The following is selected financial data of RLI Corp. and Subsidiaries for the five years ended December 31, 2016.
In 2016, RLI Corp. declared and paid a special cash dividend of $2.00 per share, which totaled $87.9 million. Special dividends were also declared and paid in each of the previous four years, totaling $87.1 million, $129.3 million, $64.5 million, and $106.3 million for 2015, 2014, 2013 and 2012, respectively. The special dividends produced corresponding decreases to book value per share and our stock price.
The GAAP and statutory combined ratios are impacted by favorable development on prior accident years’ loss reserves. For further discussion, see note 6 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.
Operating cash flow for 2012 reflects the return of a $50.0 million cash deposit that we received from a commercial surety customer in lieu of credit in 2011.
A more detailed discussion of the impact of these acquisitions and disposals is provided in note 13 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.
The combined ratio, which is derived from components of underwriting income, is a common industry performance measure of profitability for underwriting operations and is calculated in two components. First, the loss ratio is losses and settlement expenses divided by net premiums earned. The second component, the expense ratio, reflects the sum of policy acquisition costs and insurance operating expenses divided by net premiums earned. All items included in these components of the combined ratio are presented in our GAAP consolidated financial statements. The sum of the loss and expense ratios is the
reviewed frequently to consider actual losses reported and appropriate changes to our estimates are made to reflect the new information.
The historical and prospective loss and ALAE estimates, along with the risks listed, are the basis for determining our initial and subsequent carried reserves. Adjustments in the initial loss ratio by product and segment are made where necessary and reflect updated assumptions regarding loss experience, loss trends, price changes and prevailing risk factors. The LRC approves all final decisions regarding changes in the initial loss and ALAE ratios.
The process of estimating ultimate payment for claims and claim expenses begins with the collection and analysis of current and historical claim data. Data on individual reported claims, including paid amounts and individual claim adjuster estimates, are grouped by common characteristics. There is judgment involved in this grouping. Considerations when grouping data include the volume of the data available, the credibility of the data available, the homogeneity of the risks in each cohort 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 medical professional liability, as well as for executive products and professional services, we utilize external data extensively.
One reason for the variation is the above-average policyholder turnover and changes in the underlying mix of exposures typical of an excess and surplus lines business. This constant change can cause estimates based on prior experience to be less reliable than estimates for more stable, admitted books of business. Also, as a niche market insurer, there is little industry-level
information for direct comparisons of current and prior experience and other reserving parameters. These unknowns create greater-than-average variation in the actuarial central estimates.
We classify our investments in debt and equity securities into one of three categories. Available-for-sale securities are carried at fair value with unrealized gains/losses recorded as a component of comprehensive earnings and shareholders’ equity, net of deferred income taxes. We do not hold any debt securities classified as trading and we sold our remaining debt securities classified as held-to-maturity during 2014.
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,
Ceded unearned premiums and reinsurance balances recoverable on paid and unpaid losses and settlement expenses are reported separately as assets, rather than being netted with the related liabilities, since reinsurance does not relieve us of our liability to policyholders. Such balances are subject to the credit risk associated with the individual reinsurer. Additionally, the same uncertainties associated with estimating unpaid losses and settlement expenses impact the estimates for the ceded portion of such liabilities. We continually monitor the financial condition of our reinsurers. As part of our monitoring efforts, we review their annual financial statements, Securities and Exchange Commission (SEC) filings for those reinsurers that are
publicly traded, A.M. Best and S&P rating developments and insurance industry developments that may impact the financial condition of our reinsurers. In addition, we subject our reinsurance recoverables to detailed recoverability tests, including one based on average default by S&P rating. Based upon our review and testing, 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.
Periodically, management reviews our deferred tax positions to determine if it is more likely than not that the assets will be realized. These reviews include, among other things, the nature and amount of the taxable income and expense items, the expected timing of when assets will be used or liabilities will be required to be reported, as well as the reliability of historical profitability of businesses expected to provide future earnings. Furthermore, management considers tax-planning strategies it can use to increase the likelihood that the tax assets will be realized. After conducting the periodic review, if management determines that the realization of the tax asset does not meet the more likely than not criteria, an offsetting valuation allowance is recorded, thereby reducing net earnings and the deferred tax asset in that period. In addition, management must make estimates of the tax rates expected to apply in the periods in which future taxable items are realized. Such estimates include determinations and judgments as to the expected manner in which certain temporary differences, including deferred amounts related to our equity method investment, will be recovered. These estimates enter into the determination of the applicable tax rates and are subject to change based on the circumstances.
