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RLI CORP – 10-K – Management's Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
RLI Corp. is aU.S. based, specialty insurance company that underwrites select property and casualty insurance through major subsidiaries collectively known asRLI Insurance Group (Group). Our focus is on niche markets and developing unique products that are tailored to customers' needs. We hire underwriters and claim examiners with deep expertise and provide exceptional customer service and support. We maintain a highly diverse product portfolio and underwrite for profit in all market conditions. In 2022, we achieved our 27th consecutive year of underwriting profitability. Over the 27-year period, we averaged an 88.2 combined ratio. This 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. We measure the results of our insurance operations by monitoring growth and profitability across three distinct business segments: casualty, property and surety. Growth is measured in terms of gross premiums written, and profitability is analyzed through combined ratios, which are further subdivided into their respective loss and expense components.
KEY PERFORMANCE MEASURES
Following is a list of key performance measures found throughout this report with their definitions, relationships to GAAP measures and explanations of their importance to our operations.
Underwriting Income
Underwriting income or profit represents one measure of the pretax profitability of our insurance operations and is derived by subtracting losses and settlement expenses, policy acquisition costs and insurance operating expenses from net premiums earned, which are all GAAP financial measures. Each of these captions is presented in the statements of earnings but is not subtotaled. However, this information is available in total and by segment in note 12 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data. The nearest comparable GAAP measure is earnings before income taxes which, in addition to underwriting income, includes net investment income, net realized gains or losses, net unrealized gains or losses on equity securities, general corporate expenses, debt costs and our portion of earnings from unconsolidated investees. A reconciliation of net earnings to underwriting income follows:
Year ended December 31,
(in thousands) 2022 2021
Net earnings $ 583,411 $ 279,354
Income tax expense 137,267 64,967
Earnings before income taxes $ 720,678 $ 344,321
Equity in earnings of unconsolidated investees (9,853) (37,060)
General corporate expenses 12,900 13,330
Interest expense on debt 8,047 7,677
Net unrealized (gains) losses on equity securities 121,037 (65,258)
Net realized gains (588,515) (64,222)
Net investment income (86,078) (68,862)
Underwriting income $ 178,216 $ 129,926
Combined Ratio
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 combined
ratio. The difference between the combined ratio and 100 reflects the per-dollar
rate of underwriting income or loss.
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CRITICAL ACCOUNTING POLICIES
In preparing the consolidated financial statements, we are required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosures of contingent assets and liabilities as of the
date of the consolidated financial statements and the reported amounts of
revenues and expenses for the reporting period. Actual results could differ
significantly from those estimates.
The most critical accounting policies involve significant estimates and include those used in determining the liability for unpaid losses and settlement expenses, investment valuation, recoverability of reinsurance balances, deferred policy acquisition costs and deferred taxes.
LOSSES AND SETTLEMENT EXPENSES
Overview
Loss and loss adjustment expense (LAE) reserves represent our best estimate of
ultimate payments for losses and related settlement expenses from claims that
have been reported but not paid, and those losses that have been incurred but
not yet reported (IBNR) to the Company. Loss reserves do not represent an exact
calculation of liability, but instead represent our estimates, generally
utilizing individual claim estimates, actuarial expertise and estimation
techniques at a given accounting date. The loss reserve estimates are
expectations of what ultimate settlement and administration of claims will cost
upon final resolution. These estimates are based on facts and circumstances then
known to the Company, review of historical settlement patterns, estimates of
trends in claims frequency and severity, projections of loss costs, expected
interpretations of legal theories of liability and many other factors. In
establishing reserves, we also consider estimated recoveries from reinsurance as
well as salvage and subrogation.
We record two categories of loss and LAE reserves: case-specific reserves and
IBNR reserves. Within a reasonable period of time after a claim is reported, our
claim department completes an initial investigation and establishes a case
reserve. This case-specific reserve is an estimate of the ultimate amount we
will have to pay for the claim, including related legal expenses and other costs
associated with resolving and settling it. The estimate reflects all of the
current information available regarding the claim, the informed judgment of our
professional claim personnel regarding the nature and value of the specific type
of claim and our reserving practices. During the life cycle of a particular
claim, as more information becomes available, we may revise the estimate of the
ultimate value of the claim either upward or downward. We may determine that it
is appropriate to pay portions of the reserve to the claimant or related
settlement expenses before final resolution of the claim. The amount of the
individual case reserve will be adjusted accordingly and is based on the most
recent information available.
We establish IBNR reserves to estimate the amount we will have to pay for claims
that have occurred, but have not yet been reported to the Company, claims that
have been reported to the Company that may ultimately be paid out differently
than reflected in our case-specific reserves and claims that have been closed
but may reopen and require future payment.
LAE represents the cost involved in adjusting and administering losses from
policies we issued. The LAE reserves are frequently separated into two
components: allocated and unallocated. Allocated loss adjustment expense (ALAE)
reserves represent an estimate of claims settlement expenses that can be
identified with a specific claim or case. Examples of ALAE would be the hiring
of an outside adjuster to investigate a claim or an outside attorney to defend
our insured. The claim adjuster typically estimates this cost separately from
the loss component in the case reserve. Unallocated loss adjustment expense
(ULAE) reserves represent an estimate of claims settlement expenses that cannot
be identified with a specific claim. An example of ULAE would be the cost of an
internal claim examiner to manage or investigate claims.
The process of estimating loss reserves involves a high degree of judgment and
is subject to a number of variables. These variables can be affected by both
internal and external events, such as changes in claim handling procedures,
claim personnel, economic inflation, legal trends and legislative changes, among
others. The impact of many of these items on ultimate costs for loss and LAE is
difficult to estimate. Loss reserve estimations also differ significantly by
coverage due to differences in claim complexity, the volume of claims, the
policy limits written, the terms and conditions of the underlying policies, the
potential severity of individual claims, the determination of occurrence date
for a claim and reporting lags (the time between the occurrence of the
policyholder event and when it is actually reported to the insurer). Informed
judgment is applied throughout the process. We continually refine our loss
reserve estimates as historical loss experience develops and additional claims
are reported and settled. We rigorously attempt to consider all significant
facts and circumstances known at the time loss reserves are established.
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Following is a table of significant risk factors involved in estimating losses
grouped by major product line. We distinguish between loss ratio risk and
reserve estimation risk. Loss ratio risk refers to the possible dispersion of
loss ratios from year to year due to inherent volatility in the business, such
as high severity or aggregating exposures. Reserve estimation risk recognizes
the difficulty in estimating a given year's ultimate loss liability. As an
example, our property catastrophe business (included below in other property)
has significant variance in year over year results; however, its reserving
estimation risk is relatively moderate.
