities, 49 have been in an unrealized loss position for 12 consecutive months or longer and represent $1.7 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. Based on our analysis, our fixed income portfolio is of a high credit quality and we believe we will recover the amortized cost basis.
Quality in the previous table and in all subsequent tables is an average of each bond’s credit rating, adjusted for its relative weighting in the portfolio.
In selecting the maturity of securities in which we invest, we consider the relationship between the duration of our fixed income investments and the duration of our liabilities, including the expected ultimate payout patterns of our reserves. We believe that both liquidity and interest rate risk can be minimized by such asset/liability management. As of December 31, 2014, our fixed income portfolio’s duration was 4.6 years.
Our equity portfolio had a fair value of $410.6 million at December 31, 2014, entirely classified as available-for-sale. Equities comprised 21 percent of our total 2014 portfolio, down from 22 percent in 2013. Securities within the equity portfolio are well diversified and are primarily invested in large-cap issues with a focus on dividend income. Our strategy is value oriented and security selection takes precedence over market timing. Likewise, low turnover throughout our long investment horizon minimizes transaction costs and taxes.
Our allocation to agency mortgage-backed securities totaled $264.5 million as of December 31, 2014. MBS represented 18 percent of the fixed income portfolio compared to $244.4 million or 17 percent of that portfolio as of December 31, 2013.
We believe MBS investments add diversification, liquidity, credit quality and additional yield to our portfolio. Our objective for the MBS portfolio is to provide reasonable cash flow stability where we are compensated for the call risk associated with residential refinancing. The MBS portfolio includes mortgage-backed pass-through securities and collateralized mortgage obligations (CMO). A mortgage pass-through is a security consisting of a pool of residential mortgage loans which returns principal and interest cash flows to investors each month. A CMO has a more finite payment structure and can reduce the risks associated with prepayment. CMO securities are divided into maturity classes that are paid off under certain expected interest rate conditions. Our MBS portfolio does not include interest-only securities or principal-only securities. As of December 31, 2014, all of the securities in our MBS portfolio were rated AA+ and issued by Government Sponsored Enterprises (GSEs) such as the Governmental National Mortgage Association (GNMA), Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC).
Variability in the average life of principal repayment is an inherent risk of owning mortgage-related securities. However, we reduce our portfolio’s exposure to prepayment risk by seeking characteristics that tighten the probable scenarios for expected cash flows. As of December 31, 2014, the MBS portfolio contained 76 percent of pure pass-throughs compared to 78 percent as of December 31, 2013. An additional 16 percent of the MBS portfolio was invested in planned amortization class CMOs (PACs), the same as 2013. CMO PACs are securities whose cash flows are designed to remain constant in a variety of mortgage prepayment environments.
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, 2014, ABS/CMBS investments were $135.3 million (9 percent) of the fixed income portfolio, compared to $106.3 million (7 percent) as of December 31, 2013. The entire ABS/CMBS portfolio was rated AA or higher as of December 31, 2014. 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.
As of December 31, 2014, approximately 49 percent of the municipal fixed income securities in the investment portfolio were GO and the remaining 51 percent were revenue based. Ninety percent of our municipal fixed income securities were rated AA or better, while 99 percent were rated A or better.
As of December 31, 2014, our corporate debt portfolio totaled $562.7 million (38 percent) of the fixed income portfolio compared to $526.0 million (37 percent) as of December 31, 2013. Our allocation to the corporate debt portfolio increased during the year as we initiated an investment allocation to high-yield credit. This portfolio consists of 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 378 issues.
The following table illustrates our corporate debt exposure to the financial and non-financial sectors as of December 31, 2014, including fair value, cost basis and unrealized gains and losses:
As of December 31, 2014, our equity portfolio totaled $410.6 million (21 percent) of the investment portfolio, compared to $418.7 million (22 percent) as of December 31, 2013. Our common stock portfolio decreased in the normal course of rebalancing the position throughout 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 1000 Index, the S&P 500 Index, and the S&P 500 Utilities Index. No one fund makes up more than 50 percent of the ETF allocation, and the philosophy mirrors that of the actively managed equity portfolio, with a preference for dividend income and lower anticipated volatility than the market (as measured by the S&P 500). We did not recognize any impairment losses in the equity portfolio during 2014 or 2013.