Consolidated revenue advanced 3 percent in 2016, after posting a 3 percent increase in 2015 and a 10 percent increase in 2014. The overall growth in revenues was driven by higher net premiums earned from insurance operations, which have improved in each of the past three years. Net premiums earned were up 4 percent in 2016, after advancing 2 percent in 2015 and 9 percent in 2014. As disclosed in prior SEC filings, premium results for 2016 and 2015 were impacted by our exit from crop and facultative reinsurance. Reduced reinsurance costs have also contributed to the improved results in each period, with the more significant impact to net earned premiums occurring in the two prior years. We have a diverse portfolio of products to meet the specialized needs of our customers, spread across our casualty, property and surety segments. The bulk of the growth achieved over the past three years was attributable to casualty and surety, as our property segment continued to experience challenging market conditions. From an investment income perspective, revenues decreased by 3 percent in 2016, consistent with the prior year. The decrease was primarily due to the lower average yield environment seen during 2016 compared to the previous year. Additionally, credit spreads declined across most fixed income sectors during the year, putting further pressure on reinvestment rates. 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 2016 also reflect a $7.2 million non-cash goodwill impairment charge, while 2015 reflects a $6.7 million gain related to the sale of RIC.
The insurance industry remained highly competitive across all of our segments in 2016, as many of the key dynamics which impacted the marketplace in recent years were unchanged. Excess capital continues to exist in the industry and consecutive years of profitable underwriting for most lines has caused competitive pressures to remain high. The industry benefited from favorable loss reserve releases again in 2016, albeit at lower levels than experienced in recent years. From a catastrophe standpoint, insured losses were higher than those seen in the past few years, yet remained below longer-term industry norms. These factors have continued to put downward pressure on rates for the industry as a whole.
Other products contributing to growth included umbrella and our professional services group. Umbrella’s increase came from commercial accounts, where both exposure growth and improved pricing drove the change after slight declines in pricing were experienced in 2015. Our professional services group results reflected improved pricing for the product group overall, especially for our architects and engineers line. Pricing has been favorable for this business in each of the past three years, and contributed to continued growth in gross premiums during this timeframe. Gross premium growth in 2015 and 2014 was higher, up 8 percent and 24 percent, respectively, as product expansion efforts had a greater impact during those years. Growth from each of these products served to offset a modest decline from executive products, which declined 2 percent in 2016. Gross
Gross premiums written in the property segment decreased by 11 percent in 2016 after decreasing 21 percent in 2015 and 4 percent in 2014. As reported in prior SEC filings, the crop reinsurance program expired at the end of the 2015 crop year due to the acquisition of the cedant and we exited our facultative reinsurance business in late 2015. The market for our E&S property coverages continued to be challenging in 2016, as we experienced low double digit rate decreases for wind and earthquake exposed catastrophe coverages for the third consecutive year. Excess capital and an absence of significant catastrophe losses in recent years continue to adversely impact pricing. In total, commercial property premiums were down 9 percent in 2016, following declines of 9 percent and 3 percent in 2015 and 2014, respectively. Marine also declined during the year, down 2 percent in 2016, following modest top line growth in 2015. Results for each of those periods reflect slightly improved pricing for marine coverages.
Gross premiums written from our surety segment advanced for the third straight year, up 2 percent in 2016. This follows growth of 6 percent posted in 2015 and 4 percent in 2014. The majority of products in the segment have contributed to this growth. Miscellaneous surety posted steady increases over the past three years, with both new and existing programs driving the growth in the current year. Contract surety grew to $30.5 million in gross premiums written, up 5 percent in 2016 due largely to growth from bonds targeted to smaller contractors. Contract surety declined slightly in the prior year, following a period of modest top line growth in 2014. For energy surety, business continues to be impacted by falling energy prices and heightened competition in its market. Despite these pressures, gross premium production for 2016 improved slightly. Energy surety contributed top line performance in 2015, as we capitalized on opportunities provided by industry consolidation and were able to post an 8 percent increase in gross premiums written. Results from each of these product lines served to offset a decrease from commercial surety, which declined in the current year after growing in each of the prior two years. The decline in 2016 resulted from efforts to selectively trim the portfolio in favor of retaining higher quality, lower risk accounts.
Underwriting income was $12.8 million in 2016, which translates into a combined ratio of 91.6. Catastrophe losses, while relatively small in each of the past three years, were higher in 2016. Losses related to Hurricane Matthew and seasonal wind storm losses combined to impact the segment by $15.8 million in 2016. Partially offsetting these losses, favorable development on prior accident years’ reserves was experienced for most property lines during the year, mainly from marine and other property reinsurance. Favorable development improved underwriting results for the segment during 2016 by $4.8 million. Results for the year also reflect profitable underwriting performance from a current accident year standpoint, driven by our commercial property lines.