Expected loss Reserve
Length of Emergence ratio estimation
Product line reserve tail patterns relied upon Other risk factors variability variability
Commercial excess Long Internal Low frequency High High
High severity
Loss trend volatility
Exposure growth
Unforeseen tort potential
Personal umbrella Medium Internal Low frequency Medium Medium
High severity
Loss trend volatility
Exposure growth
Unforeseen tort potential
General liability Long Internal Exposure changes/mix Medium High
Unforeseen tort potential
Professional services Medium Internal Highly varied exposures Medium Medium
Loss trend volatility
Unforeseen tort potential
Commercial transportation Medium Internal High severity Medium Medium
Exposure change/mix
Loss trend volatility
Unforeseen tort potential
Small commercial Medium Internal Exposure change/mix Medium Medium
Unforeseen tort potential
Small volume
Executive products Long Internal & external Low frequency High High
High severity
Loss trend volatility
Economic volatility
Unforeseen tort potential
Exposure growth/mix
Heavily reinsured
Other casualty Medium Internal & external Small volume Medium Medium
Marine Medium Internal & external Exposure growth/mix High Medium
Aggregation exposure
Other property Short Internal Aggregation exposure High Medium
Low frequency
High severity
Surety Medium Internal Economic volatility Medium Medium
Unique exposures
Runoff including asbestos &
environmental Long Internal & external Loss trend volatility High High
Mass tort/latent exposure
Due to inherent uncertainty underlying loss reserve estimates, including, but
not limited to, the future settlement environment, final resolution of the
estimated liability may be different from that anticipated at the reporting
date. The amount by which current estimated losses differ from those estimated
for a period at a prior valuation date is known as development. Development is
unfavorable when the losses ultimately settle for more than the levels at which
they were reserved or subsequent estimates indicate a basis for reserve
increases on unresolved claims. Development is favorable when losses ultimately
settle for less than the amount reserved or subsequent estimates indicate a
basis for reducing loss reserves on unresolved claims. We reflect favorable or
unfavorable development of loss reserves in the results of operations in the
period the estimates are changed.
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Our IBNR reserving process involves three steps: (1) an initial IBNR generation process that is prospective in nature, (2) a loss and LAE reserve estimation process that occurs retrospectively and (3) a subsequent discussion and reconciliation between our prospective and retrospective IBNR estimates, which includes changes in our provisions for IBNR where deemed appropriate.
Initial IBNR Generation Process
Initial carried IBNR reserves are determined through a reserve generation process. The intent of this process is to establish an initial total reserve that will provide a reasonable provision for the ultimate value of all unpaid loss and ALAE liabilities. For most casualty and surety products, this process involves the use of an initial loss and ALAE ratio that is applied to the earned premium for a given period. The result is our best initial estimate of the expected amount of ultimate loss and ALAE for the period by product. Payments and case reserves are subtracted from this initial estimate of ultimate loss and ALAE to determine a carried IBNR reserve. For certain property products, we use an alternative method of determining an appropriate provision for initial IBNR. Since this segment is characterized by a shorter period of time between claim occurrence and claim settlement, the IBNR reserves are determined by IBNR percentages applied to premium earned. The percentages are determined based on expected loss ratios and loss development assumptions. The loss development assumptions are typically based on historical reporting patterns but could consider alternative sources of information. The IBNR percentages are reviewed and updated periodically. No deductions for paid or case reserves are made. This alternative method of determining initial IBNR allows incurred losses and ALAE to react more rapidly to the actual emergence, and is more appropriate for our property products where final claim resolution occurs over a shorter period of time. We do not reserve for natural or man-made catastrophes until an event has occurred. Shortly after such occurrence, we review insured locations exposed to the event and industry loss estimates of the event. We also consider our knowledge of frequency and severity from early claim reports to determine an appropriate reserve for the catastrophe. These reserves are reviewed frequently to consider actual losses reported and appropriate changes to our estimates are made to reflect the new information. 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 volatility and uncertainty has greater estimation risk. Products or coverages with higher estimation risk include, but are not limited to, the following characteristics:
? Significant changes in underlying policy terms and conditions,
? A new business or one experiencing significant growth and/or high turnover,
? Small volume or lacking internal data requiring significant utilization of
external data,
? Unique reinsurance features including those with aggregate stop-loss,
reinstatement clauses, commutation provisions or clash protection,
? Longer emergence patterns with exposures to latent unforeseen mass tort,
? Assumed reinsurance businesses where there is an extended reporting lag and/or
a heavier utilization of ceding company data and claims and product expertise,
? High severity and/or low frequency,
? Operational processes undergoing significant change and/or
? High sensitivity to significant swings in loss trends, economic change or
judicial change.
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.
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Loss and LAE Reserve Estimation Process
Estimates of the expected value of the unpaid loss and LAE are derived using standard actuarial methodologies on a quarterly basis. In addition, an emergence analysis is completed quarterly to determine if further adjustments are necessary. These estimates are then compared to the carried loss reserves to determine the appropriateness of the current reserve balance. 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 grouping 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. In some analyses, including businesses 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 liabilities arising out of directors and officers, management liability, workers' compensation and medical errors and omissions exposures, we utilize external data extensively. We also incorporate estimated losses relative to premium (loss ratios) by year into the analysis. The expected loss ratios are based on a review of historical loss performance, trends in frequency and severity and price level changes. The estimates are subject to judgment including consideration given to available internal and industry data, growth and policy turnover, changes in policy limits, changes in underlying policy provisions, changes in legal and regulatory interpretations of policy provisions and changes in reinsurance structure. For the most current year, these are equivalent with the ratios used in the initial IBNR generation process. Increased recognition is given to actual emergence as the years age.
We use historical development patterns, expected loss ratios and standard
actuarial methods to derive an estimate of the ultimate level of loss and LAE
payments necessary to settle all the claims occurring as of the end of the
evaluation period.
Our reserve processes include multiple standard actuarial methods for determining estimates of IBNR reserves. Other supplementary methodologies are incorporated as necessary. Mass tort and latent liabilities are examples of exposures for which supplementary methodologies are used. Each method produces an estimate of ultimate loss by accident year. We review all of these various estimates and assign weights to each based on the characteristics of the product being reviewed. The methodologies we have chosen to incorporate are a function of data availability and are reflective of our own book of business. From time to time, we evaluate the need to add supplementary methodologies. New methods are incorporated if it is believed they improve the estimate of our ultimate loss and LAE liability. All of the actuarial methods eventually converge to the same estimate as an accident year matures. Our core methodologies are listed below with a short description and their relative strengths and weaknesses:Paid Loss Development - Historical payment patterns for prior claims are used to estimate future payment patterns for current claims. These patterns are applied to current payments by accident year to yield an expected ultimate loss.
Strengths: The method reflects only the claim dollars that have been paid and is
not subject to case-basis reserve changes or changes in case reserve practices.