The following table illustrates the distribution by sector of our equity portfolio as of December 31, 2014, including fair value, cost basis and unrealized gains and losses:
We incurred $7.4 million of interest expense on outstanding debt during 2014, compared to $8.1 million in 2013 and $6.0 million in 2012. We completed a public debt offering in October 2013, issuing $150.0 million in senior notes, and used a portion of the proceeds to repay $100.0 million in senior notes that were originally set to mature in January 2014. Due to the timing of the transaction settlements associated with the new debt issuance and repayment of the 2014 notes, our weighted average debt balance was slightly higher in 2013, resulting in the higher interest expense. At December 31, 2014 and 2013, our long-term debt consisted of $150.0 million in senior notes maturing September 15, 2023, and paying interest semi-annually at the rate of 4.875 percent. At December 31, 2012, our long-term debt consisted of $100.0 million in senior notes that paid interest semi-annually at the rate of 5.95 percent.
As discussed previously, general corporate expenses tend to fluctuate relative to our incentive compensation plans. Our compensation model 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. In 2014, 2013 and 2012, we exceeded the required return, resulting in the accrual of executive bonuses. Excluding this variable component tied to performance, other general corporate expenses increased in 2014 due in part to increased shareholder-related expenses, including costs associated with the stock-split and higher legal fees associated with corporate litigation arising in 2014. In 2013 and 2012, other general corporate expenses were flat.
On February 5, 2014, we invested $5.3 million for a 20 percent equity ownership interest in Prime, an Illinois domiciled insurance carrier based in Salt Lake City, Utah. Prime is a privately-held excess and surplus lines insurance company that distributes its products through a network of wholesale brokers and specializes in hard-to-place risks. Our investment in Prime was $5.7 million at December 31, 2014 and we recorded $0.3 million in investee earnings during the year. Additionally, we entered into a 25 percent quota share reinsurance treaty with Prime, effective January 1, 2014, which contributed $10.2 million of gross premiums written and $5.3 million of net premiums earned during the year.
Our effective tax rates were 28.5 percent, 28.1 percent and 27.6 percent for 2014, 2013 and 2012, respectively. Effective rates are dependent upon components of pretax earnings and the related tax effects. The effective rate for 2014 was higher than 2013 due to an increase in net realized gains on investments along with a slight increase in underwriting income.
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, 2013 and 2012, we received a $6.6 million, $13.2 million and $6.6 million dividend from Maui Jim, respectively. In accordance with GAAP guidelines on income taxes, we recognized a $1.8 million, $3.7 million and $1.8 million tax benefit for 2014, 2013 and 2012 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, 2.1 percent and 1.3 percent reduction to the 2014, 2013 and 2012 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.
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 $785.9 million at December 31, 2014, from $774.5 million as of December 31, 2013. This reflects incurred losses of $296.6 million in 2014 offset by paid losses of $285.2 million compared to incurred losses of $259.8 million offset by $283.9 million paid in 2013. The overall increase in our net loss and LAE reserves between 2014 and 2013 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.
Gross reserves (liability) and the reinsurance balances recoverable (asset) were both subject to the same influences that affected net reserves and behaved similarly. Total gross and ceded loss and LAE reserves decreased to $1.12 billion and $335.1 million, respectively, at December 31, 2014, from $1.13 billion and $354.9 million, respectively, at December 31, 2013.
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, 2014.
We have historically grown our shareholders’ equity and/or policyholders’ surplus as a result of three sources of funds: (1) earnings on underwriting and investing activities, (2) appreciation in the value of our invested assets and (3) the issuance of common stock and debt.
Additionally, during the third quarter of 2014, two of our insurance companies, RLI Ins. and Mt. Hawley, became members of the Federal Home Loan Bank of Chicago (FHLBC). Membership in the Federal Home Loan Bank System will provide both companies access to an additional source of liquidity via a secured lending facility. According to our current membership, aggregate borrowing capacity is approximately $40 million at year end. However, under certain circumstances, that capacity may be increased based on additional FHLBC stock purchased and available collateral. Our membership allows each insurance subsidiary to determine tenor and structure at the time of borrowing. As of and during the year ended December 31, 2014, no amounts were outstanding with the FHLBC.