Results for 2015 included $11.8 million in losses from winter and spring storms, and favorable development on prior accident years’ reserves, primarily from marine, which served to partially 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 also reflected in 2015 results, and included continued improvement from marine. The crop exit, while meaningful from a premium standpoint, did not have a significant impact on 2015 underwriting profit. 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 three-point improvement in the current accident year loss ratio.
The segment’s loss ratio was 46.9 in 2016 compared to 40.9 in 2015 and 45.3 in 2014. The higher result for 2016 related primarily to the lower benefit from favorable development on prior years’ reserves, coupled with higher catastrophe losses during the year. Results for 2015 reflected the improved current accident year loss ratio performance resulting from marine re-underwriting efforts. The expense ratio for the property segment was 44.7 in 2016 compared to 42.2 in 2015 and 38.1 in 2014. The increased expense ratio for 2016 was driven largely by the overall decline in earned premium and the relative fixed nature of certain expenses. Shifts in product mix within the segment over the past three years, specifically related to crop, which carried a very low acquisition expense rate, also contributed to the higher expense ratio during this timeframe.
The segment’s loss ratio was 15.2 in 2016, compared to 9.2 in 2015 and 7.3 in 2014. While all years benefited from favorable development in prior years’ reserves, the amount of favorable development has declined in each of the past two years. In 2016, results included $4.8 million of favorable development in prior years’ reserves, compared to $7.9 million and $10.9 million in 2015 and 2014, respectively. This decrease was the primary driver of the slightly higher loss ratio over these periods. The above mentioned losses in 2016 on energy and contract surety also contributed to the loss ratio increase in 2016. The expense ratio for the segment was 62.6 in 2016, compared to 62.3 in 2015 and 66.5 in 2014. While continued premium growth has allowed for improved leveraging of our expense base in recent years, the expense ratio increased slightly in 2016 due to shifts in mix towards products with higher acquisition expense rates. In 2014, the expense ratio for the segment was higher, due in large part to reinstatement premium related to ceded loss activity on prior accident years.
Despite bond prices falling during the final quarter of the year, the fixed income portfolio increased by $67.1 million during the year as the majority of operating cash flows were used for fixed income purchases. During 2016, the portfolio experienced net realized gains of $4.2 million and ended 2016 with net unrealized gains of $9.0 million. The tax-adjusted total return on a mark-to-market basis was 3.2 percent.
During 2016, our equity portfolio decreased by $6.2 million to $369.2 million. The equity portfolio experienced net realized gains of $38.7 million during the year and ended 2016 with net unrealized gains of $181.6 million. The total return for the year on the equity portfolio was 16.3 percent.
Our investment results for the last five years are shown in the following table:
We realized a total of $34.6 million in net gains in 2016. Included in this number is $38.7 million in net realized gains in the equity portfolio, $4.2 million in net realized gains in the fixed income portfolio and $8.3 million in other net realized losses, $7.2 million of which related to a non-cash impairment charge on goodwill. In 2015, we realized $39.8 million in net gains. Included in this number is $22.1 million in net realized gains in the equity portfolio, $10.8 million in net realized gains in the fixed income portfolio and $6.9 million in other net realized gains related to the sale of RIC. In 2014, we realized $32.2 million in net gains. We realized $29.5 million in net realized gains in the equity portfolio, $4.0 million in net realized gains in the fixed income portfolio and $1.3 million in other net realized losses.
The fixed income portfolio contained 377 positions at an unrealized loss as of December 31, 2016. Of these 377 securities, 44 have been in an unrealized loss position for 12 consecutive months or longer and represent $3.3 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.
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, 2016.
We maintain a diversified investment portfolio with an 80 percent fixed income and 20 percent equity target. We continually monitor economic conditions, our capital position and the insurance market to determine our tactical equity allocation. As of December 31, 2016, the portfolio had a fair value of $2.0 billion, an increase of $70.3 million from the end of 2015.
As of December 31, 2016, our fixed income portfolio had the following rating distributions:
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) which include planned amortization classes (PACs) and sequential pay structures. 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. PACs are securities whose cash flows are designed to remain constant in a variety of mortgage prepayment environments. Sequential pay structures are a type of CMO where each risk tranche is paid off in a particular order. Our MBS portfolio does not include interest-only securities or principal-only securities. As of December 31, 2016, all of the securities in our MBS portfolio were rated AAA 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).
As of December 31, 2016, our corporate debt portfolio totaled $508.4 million (32 percent) of the fixed income portfolio compared to $517.1 million (34 percent) as of December 31, 2015. 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 512 issues.
The following table illustrates our corporate debt exposure to the financial and non-financial sectors as of December 31, 2016, including fair value, cost basis and unrealized gains and losses:
We incurred $7.4 million of interest expense on outstanding debt during 2016, 2015 and 2014. 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. At December 31, 2016, 2015 and 2014, 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.