Weaknesses: External claims environment changes can impact the rate at which claims are settled and losses paid (e.g. increase in attorney involvement or change in legal precedent). Adjustments to reflect changes in payment patterns on a prospective basis are difficult to quantify. For losses that have occurred recently, payments can be minimal and thus early estimates are subject to significant instability.Incurred Loss Development - Historical case-incurred patterns (paid losses plus case reserves) for past claims are used to estimate future case-incurred amounts for current claims. These patterns are applied to current case-incurred losses by accident year to yield an expected ultimate loss. Strengths: Losses are reported more quickly than paid, therefore, the estimates stabilize sooner. The method reflects more information in the analysis than the paid loss development method.
Weaknesses: Method involves additional estimation risk if significant changes to
case reserving practices have occurred.
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Case Reserve Development - Patterns of historical development in reported losses relative to historical case reserves are determined. These patterns are applied to current case reserves by accident year and the result is combined with paid losses to yield an expected ultimate loss. Strengths: Like the incurred development method, this method benefits from using the additional information available in case reserves that is not available from paid losses only. It also can provide a more reasonable estimate than other methods when the proportion of claims still open for an accident year is unusually high or low. Weaknesses: It is subject to the risk of changes in case reserving practices or philosophy. It may provide unstable estimates when an accident year is immature and more of the IBNR is expected to come from unreported claims rather than development on reported claims and when accident years are very mature with infrequent case reserves. Expected Loss Ratio - Historical loss ratios, in combination with projections of frequency and severity trends, as well as estimates of price and exposure changes, are analyzed to produce an estimate of the expected loss ratio for each accident year. The expected loss ratio is then applied to the earned premium for each year to estimate the expected ultimate losses. The current accident year expected loss ratio is also the prospective loss and ALAE ratio used in our initial IBNR generation process. Strengths: Reflects an estimate independent of how losses are emerging on either a paid or a case reserve basis. This method is particularly useful in the absence of historical development patterns or where losses take a long time to emerge.
Weaknesses: Ignores how losses are actually emerging and thus produces the same
estimate of ultimate loss regardless of favorable/unfavorable emergence.
Paid and Incurred Bornhuetter/Ferguson (BF) - This approach blends the expected loss ratio method with either the paid or incurred loss development method. In effect, the BF methods produce weighted average indications for each accident year. As an example, if the current accident year for commercial automobile liability is estimated to be 20 percent paid, then the paid loss development method would receive a weight of 20 percent and the expected loss ratio method would receive an 80 percent weight. Over time, this method will converge with the ultimate estimated by the respective loss development method. Strengths: Reflects actual emergence that is favorable/unfavorable, but assumes remaining emergence will continue as previously expected. Does not overreact to the early emergence (or lack of emergence) where patterns are most unstable.
Weaknesses: Could potentially understate favorable or unfavorable development by
putting weight on the expected loss ratio.
In most cases, multiple estimation methods will be valid for the particular
facts and circumstances of the claim liabilities being evaluated. Each
estimation method has its own set of assumption variables and its own advantages
and disadvantages, with no single estimation method being better than the others
in all situations, and no one set of assumption variables being meaningful for
all product line components. The relative strengths and weaknesses of the
particular estimation methods, when applied to a particular group of claims, can
also change over time. Therefore, the weight given to each estimation method
will likely change by accident year and with each evaluation.
The actuarial central estimates typically follow a progression that places
significant weight on the BF methods when accident years are younger and claim
emergence is immature. As accident years mature and claims emerge over time,
increasing weight is placed on the incurred development method, the paid
development method and the case reserve development method. For product lines
with faster loss emergence, the progression to greater weight on the incurred
and paid development methods occurs more quickly.
For our long and medium-tail products, the BF methods are typically given the
most weight for more evaluation periods than the short-tailed lines. These
methods are also predominant for the first 12 months of evaluation for
short-tail lines. Beyond these time periods, our actuaries apply their
professional judgment when weighting the estimates from the various methods
deployed, but place significant reliance on the expected stage of development in
normal circumstances.
Judgment can supersede this natural progression if risk factors and assumptions
change, or if a situation occurs that amplifies a particular strength or
weakness of a methodology. Extreme projections are critically analyzed and may
be adjusted, given less credence or discarded altogether. Internal documentation
is maintained that records any substantial changes in methods or assumptions
from one loss reserve study to another.
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Our estimates of ultimate loss and LAE reserves are subject to change as additional data emerges. This could occur as a result of change in loss development patterns, a revision in expected loss ratios, the emergence of exceptional loss activity, a change in weightings between actuarial methods, the addition of new actuarial methodologies, new information that merits inclusion or the emergence of internal variables or external factors that would alter our view.
There is uncertainty in the estimates of ultimate losses. Significant risk
factors to the reserve estimate include, but are not limited to, unforeseen or
unquantifiable changes in:
? Loss payment patterns, ? Loss reporting patterns,
? Frequency and severity trends,
? Underlying policy terms and conditions,
? Business or exposure mix,
? Operational or internal processes affecting the timing of loss and LAE
transactions,
? Regulatory and legal environment and/or
? Economic environment.
Our actuaries engage in discussions with senior management, underwriters and the claim department on a regular basis to ascertain any substantial changes in operations or other assumptions that are necessary to consider in the reserving analysis. A considerable degree of judgment in the evaluation of all these factors is involved in the analysis of reserves. The human element in the application of judgment is unavoidable when faced with uncertainty. Different experts will choose different assumptions based on their individual backgrounds, professional experiences and areas of focus. Hence, the estimates selected by various qualified experts may differ significantly from each other. We consider this uncertainty by examining our historic reserve accuracy and through an internal and external review process. Given the substantial impact of the reserve estimates on our financial statements, we subject the reserving process to significant diagnostic testing and reasonability checks. In addition, there are data validity checks and balances in our front-end processes. Data anomalies are researched and explained to reach a comfort level with the data and results. Leading indicators such as actual versus expected emergence and other diagnostics are also incorporated into the reserving processes.
Determination of Our Best Estimate
Our best estimate of ultimate loss and LAE reserves are proposed by our lead reserving actuary and then discussed and approved by our Loss Reserve Committee (LRC). The LRC is made up of various members of the management team including the lead reserving actuary, chief executive officer, chief operating officer, chief financial officer, chief legal officer and other selected executives. As part of the discussion with the LRC, the analysis supporting the actuarial central estimate of the IBNR reserve by product is reviewed. The actuaries also present explanations supporting any changes to the underlying assumptions used to calculate the indicated central estimate. Our actuaries make a recommendation to management in regard to booked reserves that reflect both their analytical assessment and relevant qualitative factors, such as their view of estimation risk. After discussion of these analyses, recommendations and all relevant risk factors among the LRC, our actuaries determine whether the reserve balances require further adjustment.