Our overall investment philosophy is designed to first protect policyholders by maintaining sufficient funds to meet corporate and policyholder obligations and then generate long-term growth in shareholders’ equity. Because our existing and projected liabilities are sufficiently funded by the fixed income portfolio, we can improve returns by investing a portion of the surplus (within limits) in an equity portfolio. As of December 31, 2014, 49 percent of our shareholders’ equity was invested in equities, compared to 51 percent at December 31, 2013 and 47 percent at December 31, 2012.
Our capital structure is comprised of equity and debt obligations. As of December 31, 2014, our capital structure consisted of $149.6 million in 10-year maturity senior notes (long-term debt) and $845.1 million of shareholders’ equity. Debt outstanding comprised 15 percent of total capital as of December 31, 2014.
Recent loss trends continued to be more muted than longer-term averages. We will focus on selective growth and controlling expenses without sacrificing service where we can in 2015. We will continue to look for additional underwriting talent and companies to acquire that fit our underwriting culture. We will remain a destination for rational underwriters and talented claim staff. We anticipate adding underwriters, additional classes or business units in niche segments of the insurance market. We expect our expansions in 2014, including healthcare liability, assumed E&S business, small programs and coverage enhancements to our package products, to have a larger impact on the top line over the long run. At the beginning of 2015, we renewed our major property and casualty reinsurance treaties, which resulted in savings of approximately $7.0 million from improved reinsurance rates, while we expanded some coverages. This follows several years of improvements in terms and conditions. We expect a more stable reinsurance market through the remainder of 2015.
The property market is the most competitive of our three segments, due largely to the diversified catastrophe component within this segment. Alternative capital that continues to provide cheaper capacity to the (re)insurance community, particularly in Florida, has affected primary pricing. We experienced a decrease in exposure and premium in our difference in condition
and earthquake portfolios during 2014. Our wind and fire business remained relatively flat. Based on market conditions, we do not expect growth in our E&S Property book. Our marine business has refocused on key classes and we expect measured, profitable growth in 2015. The recreational vehicles program, which was launched in 2012, experienced heightened loss activity in 2014. We implemented rate increases and expect a flat top line, as some insureds will choose to purchase coverage elsewhere. Finally, our crop reinsurance relationship will expire over the next year. In 2014, we recorded $50.3 million and $28.3 million of gross and net premium, respectively. With our cedant under new ownership, our participation has been greatly reduced. We will assume approximately $10.0 million of gross and net premium in 2015. We expect this will be the last year of this assumed reinsurance agreement.
We added two small production sources in 2014 involving E&S homeowners and catastrophe coverage for builders’ risk policies. Despite these new ventures and the recovery in marine, we do not expect to overcome the decrease in production from the crop business. Premium will likely decrease by more than 10 percent in the property segment in 2015. With the underwriting changes that have been implemented in our fire, marine and recreational vehicle business and the reduction in the underperforming crop business, we expect a slightly improved underwriting margin in 2015, barring significant catastrophe activity. Overall, we expect the property market to remain crowded and competitive in the year ahead.
The surety segment has grown materially over the last few years as we added underwriters in all business units: miscellaneous, commercial, energy and contract surety. In addition, we purchased CBIC in 2011, which expanded our footprint in the western states. The success in 2014 was largely driven by commercial surety where, despite increased competition, we were able to write additional bonds for current accounts and add some new accounts. Our energy-focused unit offset some of this growth, as they became very selective in light of challenging market conditions. Our underwriters required collateral or declined accounts where the company’s financial status deteriorated as a result the reduction in energy prices. We also recognize global economic conditions could impact the U.S. economy and pressure contractors that have overextended their resources. We see these trends continuing into 2015, which will put pressure on energy and contract surety’s top line. We continue to see new entrants to the market and competitors offering increased capacity. We expect a flat top line in 2015, but with our continued underwriting discipline, we would expect similar underwriting margins.