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 2016, 2015 and 2014, we exceeded the required return, resulting in the accrual of executive bonuses. Excluding this variable component tied to performance, other general corporate expenses were relatively flat in 2016 compared to 2015.
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 2016, we recorded $9.7 million in earnings from this investment compared to $9.9 million in 2015 and $12.0 million in 2014. Sunglass sales were up 2 percent in 2016, after decreasing 2 percent in 2015 and increasing 14 percent in 2014. Unfavorable foreign exchange results and increased marketing and advertising expense led to Maui Jim’s decrease in earnings for 2016 compared to 2015.
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 2016 and 2014, we received a $9.9 million and $6.6 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 $2.8 million and $1.8 million tax benefit for 2016 and 2014, 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 1.8 percent and 1.0 percent reduction to the 2016 and 2014 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 $851.1 million at December 31, 2016, from $805.9 million as of December 31, 2015. This reflects incurred losses of $349.8 million in 2016 offset by paid losses of $304.6 million compared to incurred losses of $299.0 million offset by $279.0 million paid in 2015. For more information on the changes in loss and LAE reserves by segment, see note 6 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.
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, 2016.
At December 31, 2016, we had cash, short-term investments and other investments maturing within one year of approximately $43.4 million and an additional $335.1 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, 2016, no amounts were outstanding on the revolving line of credit.
Additionally, two of our insurance companies, RLI Ins. and Mt. Hawley, are members of the Federal Home Loan Bank of Chicago (FHLBC). Membership in the Federal Home Loan Bank system provides both companies access to an additional source of liquidity via a secured lending facility. Based on qualifying assets at year end, aggregate borrowing capacity is approximately $25 million. 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, 2016, no amounts were outstanding with the FHLBC.
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 21 consecutive years.
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, 2016, our holding company had $823.6 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 $45.9 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 ordinary 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
Our 163rd consecutive dividend payment was declared in February 2017 and will be paid on March 20, 2017, in the amount of $0.20 per share. Since the inception of cash dividends in 1976, we have increased our annual dividend every year.
Margins in the property-casualty insurance industry remain under pressure. While the industry has produced an underwriting profit in recent years, results are projected to be near breakeven for 2016 and may deteriorate further in 2017. The combination of several years of underwriting profit, lack of significant catastrophe losses, excess capital and increased competition may result in many insurers reducing rates and loosening terms, which will reduce underwriting margins. Loss trends have increased in some lines, most notably in commercial auto, resulting in several companies recording adverse loss development. In addition, more recent trends in the litigation environment, including increased settlement values, higher bodily injury costs and more aggressive plaintiff’s attorneys are also driving up loss costs. Although higher interest rates and increased investment income may distract some insurers from maintaining underwriting discipline, higher inflation may further impact loss trends. The impact that the recent political transition in the U.S. will have on economic growth, on our business or that of our insureds is unknown. While the detailed changes to regulation, the litigation environment and corporate tax policies are yet to be determined, we are optimistic that new policies may offer more opportunities for our business. For example, if less regulation and more economic growth are achieved, the insured base will expand and provide more opportunities for rational participants in the insurance market.
We believe disciplined underwriting will continue to be a differentiator through all market cycles. We define underwriting as the thorough evaluation of risk by underwriters who are supported by claim and analytical professionals. These individuals work as a team to provide coverage within our risk appetite for the right premium. We will continue to invest in both organic and new growth opportunities and will expand where it makes sense given the current market environment. In 2017, that will likely translate into a larger casualty segment, some incremental growth for surety and a smaller property segment. We would expect much of the casualty increase to come from more recent product initiatives.
This past year was acutely influenced by several major shock events that drove periodic bouts of volatility. Weak data out of China and continued declines in crude oil resulted in a risk-off tone to start the year. Central bankers responded accordingly with further accommodation in Europe and a U.S. Federal Reserve, which kept interest rates steady. As a result, U.S. interest rates fell sharply through the first half of the year and reached their low point around the UK’s vote to leave the European Union. Unexpected outcomes continued through the end of the year as the outcome for U.S. elections moved both the legislative and executive branches in favor of the Republican Party. Markets have since responded with optimism on pro-growth expectations from the possibility that lower tax rates, less regulation and fiscal stimulus will accompany a new administration. Despite equities moving higher in the wake of the election, macroeconomic data was already on an upswing in the second half of the year: job growth continued at nearly 200,000 new payrolls per month, oil prices were trending up, GDP was markedly higher and wages and inflation were more robust. Recently we have also seen an upswing in consumer behavior and consumption is showing some recovery. This backdrop gave the Federal Reserve enough reason to raise the Fed Funds rate by 25 basis points in December for the first and only time in 2016, but also to set the stage for more frequent tightening in 2017. Treasury rates have responded to the current environment by moving sharply higher. The bellwether 10-year Treasury yield ended 2016 at 2.45 percent, up 0.18 percent from year end 2015. While we believe the U.S. will continue to lead world growth over the next twelve months, the expectations of the new administration are extremely high, and we will be approaching 2017 with some cautious optimism. Tax reform will likely be a heavy influence on our strategies related to municipal bonds and tax credit financings.