As a predominantly excess and surplus lines and specialty admitted insurer
serving niche markets, we believe we are subject to above-average variation in
estimates and that this variation is not symmetrical around the actuarial
central estimate.
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
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direct comparisons of current and prior experience and other reserving
parameters. These unknowns create greater-than-average variation in the
actuarial central estimates.
Actuarial methods attempt to quantify future outcomes. However, insurance companies are subject to unique exposures that are difficult to foresee when coverage is initiated. Judicial and regulatory bodies involved in interpretation of insurance contracts have increasingly found opportunities to expand coverage beyond that which was intended or contemplated at the time the policy was issued. Many of these policies offer broad coverages (with named exclusion) and are issued on an occurrence basis. Claimants have at times sought coverage beyond the insurer's original intent, including seeking to void or limit exclusionary language. Because of the variation and the likelihood that there are unforeseen and under-quantified liabilities absent from the actuarial estimate, we believe there are circumstances where it is prudent to enhance our normal reserving process. Generally, these are circumstances where we have qualitative information and knowledge of increased risk, but those circumstances have not occurred within the history of our quantitative data. In these situations, we will rely on that qualitative information, usually from our claim team or underwriting staff, and make an enhancement to our normal process. In general, these enhancements will result in an increased overall reserve level compared to reserves based only on observed quantitative information. In the cases where these risks fail to materialize, favorable loss development will likely occur in subsequent periods. It is also possible that the risks materialize above the enhanced reserve level, in which case unfavorable loss development will likely occur in subsequent periods. Our best estimate of loss and LAE reserves may change as a result of a revision in the actuarial central estimate, the actuary's certainty in the estimates and processes and our overall view of the underlying risks. From time to time, we benchmark our reserving policies and procedures and refine them by adopting industry best practices where appropriate. A detailed, ground-up analysis of the reserve estimation risks associated with each of our products and segments, including an assessment of industry information, is performed annually. This information is used when determining management's best estimate of booked reserves.
We do not use discounting (recognition of the time value of money) in reporting
our estimated reserves for losses and settlement expenses.
Loss reserve estimates are subject to a high degree of variability due to the inherent uncertainty of ultimate settlement values. Periodic adjustments to these estimates will likely occur as the actual loss emergence reveals itself over time. Our loss reserving processes reflect accepted actuarial practices and our methodologies result in a reasonable provision for reserves as ofDecember 31, 2022 .
Reserve Sensitivities
There are three major parameters that have significant influence on our actuarial estimates of ultimate liabilities by product. They are the actual losses that are reported, the expected loss emergence pattern and the expected loss ratios used in the analyses. If the actual losses reported do not emerge as expected, it may cause the Company to challenge all or some of our previous assumptions. We may change expected loss emergence patterns, the expected loss ratios used in our analysis and/or the weights we place on a given actuarial method. The impact will be much greater and more leveraged for products with longer emergence patterns. Our general liability product is an example of a product with a relatively long emergence pattern. The following chart illustrates the sensitivity of our general liability reserve estimates to these key parameters. We believe the scenarios to be reasonable, as similar favorable variations have occurred in recent years. For example, our general liability emergence has ranged from 16 percent to 20 percent favorable and our management liability emergence has ranged from 13 percent adverse to 61 percent favorable over the last three years, while our overall emergence for all products combined has ranged from 9 percent to 30 percent favorable. The numbers below are the changes in estimated ultimate loss and ALAE in millions of dollars as ofDecember 31, 2022 , resulting from the change in the parameters shown. These parameters were applied to a general liability net loss and LAE reserve balance of$212.2 million , in addition to associated ULAE and latent liability reserves, atDecember 31, 2022 . Result from favorable Result from unfavorable (in millions) change in parameter change in parameter +/- 5 point change in expected loss ratio for all accident years $ (16.0) $ 16.7 +/- 10% change in expected emergence patterns $ (5.2) $ 5.6 +/- 30% change in actual loss emergence over a calendar year $ (7.8) $ 8.6 Simultaneous change in expected loss ratio (5pts), expected emergence patterns (10%) and actual loss emergence (30%). $ (29.2) $ 30.6 There are often significant interrelationships between our reserving assumptions that have offsetting or compounding effects on the reserve estimate. Thus, in almost all cases, it is impossible to discretely measure the effect of a single assumption or construct a 35 Table of Contents meaningful sensitivity expectation that holds true in all cases. The scenario above is representative of general liability, one of our largest and longest-tailed products. It is unlikely that all of our products would have variations as wide as illustrated in the example. It is also unlikely that all of our products would simultaneously experience favorable or unfavorable loss development in the same direction or at their extremes during a calendar year. Because our portfolio is made up of a diversified mix of products, there would ordinarily be some offsetting favorable and unfavorable emergence by product as actual losses start to emerge and our loss estimates become more reliable.
INVESTMENT VALUATION
Throughout each year, we and our investment managers buy and sell securities to achieve investment objectives in accordance with investment policies established and monitored by our board of directors and executive officers. Equity securities are carried at fair value with unrealized gains and losses recorded within net earnings. We classify our investments in fixed income securities into one of three categories: trading, held-to-maturity or available-for-sale. We do not hold any securities classified as trading or held-to-maturity. Available-for-sale securities are carried at fair value with unrealized gains and losses recorded as a component of comprehensive earnings and shareholders' equity, net of deferred income taxes. Fair value is defined as the price in the principal market that would be received for an asset to facilitate an orderly transaction between market participants on the measurement date. We determine the fair value of certain financial instruments based on their underlying characteristics and relevant transactions in the marketplace. We maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
RECOVERABILITY OF REINSURANCE BALANCES
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 the Company of its liability to policyholders. Such balances are subject to the credit risk associated with the individual reinsurer. We continually monitor the financial condition of our reinsurers and actively follow up on any past due or disputed amounts. As part of our monitoring efforts, we review their annual financial statements andSecurities and Exchange Commission (SEC) filings for 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 AM Best andStandard & Poor's (S&P) ratings of our reinsurers. Additionally, we perform an in-depth reinsurer financial condition analysis prior to the renewal of our reinsurance placements. 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 balance recoverable from the reinsurer are specifically identified and charged to earnings in the form of an allowance for uncollectible amounts. We subject our remaining reinsurance balances receivable to detailed recoverability tests, including a segment-based analysis using the average default rating percentage by S&P rating, and record an additional allowance for unrecoverable amounts from reinsurers. This credit 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.