Sluggish global growth, a decline in European government bond yields and a preference for U.S. dollar assets increased the demand for long U.S. Treasuries, which limited the potential for yields to rise in 2014. The bellwether 10 year Treasury yield ended 2014 at 2.17 percent, down 0.86 percent from year end 2013. Uncertainty propelled enough market volatility by the fourth quarter that risk premiums rose for many fixed income asset classes. The most pronounced volatility was concentrated in securities related to the energy sector. Despite wider credit spreads, fixed income securities experienced price appreciation above expectations for the year on the decline in rates across the yield curve. Equities were a significant contributor as well, with the low rate environment boosting demand for stocks.
The accompanying consolidated financial statements were prepared in conformity with generally accepted accounting principles in the United States of America (GAAP), which differ in some respects from those followed in reports to insurance regulatory authorities. The consolidated financial statements include the accounts of our holding company and our subsidiaries. All significant intercompany balances and transactions have been eliminated. Certain reclassifications were made to 2013 and 2012 to conform to the classifications used in the current year.
ASU 2014-01, Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects
We elected to early adopt this ASU during 2014 in conjunction with our investment in Federal Low Income Housing Tax Credits. A discussion of our investment and the required disclosures of this accounting standards update are included in Note 2 to these consolidated financial statements.
The liability for unpaid losses and settlement expenses represents estimates of amounts needed to pay reported and unreported claims and related expenses. The estimates are based on certain actuarial and other assumptions related to the ultimate cost to settle such claims. Such assumptions are subject to occasional changes due to evolving economic, social and political conditions. All estimates are periodically reviewed and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Such adjustments are reflected in the results of operations in the period in which they are determined. Due to the inherent uncertainty in estimating reserves for losses and settlement expenses, there can be no assurance that the ultimate liability will not exceed recorded amounts. If actual liabilities do exceed recorded amounts, there will be an adverse effect. Furthermore, we may determine that recorded reserves are more than adequate to cover expected losses, as happened during 2010 through 2014, when favorable experience primarily on casualty business led us to reduce our reserves. Based on the current assumptions used in estimating reserves, we believe that our overall reserve levels at December 31, 2014, make a reasonable provision to meet our future obligations. See note 6 for a further discussion of unpaid losses and settlement expenses.
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 all or some of the deferred tax assets will not be realized.
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. Although 2011 has been examined by the IRS, tax years 2011 through 2014 remain open and are subject to examination or re-examination.
As an insurance company, we are subject to minimal state income tax liabilities. On a state basis, since the majority of our income is from insurance operations, we pay premium tax in lieu of state income tax. Premium taxes are a component of policy acquisition costs and calculated as a percentage of gross premiums written.
information. This process allows the pricing vendor to obtain evaluations of a broad universe of securities in a way that reflects changes in yield curve, index rates, implied volatility, mortgage rates and recent trade activity. MBS/CMO and ABS with corroborated, observable inputs are classified as Level 2. All of our MBS/CMO and ABS are deemed Level 2.
See note 8 for further discussion and related disclosures regarding stock options.
Reinsurance does not discharge us from our primary liability to policyholders, and to the extent that a reinsurer is unable to meet its obligations, we would be liable. We continuously monitor the financial condition of prospective and existing reinsurers. As a result, we purchase reinsurance from a number of financially strong reinsurers. We provide an allowance for reinsurance balances deemed uncollectible. See further discussion of reinsurance exposures in note 5.
Our insurance subsidiaries are highly regulated by the state in which they are incorporated and by the states in which they do business. Such regulations, among other things, limit the amount of dividends, impose restrictions on the amount and types of investments and regulate rates insurers may charge for various coverages. We are also subject to insolvency and guarantee fund assessments for various programs designed to ensure policyholder indemnification. We generally accrue an assessment during the period in which it becomes probable that a liability has been incurred from an insolvency and the amount of the related assessment can be reasonably estimated.
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, 2014, 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.
In addition, ratings are a critical factor in establishing the competitive position of insurance companies. Our insurance companies are rated by A.M. Best, S&P and Moody’s. Their ratings reflect their opinions of an insurance company’s and an insurance holding company’s, financial strength, operating performance, strategic position and ability to meet its obligations to policyholders.