Our portfolio exhibited strong total return results in 2016 as tighter credit spreads in fixed income insulated the portfolio from some of the rise in Treasury yields and equities finished the year with double digit returns. We were fairly active in seeking out relative value in our bond portfolio as our municipal allocation moved down during the first quarter and was back to a neutral position by year end. Further, active equity positioning in utilities, financials and health care resulted in outperformance relative to the S&P 500 Index. Fiscal policy, monetary policy and fundamental expectations will continue to influence markets in 2017; however, our strategy will remain focused on the support of insurance operations through current income and contributing to long-term growth in book value via surplus assigned strategies like equities. We are pleased to be putting marginal dollars to work in the portfolio at higher interest rates than we saw in mid-2016 and expect that to have a positive impact on our investment income profile going forward.
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. The Company has evaluated subsequent events through the date these consolidated financial statements were issued. There were no subsequent events requiring adjustment to the financial statements or disclosure.
This ASU was issued to simplify the presentation of debt issuance costs by requiring them to be presented in the balance sheet as a direct deduction from the carrying amount of the related recognized debt liability, consistent with debt discounts. We adopted ASU 2015-03 on January 1, 2016 on a retrospective basis. Our adoption of the new standard resulted in a $1.1 million decrease to long-term debt and other assets at December 31, 2015.
A reconciliation of incurred and paid claims development information to the aggregate carrying amount of the liability for unpaid claims and claim adjustment expenses, with separate disclosure of reinsurance recoverable on unpaid claims for each period presented in the statement of financial position;
We adopted ASU 2015-09 during 2016 and present the required disclosures of this accounting standards updated in Note 6 to these consolidated financial statements.
Requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments;
This ASU is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is only permitted for provision (e) above. Upon adoption, a cumulative-effect adjustment to the balance sheet will be made as of the beginning of the fiscal year of adoption. The primary impact this guidance will have on our financial statements relates to recognizing changes in the fair value of equity securities through the income statement. The impact to our income statement will vary depending upon the level of volatility in the performance of the securities held in our equity portfolio and the overall market.
ASU 2016-02 was issued to improve the financial reporting of leasing transactions. Under current guidance for lessees, leases are only included on the balance sheet if certain criteria, classifying the agreement as a capital lease, are met. This update will require the recognition of a right-of-use asset and a corresponding lease liability, discounted to the present value, for all leases that extend beyond 12 months. For operating leases, the asset and liability will be expensed over the lease term on a straight-line basis, with all cash flows included in the operating section of the statement of cash flows. For finance leases, interest on the lease liability will be recognized separately from the amortization of the right-of-use asset in the statement of comprehensive income and the repayment of the principal portion of the lease liability will be classified as a financing activity while the interest component will be included in the operating section of the statement of cash flows.
ASU 2016-09 was issued to simplify the accounting for share-based payment awards. The guidance requires that, prospectively, all tax effects related to share-based payments be made through the income statement at the time of settlement as opposed to excess tax benefits being recognized in additional paid-in-capital under the current guidance. The ASU also removes the requirement to delay recognition of a tax benefit until it reduces current taxes payable. This change is required to be applied on a modified retrospective basis, with a cumulative-effect adjustment to opening retained earnings. Additionally, all tax related cash flows resulting from share-based payments are to be reported as operating activities on the statement of cash flows, a change from the current requirement to present tax benefits as an inflow from financing activities and an outflow from operating activities. Finally, entities will be allowed to withhold an amount up to the employees’ maximum individual tax rate
This ASU is effective for annual and interim reporting periods beginning after December 15, 2016. Early adoption is permitted with any adjustments reflected as of the beginning of the fiscal year of adoption. The primary impact this guidance will have on our financial statements relates to the provision concerning the recognition of tax effects through the income statement. The impact to our income statement will vary depending upon the level of intrinsic value associated with option exercises in a particular period.
ASU 2016-15 was issued to reduce the diversity in practice of how certain cash receipts and payments, for which current guidance is silent, are classified in the statement of cash flows. The update addresses eight specific issues, including contingent consideration payments made after a business combination, distributions received from equity method investees and the classification of cash receipts and payments that have aspects of more than one class of cash flows. This ASU is effective for annual and interim reporting periods beginning after December 15, 2017. Early adoption is permitted. Upon adoption, the update will be applied using the retrospective transition method. We do not expect a material impact on our statement of cash flows.