DEFERRED POLICY ACQUISITION COSTS
We defer incremental direct costs that relate to the successful acquisition of new or renewal insurance contracts, including commissions and premium taxes. Acquisition-related costs may be deemed ineligible for deferral when they are based on contingent or performance criteria beyond the basic acquisition of the insurance contract, or when efforts to obtain or renew the insurance contract are unsuccessful. All eligible costs are capitalized and charged to expense in proportion to premium revenue recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value. This process contemplates the premiums to be earned, anticipated losses and settlement expenses and certain other costs expected to be incurred, but does not consider investment income. Judgments as to the ultimate recoverability of such deferred costs are reviewed on a segment basis and are highly dependent upon estimated future loss costs associated with the premiums written. This deferral methodology applies to both gross and ceded premiums and acquisition costs.
DEFERRED TAXES
We record deferred tax assets and liabilities to the extent that temporary differences between the tax basis and GAAP basis of an asset or liability result in future taxable or deductible amounts. Our deferred tax assets relate to expected future tax deductions arising from claim reserves and future taxable income related to changes in our unearned premium and unrealized losses on
our
fixed income
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portfolio. We also have a significant amount of deferred tax liabilities from
unrealized gains on the equity portfolio and deferred acquisition costs.
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. We consider uncertainties in income taxes and recognize those in our financial statements as required. As it relates to uncertainties in income taxes, our unrecognized tax benefits, including interest and penalty accruals, are not considered material to the consolidated financial statements. Also, no tax uncertainties are expected to result in significant increases or decreases to unrecognized tax benefits within the next 12-month period. Penalties and interest related to income tax uncertainties, should they occur, would be included in income tax expense in the period in which they are incurred.
Additional discussion of other significant accounting policies may be found in
note 1 to the consolidated financial statements within Item 8, Financial
Statements and Supplementary Data.
IMPACT OF COVID-19
Our processes and controls continue to operate effectively and we have been able to maintain high service and support levels for our customers throughout the COVID-19 pandemic. Overall, our premium production was not materially affected by the direct impacts of the pandemic. We expect there will be impacts to the timing of loss emergence and ultimate loss ratios for certain coverages. The industry experienced new issues throughout the pandemic, including the postponement of civil court cases, the extension of various statutes of limitations, claim uncertainty due to supply shortages and changes in settlement trends. Our booked reserves include consideration of these factors, but the duration and degree to which these issues persist, along with potential legislative, regulatory or judicial actions, could result in loss reserve deficiencies and reduce earnings in future periods.
We continue to evaluate all aspects of our operations and are making necessary
adjustments to manage our business as the economic environment evolves.
RESULTS OF OPERATIONS
This section of this Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company's Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 , incorporated herein by reference. Consolidated revenue for 2022 increased$518.7 million from 2021 to$1.7 billion . Net premiums earned for the Group increased 17 percent, driven by growth from our property and casualty segments. Overall market declines resulted in$121.0 million of unrealized losses on equity securities in 2022, while positive market performance resulted in$65.3 million of unrealized gains in our equity portfolio in 2021. Net investment income increased by 25 percent in 2022, primarily due to a larger average asset base and higher interest rates relative to the prior year. The sale of our equity method investment inMaui Jim, Inc. (Maui Jim ) resulted in$571.0 million of realized gains in 2022. Additionally, we recorded net realized gains in the normal course of rebalancing our investment portfolio for both years. 37 Table of Contents CONSOLIDATED REVENUE Year ended December 31, (in thousands) 2022 2021 Net premiums earned$ 1,144,436 $ 980,903 Net investment income 86,078 68,862 Net realized gains 588,515 64,222
Net unrealized gains (losses) on equity securities (121,037) 65,258
Total consolidated revenue
$ 1,697,992 $ 1,179,245 Net earnings for 2022 totaled$583.4 million , up from$279.4 million in 2021. Improved underwriting income was bolstered by an increase in investment income and the gain recognized on the sale of our interest inMaui Jim . NET EARNINGS Year ended December 31, (in thousands) 2022 2021 Underwriting income$ 178,216 $ 129,926 Net investment income 86,078 68,862 Net realized gains 588,515 64,222 Net unrealized gains (losses) on equity securities (121,037) 65,258 Interest expense on debt (8,047) (7,677) General corporate expenses (12,900) (13,330) Equity in earnings of unconsolidated investees 9,853 37,060 Earnings before income taxes$ 720,678 $ 344,321 Income tax expense (137,267) (64,967) Net earnings$ 583,411 $ 279,354 UNDERWRITING RESULTS We achieved our 27th consecutive year of underwriting profit in 2022. Our ability to continue to produce underwriting income, and do so at margins 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 the Company from the broader insurance market by ensuring sound risk selection and appropriate pricing. Gross premiums written increased$218.1 million , or 16 percent, in 2022 when compared to 2021. Growth was achieved in all three segments. Positive rate movement across most of the casualty and property portfolio and expanded distribution provided for growth opportunities across most lines. Net premiums earned increased$163.5 million , or 17 percent, in 2022 when compared to 2021. Assuming the competitive environment responds rationally to current trends, we anticipate continued rate increases and further disruption that should create new opportunities for profitable growth into 2023. Underwriting results for 2022 included$38.0 million of pretax losses from Hurricane Ian, as well as$13.0 million of other storm losses. Comparatively, 2021 included$33.6 million of pretax losses and$0.4 million of reinstatement premium from hurricanes, as well as$25.0 million of other storm losses. Results for each period benefited from favorable development on prior years' loss reserves, which provided additional pretax earnings of$122.6 million in 2022, compared to$125.5 million in 2021. Further discussion of reserve development can be found in note 6 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data. Bonus and profit-sharing amounts earned by executives, managers and associates are predominately influenced by corporate performance including operating earnings, combined ratio and return on capital. Favorable development and other drivers of growth in book value would increase bonus and profit-sharing expenses, while catastrophe losses, adverse development and decreased investment portfolio returns would lead to expense reductions. These performance-related expenses impact policy acquisition, insurance operating and general corporate expenses. In total, underwriting income was$178.2 million on an 84.4 combined ratio in 2022, compared to$129.9 million on an 86.8 combined ratio in 2021. The loss ratio was 44.9 in 2022, compared to 46.5 in 2021. In addition to lower storm losses in 2022, the current accident year improved modestly due to lower attritional, non-catastrophe losses and mix changes. The expense ratio decreased to 39.5 in 2022, from 40.3 in 2021. The decrease was reflective of improved leveraging of our expense base, as net premiums earned continued to grow, and lower levels of bonus and profit-sharing expenses, resulting from negative investment returns during the year. 38
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We remain optimistic about the expected underlying profitability of our portfolio. However, theJanuary 1, 2023 reinsurance renewals did result in changes to the reinsurance structures in place for 2023. In the past, we have been able to access low attaching earnings protection from high-quality reinsurers at favorable prices. We evaluate the risk-reward equation carefully at each reinsurance renewal and our strong capital base provides the option to take more net exposure where the expected reinsurance ceded margins exceed a fair return. As a result of the current property reinsurance market, we increased our retentions, changed from prepaid to paid reinstatements on most layers and took mid-double-digit rate increases, on a risk-adjusted basis, on our property and catastrophe treaties. For our casualty treaties, co-participations increased and risk-adjusted rate change will be flat to up low double digits, depending on the line of business. Given increased reinsurance prices, we believe retaining more of our gross portfolio is an efficient use of our capital. We expect our reinsurance strategy going forward to primarily focus on buying traditional reinsurance from financially secure partners who support concurrent terms and have high regard for our business model of disciplined underwriting.