During 2014, we recorded $32.2 million in net realized gains along with a change in unrealized gains of $55.2 million. The majority of our net realized gains were due to sales of equity securities while the change in unrealized gains was due to increases in the fixed income and equity portfolios. For 2014, the net realized investment gains and changes in unrealized gains (losses) on investments totaled $87.4 million.
Assets measured at fair value on a recurring basis as of December 31, 2013, are summarized below:
Expected maturities may differ from contractual maturities due to call provisions on some existing securities. At December 31, 2014, the net unrealized appreciation of available-for-sale fixed income and equity securities totaled $264.0 million pretax. At December 31, 2013, the net unrealized appreciation of available-for-sale fixed maturities and equity securities totaled $208.8 million pretax.
For all fixed income securities at a loss at December 31, 2014, 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 maturity. We do not consider these investments to be other-than-temporarily impaired at December 31, 2014.
Unrealized losses in the corporate bond portfolio decreased to $4.2 million in 2014 from $8.0 million at the end of 2013 as interest rates decreased during the year. While these unrealized losses are not due to credit-specific issues, the energy sector experienced a shift in risk premiums higher near year-end; wider credit spreads in energy were largely due to a rapid decline in oil and a repricing of risk for related companies. The corporate bond portfolio has an overall rating of BBB.
As of December 31, 2014, we held four equity securities that were in unrealized loss positions. The total unrealized loss on these securities was $1.0 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.
Based on our analysis, we concluded that the securities in an unrealized loss position were not other-than-temporarily impaired at December 31, 2014, and 2013.
During 2014 and 2013, we did not recognize any impairment losses. There were $1.2 million in losses associated with OTTI of securities in 2012.
As required by law, certain fixed maturity investments amounting to $28.1 million at December 31, 2014, were on deposit with either regulatory authorities or banks.
In 2014, 2013 and 2012, we incurred interest expense on our senior notes in the amounts of $7.4 million, $8.1 million and $6.0 million, respectively. The average rate on debt in 2014, 2013 and 2012 was 4.91 percent, 5.71 percent and 6.02 percent, respectively.
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 $13.3 million and $13.1 million, respectively, at December 31, 2014. At December 31, 2013, the amounts were $12.2 million and $14.2 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, other than the receivable related to our crop reinsurance program. The amount receivable under our crop reinsurance business, which represents $23.7 million of our total premiums and reinsurance balances receivable at December 31, 2014, is not contractually due until the final settlement of the 2014 crop year, which is scheduled to occur during the fourth quarter of 2015.
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 systematic changes in the loss environment, we also must consider the volume of experience directly available to us and interpret any particular period’s indications with a realistic technical understanding of the reliability of those observations.
2014. We experienced favorable emergence relative to prior years’ reserve estimates in all our segments during 2014. The casualty segment contributed $52.8 million in favorable development. Accident years 2012 and 2013 contributed significantly to the favorable development, with accident years 2007 to 2011 also continuing to develop favorably. The favorable development in 2014 was smaller than 2013. This was predominantly caused by favorable frequency and severity trends that continued to be better than our long-term expectations. In addition, we believe this to be the result of our underwriters’ risk selection, which has mostly offset price declines and loss cost inflation. Nearly all of our casualty products contributed to the favorable development, but this was particularly true for our general liability product. The general liability product contributed $28.1 million to our favorable development with all coverages contributing to the favorable development in 2014. P&C package products were the second largest contributor with $9.4 million in favorable development mostly from accident years 2011, 2012 and 2013. Personal and commercial umbrella were favorable by $0.8 million and $4.4 million, respectively. Run-off business had favorable development of $0.9 million due mostly to favorable development in the discontinued restaurant-bar-tavern business.
The surety segment experienced favorable development of $10.9 million. The majority of the favorable development was from accident year 2013. Contract and commercial surety products were the main contributors with favorable development of $4.6 million and $4.3 million, respectively. Oil and gas surety had favorable development of $1.2 million and miscellaneous surety had favorable development of $0.9 million.