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 the key factors for determining if a security is other-than-temporarily impaired:
We continuously monitor the financial condition of our reinsurers. As part of our monitoring efforts, we review their annual financial statements, quarterly disclosures and Securities and Exchange Commission (SEC) filings for those reinsurers that are publicly traded. We also review insurance industry developments that may impact the financial condition of our reinsurers. We analyze the credit risk associated with our reinsurance balances recoverable by monitoring the A.M. Best and Standard & Poor’s (S&P) ratings of our reinsurers. In addition, we subject our reinsurance recoverables to detailed recoverable tests, including one based on average default by S&P rating. Based upon our review and testing, 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.
We maintain a 40 percent interest in the equity and 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 level as it is not core to our insurance operations. Our investment in Maui Jim was $62.6 million in 2016 and $62.7 million in 2015. In 2016, we recorded $9.7 million in investee earnings for Maui Jim, compared to $9.9 million in 2015 and $12.0 million in 2014. Maui Jim recorded net income of $26.9 million in 2016, $23.7 million in 2015 and $30.7 million in 2014. Additional summarized financial information for Maui Jim for 2016 and 2015 is outlined in the following table:
Approximately $51.9 million of undistributed earnings from Maui Jim are included in our retained earnings as of December 31, 2016. In 2016 and 2014, we received dividends of $9.9 million and $6.6 million, respectively, from Maui Jim. No dividends were received in 2015.
We perform annual impairment reviews of our investments in our unconsolidated investees, which take into consideration current valuation and operating results. Based upon the most recent reviews, the assets were not impaired.
Annual impairment testing was performed on each of these goodwill and indefinite-lived intangible assets during 2016. Based upon these reviews, our energy surety goodwill, miscellaneous and contract surety goodwill, small commercial goodwill and state insurance license indefinite-lived intangible asset were not impaired. In addition, as of December 31, 2016, there were no triggering events on the above mentioned goodwill and intangible assets that would suggest an updated review was necessary. However, as disclosed in previous SEC filings, premium declines have decreased the fair value of our medical professional liability business in recent periods. Continuing rate and volume declines coupled with recent adverse loss experience resulted in a triggering event during the second quarter of 2016. A fair value was determined by using a weighted average of a market approach valuation and income approach (or discounted cash flow method) valuation. It was determined that the carrying cost of our medical professional liability goodwill exceeded the fair value. As a result, we recorded a $7.2 million non-cash impairment charge included as a net realized loss in the consolidated statement of earnings during the second quarter of 2016. The annual impairment testing indicated no further impairment and no additional triggering events occurred subsequent to the second quarter of 2016. As an additional consequence of the premium declines and adverse loss experience, the remaining portion of the contingent earn-out agreement associated with our acquisition of this medical professional liability business was eliminated, resulting in a $1.5 million reduction to expenses for 2016.
In the fourth quarter of 2014, a triggering event occurred when a fair value amount for state insurance licenses was obtained from a merger and acquisition broker with expertise in providing valuations for fully-licensed P&C shell companies. The carrying cost of CBIC’s licenses exceeded the fair value and resulted in a $1.3 million impairment included as a net realized loss in the 2014 consolidated statement of earnings.
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 for 2016, 2015 and 2014. We anticipate we will recognize amortization expense of $0.8 million in 2017 and 2018 and $0.7 million in 2019, 2020 and 2021.
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 these items.
The sale or other-than-temporary impairment of an available-for-sale security results in amounts being reclassified from accumulated other comprehensive earnings to current period net earnings. The effects of reclassifications out of accumulated other comprehensive earnings by the respective line items of net earnings are presented in the following table.
As a part of management’s process to determine fair value, we utilize widely recognized, third-party pricing sources to determine our fair values. We have obtained an understanding of the third-party pricing sources’ valuation methodologies and inputs. The following is a description of the valuation techniques used for financial assets that are measured at fair value, including the general classification of such assets pursuant to the fair value hierarchy.
Common Stock: For common stock securities, we receive prices from a nationally recognized pricing service. All of our common stock holdings are deemed Level 1 as exchange traded equities have readily observable price levels (fair value based on quoted market prices). As such, we have determined that the fair values of our Level 1 securities provided by our pricing service are reasonable.