The following tables and narrative provide a more detailed look at individual
segment performance over the last two years.
GROSS PREMIUMS WRITTEN AND NET PREMIUMS EARNED
Gross Premiums Written Net Premiums Earned
(in thousands) 2022 2021 % Change 2022 2021 % Change
CASUALTY
Commercial excess and
personal umbrella $ 325,218 $ 283,242 15 % $ 253,921 $ 219,437 16 %
General liability 110,659 99,017 12 % 100,374 90,853 10 %
Commercial transportation 123,099 106,432 16 %
96,992 83,352 16 % Professional services 103,922 96,735 7 % 95,187 88,855 7 % Small commercial 72,347 68,475 6 % 67,673 64,660 5 % Executive products 103,742 136,078 (24) % 26,606 21,873 22 % Other casualty 87,244 81,605 7 % 71,079 64,609 10 % Total casualty$ 926,231 $ 871,584 6 %$ 711,832 $ 633,639 12 % PROPERTY Commercial property$ 326,609 $ 202,855 61 %$ 163,078 $ 107,941 51 % Marine 133,539 112,721 18 % 113,208 97,745 16 % Other property 39,313 32,290 22 % 31,600 26,151 21 % Total property$ 499,461 $ 347,866 44 %$ 307,886 $ 231,837 33 % SURETY Commercial$ 55,026 $ 51,529 7 %$ 47,652 $ 43,738 9 % Miscellaneous 48,926 46,599 5 % 45,826 43,982 4 % Contract 35,842 29,776 20 % 31,240 27,707 13 % Total surety$ 139,794 $ 127,904 9 %$ 124,718 $ 115,427 8 % Grand total$ 1,565,486 $ 1,347,354 16 %$ 1,144,436 $ 980,903 17 % Casualty Gross premiums written for the casualty segment were up$54.6 million in 2022. Gross premiums from commercial excess and personal umbrella increased$42.0 million , due to rate increases and an expanded distribution base. The personal umbrella market continues to be disrupted, as many of our competitors for standalone umbrella have reduced their appetite or left the space altogether. Within the commercial excess category, we wrote$13.8 million of excess energy liability business, which we have decided to run off throughout 2023. Increases in new construction projects, outside of the competitiveNew York City construction market, led to the increase in general liability premium. Commercial transportation premium increased by$16.7 million , driven by our public transportation line, where customers put vehicles back in service on policies that were suspended throughout the first two years of the pandemic. Executive products premium decreased as a result of a more competitive market and the exit from our large account cyber and representations and warranties programs. 39 Table of Contents Property Gross premiums written for the property segment were up$151.6 million in 2022. Our commercial property business was up$123.8 million , as rates on wind exposures continued to increase, building valuations rose and market disruption provided an opportunity to grow while strengthening terms and conditions. We believe the trend of increasing hurricane rate will continue given the disorderly market conditions that are further supported by increased reinsurance costs. Rate increases, improved retention and new opportunities in the inland marine space led to$20.8 million of premium growth for our marine product. Other property premium grew as a result of local underwriting efforts for ourHawaii homeowners product, which helped us obtain new accounts, and rate increases on property-exposed GBA business.
Surety
Gross premiums written for the surety segment were up$11.9 million in 2022. Contract surety benefited from new construction opportunities and larger contract values, driven by the inflation of material prices and increased public spending on infrastructure projects. The expansion of existing accounts and new business resulted in increased premium for commercial surety. The growth in miscellaneous surety was broad based and has been supported by our focus on customer experience and technology. We continue to carefully pursue growth opportunities, while monitoring the financial results of our principals closely, given the evolving economic environment. UNDERWRITING INCOME Underwriting Income (in thousands) 2022 2021 Casualty$ 73,789 $ 95,519 Property 72,522 11,300 Surety 31,905 23,107 Total$ 178,216 $ 129,926 Combined Ratio 2022 2021 Casualty 89.6 84.9 Property 76.4 95.1 Surety 74.4 80.0 Total 84.4 86.8 Casualty Underwriting income for the casualty segment was$73.8 million on an 89.6 combined ratio in 2022, compared to$95.5 million on an 84.9 combined ratio in 2021. The decline was the result of decreased favorable development on prior accident years' reserves, which was partially offset by improved current accident year performance. Favorable development on prior accident years' loss reserves contributed to underwriting earnings in each of the past two years. The total benefit from favorable development on prior years' reserves was$87.2 million for 2022, which was experienced across accident years 2016 and 2018 through 2021. Favorable development was widespread, with notable amounts from general liability, professional services, commercial excess, transportation, small commercial and executive products. No product experienced significant adverse development. Comparatively, results for the casualty segment in 2021 included favorable development of$108.6 million , with the bulk of the development attributable to general liability, transportation, professional services, commercial excess and personal umbrella across accident years 2014 through 2020. Hurricane and storm losses on casualty-oriented package policies that include property coverage resulted in$8.3 million of losses in 2022, compared to$4.1 million in 2021. The segment's loss ratio was 53.6 in 2022, compared to 49.2 in 2021. The higher loss ratio in 2022 was due to the lower amounts of favorable development on prior years' reserves and increased current year hurricane and storm losses on casualty-oriented package policies. The expense ratio for the casualty segment was 36.0 in 2022, compared to 35.7 in 2021.