The marine product was the primary driver of the favorable development in the property segment. Marine contributed $5.9 million of the $7.3 million total favorable property development. Accident year 2009 to 2012 contributed to the marine products’ favorable development. The marine protection & indemnity and liability coverages accounted for the majority of the favorable
The surety segment experienced $7.3 million of favorable development with nearly all of it coming from accident years 2010 and 2011. The development from the commercial, miscellaneous and energy products more than offset $2.6 million of unfavorable development from the contract surety product. Last year we started seeing evidence that the cumulative effect of the economic environment was having an adverse impact on our customers and our experience, in particular for contract surety. This continued during 2012 causing us to increase our estimates for contract surety for prior accident years, in particular accident year 2011.
Income tax expense attributable to income from operations for the years ended December 31, 2014, 2013 and 2012, differed from the amounts computed by applying the U.S. federal tax rate of 35 percent to pretax income from continuing operations as demonstrated in the following table:
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, 2013 and 2012, we received a $6.6 million, $13.2 million and $6.6 million dividend from Maui Jim, respectively. In accordance with GAAP guidelines on income taxes, we recognized a $1.8 million, $3.7 million and $1.8 million tax benefit for 2014, 2013 and 2012, 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, 2.1 percent and 1.3 percent reduction to the 2014, 2013 and 2012 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.
We maintain ESOP, 401(k) and bonus and incentive plans covering executives, managers and associates. At the board of directors’ discretion, 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.
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 $23.1 million, $23.2 million and $16.7 million for 2014, 2013 and 2012, respectively.
Our RLI Corp. Omnibus Stock Plan (omnibus plan) was in place from 2005 to 2010. The omnibus plan provided for equity-based compensation, including stock options, up to a maximum of 3,000,000 shares (subject to adjustment for changes in our capitalization and other events). Between 2005 and 2010, we granted 2,458,059 stock options under this plan, including incentive stock options (ISOs), which were adjusted as part of the special dividends paid in 2014 and prior years.
The following tables summarize option activity in 2014, 2013 and 2012:
In 2012, 669,800 options were granted with an average exercise price of $31.71 and an average fair value of $6.55. Of these grants, 437,800 were granted at the board meeting in May with a calculated fair value of $6.54. We recognized $3.6 million of expense during 2012 related to options vesting. Since options granted under our plan are non-qualified, we recorded a tax benefit of $1.3 million related to this compensation expense. Total unrecognized compensation expense relating to outstanding and unvested options was $4.3 million, which will be recognized over the remainder of the vesting period.
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 2014, the expected volatility was calculated based on the median of the rolling volatilities for the expected life of the options. In 2013 and 2012, 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.
The NAIC has RBC requirements that require 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, 2014, 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 $118.4 million, $90.6 million and $90.4 million as of December 31, 2014, 2013 and 2012, respectively, compared to actual statutory capital and surplus of $849.3 million, $859.2 million and $684.1 million, respectively, for these same periods.
The following table includes selected information for our insurance subsidiaries for the year ending and as of December 31:
As discussed in note 1.A., our insurance subsidiaries are organized in a vertical structure with RLI Ins. as the first-level, or principal, insurance subsidiary of RLI Corp. At the holding company (RLI Corp.) level, we rely largely on dividends from our insurance company subsidiaries to meet our obligations for paying principal and interest on outstanding debt, corporate expenses and dividends to RLI Corp. shareholders. As discussed further below, dividend payments to RLI Corp. from our principal insurance subsidiary are restricted by state insurance laws as to the amount that may be paid without prior approval of the insurance regulatory authorities of Illinois. As a result, we may not be able to receive dividends from such subsidiary at times and in amounts necessary to pay desired dividends to RLI Corp. shareholders. On a GAAP basis, as of December 31, 2014, our holding company had $845.1 million in equity. This includes amounts related to the equity of our insurance subsidiaries, which is subject to regulatory restrictions under state insurance laws. The unrestricted portion of holding company net assets is comprised primarily of investments and cash, including $46.7 million in liquid assets, which approximates annual holding company expenditures. Unrestricted funds at the holding company are available to fund debt interest, general corporate obligations and dividend payments to our shareholders. If necessary, the holding company also has other potential sources of liquidity that could provide for additional funding to meet corporate obligations or pay shareholder dividends, which include a revolving line of credit, as well as issuances of common stock and debt.