Our insurance coverages include exposure to catastrophic events. We monitor all catastrophe exposures by quantifying our exposed policy limits in each region and by using computer-assisted modeling techniques. Additionally, we limit our risk to such catastrophes through restraining the total policy limits written in each region and by purchasing reinsurance. Our major catastrophe exposure is to losses caused by earthquakes, primarily on the West Coast. In 2016, for this coverage, we had reinsurance protection of $300 million in excess of $25 million first-dollar retention for earthquakes in California and $325 million in excess of a $25 million first-dollar retention for earthquakes outside of California. These amounts are subject to certain co-participations by us on losses in excess of the $25 million retentions. Our second largest catastrophe exposure is to losses caused by wind storms to commercial properties throughout the Gulf and East Coasts, as well as to homes we insure in Hawaii. In 2016, these coverages were supported by $225 million in excess of a $25 million first-dollar retention in traditional catastrophe reinsurance protection, subject to certain co-participations by us in the excess layers. In addition, we have incidental exposure to international catastrophic events.
Our catastrophe reinsurance treaty renewed on January 1, 2017. We purchased the same limits over the same first-dollar retention amounts outlined above, subject to certain retentions by us in the excess layers. We actively manage our catastrophe program to keep our net retention in line with risk tolerances and to optimize the risk/return trade off.
We made loss and settlement expense payments on environmental liability claims and have loss and settlement expense reserves for others. We include this historical environmental loss experience with the remaining loss experience in the
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 guaranty
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, 2016, 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.
As noted in the previous tables, we did not have any assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as of December 31, 2016 and 2015. Additionally, there were no securities transferred in or out of levels 1 or 2 during 2016 or 2015.
Our equity portfolio consists of common stocks and exchange traded funds (ETF). Gross unrealized losses in the equity portfolio decreased $0.2 million to $1.3 million in 2016. 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.
As required by law, certain fixed maturity investments amounting to $31.8 million at December 31, 2016, were on deposit with either regulatory authorities or banks.
The assumed business is made up of short-tail property, casualty, catastrophe and multi-peril crop and hail reinsurance. The majority of this assumed reinsurance is proportional and a large portion of the assumed incurred losses can be attributed to crop-related reinsurance and specialty property treaties. As noted in previous filings, our portion of assumed crop reinsurance was reduced for 2015 and ended with the 2015 crop year due to the acquisition of the cedant. Additionally, we discontinued offering facultative reinsurance at the end of the third quarter of 2015 as a result of challenging market conditions and have begun curtailing treaty reinsurance offerings in our property segment at the end of 2016.
The following table displays net reinsurance balances recoverable, after consideration of collateral, from our top 10 reinsurers as of December 31, 2016. These reinsurers all have financial strength ratings of “A” or better by A.M. Best and Standard and Poor’s ratings services. Also shown are the amounts of written premium ceded to these reinsurers during the calendar year 2016.
*All other reinsurance balances recoverable, when considered by individual reinsurer, are less than 2 percent of shareholders’ equity.
The following table is a reconciliation of our unpaid losses and settlement expenses (LAE) for the years 2016, 2015 and 2014.
Initial carried IBNR reserves are determined through a reserve estimation process. For most casualty and surety products, this process involves the use of an initial loss and allocated loss adjustment expense (ALAE) ratio that is applied to the earned premium for a given period. Payments and case reserves are subtracted from this initial estimate of ultimate loss and ALAE to determine a carried IBNR reserve. For most property products, the IBNR reserves are determined by IBNR percentages applied to premium earned. The percentages are determined based on historical reporting patterns and are updated periodically. No deductions for paid or case reserves are made. Shortly after natural or man-made catastrophes, we review insured locations exposed to the event and model losses 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. Adjustments to the initial loss ratio by product and segment are made where necessary and reflect updated assumptions regarding loss experience, loss trends, price changes and prevailing risk factors.
The following table summarizes our prior accident years’ loss reserve development by segment for 2016, 2015 and 2014:
The surety segment experienced $7.9 million of favorable development, inclusive of ULAE. 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 experienced adverse development totaling $0.3 million.
The marine product was the primary driver of the favorable development in the property segment. Marine contributed $5.8 million of the $1.1 million total favorable property development, inclusive of ULAE. Accident years 2012 and 2013 contributed to the marine products’ favorable development. Assumed property and crop were unfavorable by $4.0 million and $1.2 million, respectively. 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.
We are subject to environmental site cleanup, asbestos removal and mass tort claims and exposures through our commercial umbrella, general liability and discontinued assumed casualty reinsurance lines of business. The majority of the exposure is in the excess layers of our commercial umbrella and assumed reinsurance books of business.
decades ago. Some are for assumed reinsurance, some are for excess liability business and some followed from the acquisition of Underwriters Indemnity Company in 1999.
Calendar year 2016 included an increase in inception-to-date paid losses, offsetting a decrease in unpaid losses. The activity was related to a payment on a previously reserved claim. In aggregate, inception-to-date incurred losses decreased on a gross basis, but increased on a net basis.