Property
Underwriting income from the property segment was
combined ratio in 2022, compared to
2021. Underwriting results for 2022 included
development on prior years' loss
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and catastrophe reserves, largely from the marine business,$31.2 million of hurricane losses and$11.5 million of other storm losses. Comparatively, results for 2021 included$11.0 million of favorable development on prior years' loss and catastrophe reserves, primarily from the marine business,$32.2 million of hurricane losses and$22.3 million of other storm losses. A larger earned premium base resulted in higher levels of underwriting income as well as lower loss and expense ratios. The segment's loss ratio was 39.2 in 2022, compared to 56.0 in 2021. Catastrophe losses added 14 points to the loss ratio in 2022, compared to 24 points of impact in 2021. Lower attritional losses in the current accident year also led to an improved loss ratio in 2022. The expense ratio for the property segment declined to 37.2 in 2022, from 39.1
in 2021. Surety
Underwriting income for the surety segment totaled$31.9 million on a 74.4 combined ratio in 2022, compared to$23.1 million on an 80.0 combined ratio in 2021. Underwriting performance for each year reflects a combination of positive current accident year results and favorable development in prior accident years' loss reserves. The current accident year combined ratio for each period has been in the low to mid 80s. Results for 2022 included favorable development on prior accident years' reserves, which decreased loss and settlement expenses for the segment by$10.4 million . Comparatively, 2021 results included favorable development on prior accident years' reserves, which decreased loss and settlement expenses for the segment by$5.9 million . The segment's loss ratio was 9.8 in 2022, compared to 13.0 in 2021. An increased amount of favorable development on prior years' reserves in 2022 led to a lower loss ratio. The expense ratio for the surety segment was 64.6 in 2022, down from 67.0 in 2021, as 2022 had a higher earned premium base that allowed for a better leveraging of expenses.
NET INVESTMENT INCOME AND REALIZED INVESTMENT GAINS
During 2022, net investment income increased by 25 percent. The increase was
primarily due to an increased asset base and higher interest rates relative to
the prior year. The average annual yields on our investments were as follows for
2022 and 2021:
2022 2021
PRETAX YIELD
Taxable (on book value) 2.94 % 2.76 %
Tax-exempt (on book value) 2.71 % 2.63 %
Equities (on fair value) 2.20 % 2.07 %
AFTER-TAX YIELD
Taxable (on book value) 2.32 % 2.18 %
Tax-exempt (on book value) 2.57 % 2.49 %
Equities (on fair value) 1.91 % 1.80 %
The after-tax yield reflects the different tax rates applicable to each category
of investment. Our taxable fixed income securities were subject to a corporate
tax rate of 21.0 percent, our tax-exempt municipal securities were subject to a
tax rate of 5.3 percent and our dividend income was generally subject to a tax
rate of 13.1 percent. During 2022, the average after-tax yield on the taxable
fixed income portfolio was 2.3 percent, an increase from 2.2 percent in the
prior year. The average after-tax yield on the tax-exempt portfolio increased
slightly to 2.6 percent.
The fixed income portfolio increased by $257.1 million during the year, as the
majority of operating cash flows were allocated to the fixed income portfolio.
The tax-adjusted total return on a mark-to-market basis was -11.1 percent. Our
equity portfolio decreased by $115.4 million to $498.4 million in 2022 as a
result of a decline in equity market returns during the year. The total return
for the year on the equity portfolio was -13.8 percent.
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Our investment results for the last five years are shown in the following table:
Tax
Pre-tax Equivalent
Annualized Annualized
Change in Return on Return on
Average Net Unrealized Avg. Avg.
Invested Investment Net Realized Appreciation Invested Invested
(in thousands) Assets (1) Income (2)(3) Gains (3)(4) (3)(5) Assets Assets
2018 $ 2,167,510 $ 62,085 $ 63,407 $ (140,513) (0.7) % (0.6) %
2019 2,377,295 68,870 17,520 161,848 10.4 % 10.5 %
2020 2,698,721 67,893 17,885 99,451 6.9 % 6.9 %
2021 3,000,025 68,862 64,222 (6,280) 4.2 % 4.3 %
2022 3,217,635 86,078 588,515 (462,981) 6.6 % 6.6 %
5-yr Avg. $ 2,692,237 $ 70,758 $ 150,310 $ (69,695) 5.5 % 5.5 %
(1) Average amounts at beginning and end of year (inclusive of cash and
short-term investments).
(2) Investment income, net of investment expenses.
(3) Before income taxes.
(4) Net realized gains for 2022 include
our equity method investment in
(5) Relates to available-for-sale fixed income and equity securities.
In 2022, we recognized$20.3 million in net realized gains in the equity portfolio,$3.0 million in net realized losses in the fixed income portfolio and$571.2 million in other net realized gains, primarily from our sale ofMaui Jim . In 2021, we recognized$62.5 million in net realized gains in the equity portfolio,$1.9 million in net realized gains in the fixed income portfolio and$0.2 million in other net realized losses. Investment income was aided by higher interest rates in 2022, as theFederal Reserve raised the Fed Funds target to fight inflation. As we enter 2023, the path of rates remains uncertain as policy makers try to cap inflation without sending the economy into recession. Should current yields increase or simply hold for most of the year, investment income will likely increase in 2023. However, if shorter term rates decline, investment income growth may be limited.
INVESTMENTS
We maintain a diversified investment portfolio with a prudent mix of fixed income and risk assets. We continually monitor economic conditions, our capital position and the insurance market to determine our tactical allocation. As ofDecember 31, 2022 , the portfolio had a fair value of$3.3 billion , an increase of$109.3 million from the end of 2021. ExcludingU.S. government and agency issues, no single issuer in either the fixed income or equity portfolio represented more than 1 percent of invested assets. We determined the fair value of certain financial instruments based on their underlying characteristics and relevant transactions in the marketplace. We maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. For additional information, see notes 1 and 2 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data. 42 Table of Contents As ofDecember 31, 2022 , our investment portfolio had the following asset allocation breakdown: Cost or Unrealized % of Total (in thousands) Amortized Cost Fair Value Gain/(Loss) Fair Value Quality* U.S. government$ 462,884 $ 454,021 $ (8,863) 13.9 % AAA U.S. agency 75,074 73,063 (2,011) 2.2 % AA+
Non-U.S. government & agency 6,798 5,847
(951) 0.2 % BBB+ Agency MBS 373,687 331,806 (41,881) 10.1 % AAA ABS/CMBS/MBS** 276,126 240,736 (35,390) 7.4 % AA+ Corporate 1,122,097 1,034,330 (87,767) 31.6 % A- Municipal 628,607 527,147 (101,460) 16.1 % AA
Total fixed income$ 2,945,273 $ 2,666,950 $ (278,323) 81.5 % AA- Equities 328,019 498,382 170,363 15.2 % Short-term investments 36,229 36,229 - 1.1 % Other invested assets 43,980 47,922 3,942 1.5 % Cash 22,818 22,818 - 0.7 % Total portfolio$ 3,376,319 $ 3,272,301 $
(104,018) 100.0 %
*Quality ratings provided by Moody's, S&P and Fitch
**Non-agency asset-backed, commercial mortgage-backed and mortgage-backed
securities
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.