Ordinary dividends, which may be paid by our principal insurance subsidiary without prior regulatory approval, are subject to certain limitations based upon statutory income, surplus and earned surplus. The maximum ordinary dividend distribution from our principal insurance subsidiary in a rolling 12-month period is limited by Illinois law to the greater of 10 percent of RLI Ins. policyholder surplus, as of December 31 of the preceding year, or the net income of RLI Ins. for the 12-month period ending December 31 of the preceding year. Ordinary dividends are further restricted by the requirement that they be paid from earned surplus. In 2014, 2013 and 2012, our principal insurance subsidiary paid ordinary dividends totaling $185.0 million, $40.0 million and $13.0 million, respectively, to RLI Corp. Any dividend distribution in excess of the ordinary dividend limits is deemed extraordinary and requires prior approval from the Illinois Department of Insurance. While no extraordinary dividends were paid in 2014 or 2013, our principal insurance subsidiary sought and received regulatory approval in 2012, prior to the payment of extraordinary dividends totaling $125.0 million. As of December 31, 2014, $53.4 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.
We have operating lease obligations for regional office facilities. These leases expire in various years through 2023. Expenses associated with these leases totaled $5.8 million in 2014, $5.7 million in 2013 and $5.4 million in 2012. Minimum future rental payments under non-cancellable leases are as follows:
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 relatively low loss ratio, losses may fluctuate due to adverse economic conditions affecting the financial viability of our insureds. The contract surety product guarantees the construction work of a commercial contractor for a specific project. Generally, losses occur due to the deterioration of a contractor’s financial condition. This line has historically produced marginally higher loss ratios than other surety lines during economic downturns.
Net investment income is the by-product of the interest and dividend income streams from our investments in fixed income and equity securities. Interest and general corporate expenses include the cost of debt and other director and shareholder relations costs incurred for the benefit of the corporation, but not attributable to the operations of our insurance segments. Investee earnings represent our share in Maui Jim and Prime earnings. We own 40 percent of Maui Jim, a privately held company which operates in the sunglass and optical goods industries, and 20 percent of Prime, a privately-held excess and surplus lines insurance company which specializes in hard-to-place risks. Our investment in Maui Jim, which is carried at the holding company, is unrelated to our core insurance operations.
The following table summarizes our segment data based on the internal structure and reporting of information as it is used by management. The net earnings of each segment are before taxes and include revenues (if applicable), direct product or segment costs (such as commissions and claims costs), as well as allocated support costs from various support departments. While
On February 5, 2014, we invested $5.3 million for a 20 percent equity ownership interest in Prime, an Illinois domiciled insurance carrier based in Salt Lake City, Utah. Prime is a privately-held excess and surplus lines insurance company that distributes its products through a network of wholesale brokers and specializes in hard-to-place risks. The investment in Prime is reflected on our balance sheet as an investment in unconsolidated investee. 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 $0.3 million during 2014. Additionally, we entered into a 25 percent quota share reinsurance treaty with Prime, effective January 1, 2014, which contributed $10.2 million of gross premiums written and $5.3 million of net premiums earned during the year.
On November 2, 2012, we acquired Rockbridge, a Houston-based managing general agency. Rockbridge specializes in medical professional liability insurance in the excess and surplus markets. Coverage is offered to individual physicians and physician groups in all 50 states through a network of retail and wholesale brokers. Total consideration for the acquisition was $16.7 million, which included $15.5 million of cash paid at acquisition, and $1.2 million associated with the present value of a contingent earn-out agreement. The earn-out is subject to the achievement of certain loss ratio targets and may be adjusted, either upward or downward, in future periods based on actual performance achieved. As of December 31, 2014, the recorded value of the contingent earn-out agreement was $1.0 million. Rockbridge contributed $15.1 million and $16.7 million of gross premiums written during 2014 and 2013, respectively, and $15.9 million and $8.6 million of net premiums earned over the same periods.