We have recorded our deferred tax assets and liabilities using the statutory federal tax rate of 35 percent. We believe it is more likely than not that all deferred tax assets will be recovered, given the carry back availability as well as the results of future operations, which will generate sufficient taxable income to realize the deferred tax asset. In addition, we believe when these deferred items reverse in future years, our taxable income will be taxed at an effective rate of 35 percent.
Our 401(k) plan allows voluntary contributions by employees and permits ESOP diversification transfers for employees meeting certain age and service requirements. We provide a basic 401(k) contribution of 3 percent of eligible compensation. Participants are 100 percent vested in both voluntary and basic contributions. Additionally, an annual discretionary profit-sharing contribution may be made to the ESOP and 401(k), subject to the achievement of certain overall financial goals and board approval. Profit-sharing contributions vest after three years of plan service.
During 2016, the ESOP purchased 112,608 shares of RLI stock on the open market at an average price of $64.20 ($7.2 million) relating to the contribution for plan year 2015. Shares held by the ESOP as of December 31, 2016, totaled 3,360,325 and are treated as outstanding in computing our earnings per share. During 2015, the ESOP purchased 178,492 shares of RLI stock on the open market at an average price of $49.98 ($8.9 million) relating to the contribution for plan year 2014. During 2014, the ESOP purchased 178,987 shares of RLI stock on the open market at an average price of $44.43 ($7.9 million) relating to the contribution for plan year 2013. The above mentioned ESOP purchases relate only to our annual contributions to the plan and do not include amounts or shares resulting from the reinvestment of dividends.
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 $ 19.2 million, $20.4 million and $23.1 million for 2016, 2015 and 2014, respectively.
In 2016, the trusts purchased 6,702 shares of our common stock on the open market at an average price of $61.61 ($0.4 million). In 2015, the trusts purchased 9,348 shares of our common stock on the open market at an average price of $53.15 ($0.5 million). In 2014, the trusts purchased 9,920 shares of our common stock on the open market at an average price of $44.40 ($0.4 million). At December 31, 2016, the trusts’ assets were valued at $39.9 million.
On November 10, 2016, the board of directors declared a $2.00 per share special cash dividend to be paid on December 23, 2016, to shareholders of record at the close of business on November 30, 2016. Similarly, on November 12, 2015, the board of directors declared a $2.00 per share special cash dividend to be paid on December 22, 2015, to shareholders of record at the close of business on November 30, 2015. On November 13, 2014, the board of directors declared a $3.00 per share special cash dividend to be paid on December 22, 2014, to shareholders of record at the close of business on November 28, 2014. To preserve the intrinsic value of the options, the board also approved, pursuant to the terms of our various stock option plans, a proportional adjustment to the exercise price (equivalent to the special dividend) for all outstanding non-qualified options in relation to the 2015 and 2014 special dividends. These adjustments did not result in any incremental compensation expense as the aggregate fair value, aggregate intrinsic value and the ratio of the exercise price to the market price were approximately equal immediately before and after the adjustments. Additionally, the board approved a proportional adjustment to the exercise price and the number of shares covered by each award for all outstanding ISOs in 2014. Most (99 percent) of the outstanding options at the time of the adjustments were non-qualified and no incremental compensation expense was recognized as a result of the adjustments.
*An adjustment was made to the exercise price and number of ISOs outstanding for the special cash dividends paid during December 2014. “Special dividend” represents the incremental ISOs issued as a result of these adjustments. No adjustments were made to ISOs in 2016 or 2015 as all ISOs had been exercised before the special dividend occurred.
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. The expected volatility was calculated based on the median of the rolling volatilities for the expected life of the options. 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 risk based capital (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, 2016, 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 $127.0 million, $123.6 million and $118.4 million as of December 31, 2016, 2015 and 2014, respectively, compared to actual statutory capital and surplus of $860.0 million, $865.3 million and $849.3 million, respectively, for these same periods.
We have operating lease obligations for regional office facilities. These leases expire in various years through 2034. Expenses associated with these leases totaled $6.4 million in 2016, $6.1 million in 2015 and $5.8 million in 2014. Minimum future rental payments under non-cancellable leases are as follows:
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 and executive products 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 medical and healthcare professional liability coverage in the excess and surplus market. We also assume a limited amount of hard-to-place risks through a quota share reinsurance agreement. 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 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.
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 $9.6 million at December 31, 2016 and $8.1 million at December 31, 2015. 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 $1.1 million during 2016 compared to $1.0 million during 2015 and $0.3 million during 2014.
We have audited the accompanying consolidated balance sheets of RLI Corp. and subsidiaries as of December 31, 2016 and 2015, 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, 2016. 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, 2016, 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, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2016, 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. Also in our opinion, RLI Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).