Fixed income represented 82 percent of our total 2022 portfolio, up from 76 percent in 2021. As ofDecember 31, 2022 , the fair value of our fixed income portfolio consisted of 42 percent AAA-rated securities, 19 percent AA-rated securities, 20 percent A-rated securities, 11 percent BBB-rated securities and 8 percent non-investment grade or non-rated securities. This compares to 36 percent AAA-rated securities, 23 percent AA-rated securities, 20 percent A-rated securities, 13 percent BBB-rated securities and 8 percent non-investment grade or non-rated securities in 2021. 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 ofDecember 31, 2022 , our fixed income portfolio's duration was 4.2 years. Consistent underwriting income allows a portion of our investment portfolio to be invested in equity securities and other risk asset classes. Equities comprised 15 percent of our total 2022 portfolio, down from 19 percent at the end of 2021, as we reduced our risk asset profile and equity markets declined over the course of the year. Securities within the equity portfolio are well diversified and are primarily invested in broad index exchange traded funds (ETFs). Our actively managed equity strategy has a preference for dividend income and value-oriented security selection with low turnover, which minimizes transaction costs and taxes throughout our long investment horizon. 43 Table of Contents FIXED INCOME PORTFOLIO As ofDecember 31, 2022 , our fixed income portfolio had the following rating distributions: FAIR VALUE Below Investment (in thousands) AAA AA A BBB Grade No Rating Fair Value Bonds:
U.S. government & agency (GSE)$ 475,159 $ 51,925 $ - $
- $ - $ -$ 527,084 Non-U.S. government & agency - - 1,677 4,170 - - 5,847 Corporate - industrial 19,840 49,528 170,110 197,396 36,438 3,027 476,339 Corporate - financial 9,628 43,221 223,638 72,586 12,202 - 361,275 Corporate - utilities 1,036 928 28,502 25,231 4,419 - 60,116 Corporate industrial - private placements - - - 3,291 70,377 20,729 94,397 Corporate financial - private placements - - - - 8,791 31,915 40,706 Corporate utilities - private placements - - - - 485 1,012 1,497 Municipal 126,973 334,961 64,768 - - 445 527,147 Structured: GSE - RMBS 274,032 - - - - - 274,032 Non-GSE RMBS 76,626 14,249 1,446 - - - 92,321 CLO 24,251 3,820 - - - 2,336 30,407 ABS - auto loans 5,207 10,991 - - - - 16,198 ABS - railcars - - 13,923 - - - 13,923 All other ABS/MBS 11,370 1,873 21,919 - - 11,132 46,294 GSE - CMBS 57,774 - - - - - 57,774 CMBS 26,997 3,273 11,323 - - - 41,593 Total$ 1,108,893 $ 514,769 $ 537,306 $ 302,674 $ 132,712 $ 70,596 $ 2,666,950
Mortgage-Backed,
We believe mortgage-backed securities (MBS), asset-backed securities (ABS) and commercial mortgage-backed securities (CMBS) add diversification, liquidity, credit quality and additional yield to our portfolio. The following table summarizes the distribution of our mortgage-backed securities (MBS) portfolio by investment type, as ofDecember 31 : (in thousands) Amortized Cost Fair Value % of Total 2022 Pass-throughs$ 238,259 $ 214,226 64.6 % Planned amortization class 71,051 59,806 18.0 % Sequential 64,377 57,774 17.4 % Total$ 373,687 $ 331,806 100.0 % 2021 Pass-throughs$ 187,456 $ 190,512 51.9 % Planned amortization class 95,182 93,095 25.3 % Sequential 80,223 83,580 22.8 % Total$ 362,861 $ 367,187 100.0 % Agency MBS represented 12 percent of the fixed income portfolio, compared to 15 percent as ofDecember 31, 2021 . Our objective for the agency MBS portfolio is to provide reasonable cash flow stability where we are compensated for the call risk associated with residential refinancing. The agency MBS portfolio includes mortgage-backed pass-through securities and collateralized mortgage obligations (CMO), which include planned amortization classes and sequential pay structures. As ofDecember 31, 2022 , all of the securities in our agency MBS portfolio were ratedAAA and issued byGovernment Sponsored Enterprises (GSEs) such as theGovernmental National Mortgage Association , Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation. 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 44 Table of Contents flows. As ofDecember 31, 2022 , the agency MBS portfolio contained 65 percent of pure pass-throughs, compared to 52 percent as ofDecember 31, 2021 . An additional 17 percent of the MBS portfolio was invested in sequential payer, down from 23 percent in 2021.
The following table summarizes the distribution of our asset-backed and
commercial mortgage-backed securities portfolio as of
Amortized
(in thousands) Cost Fair Value % of Total
2022
Non-GSE RMBS $ 109,852 $ 92,321 38.4 %
CMBS 49,333 41,593 17.3 %
CLO 31,393 30,407 12.6 %
Auto 17,194 16,198 6.7 %
Railcars 16,072 13,923 5.8 %
Consumers 12,241 10,904 4.5 %
Marine 8,554 7,319 3.0 %
Other 31,487 28,071 11.7 %
Total $ 276,126 $ 240,736 100.0 %
2021
Non-GSE RMBS $ 79,281 $ 78,497 29.7 %
CMBS 55,293 55,592 21.1 %
CLO 34,305 34,362 13.0 %
Auto 17,401 17,491 6.6 %
Railcars 15,383 15,245 5.8 %
Consumers 12,242 12,442 4.7 %
Marine 9,353 9,253 3.5 %
Other 41,015 41,172 15.6 %
Total $ 264,273 $ 264,054 100.0 %
An ABS, CMBS or non-agency residential mortgage-backed security (RMBS) 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, structured bank loans in the form of collateralized loan obligations (CLOs) and residential or commercial mortgages. As ofDecember 31, 2022 , ABS/CMBS/RMBS investments were 9 percent of the fixed income portfolio, compared to 11 percent as ofDecember 31, 2021 . Sixty percent of the securities in the ABS/CMBS/RMBS portfolio were ratedAAA as ofDecember 31, 2022 , while 94 percent were rated A or better. We believe that ABS/CMBS investments often add superior cash flow stability over mortgage pass-throughs or CMOs. When making investments in MBS/ABS/CMBS, we evaluate the quality of the underlying collateral, the structure of the transaction, which dictates how any losses in the underlying collateral will be distributed, and prepayment risks. We had$77.3 million in unrealized losses in these asset classes as ofDecember 31, 2022 .
As ofDecember 31, 2022 , municipal bonds composed 20 percent of our fixed income portfolio, compared to 27 percent as ofDecember 31, 2021 . We believe municipal fixed income securities can provide diversification and additional tax-advantaged yield to our portfolio. Our objective for the municipal fixed income portfolio is to provide reasonable cash flow stability and increased after-tax yield. Our municipal fixed income portfolio is comprised of general obligation (GO) and revenue securities. The revenue sources include sectors such as sewer and water, public improvement, school, transportation and colleges and universities. As ofDecember 31, 2022 , approximately 46 percent of the municipal fixed income securities in the investment portfolio were GO and the remaining 54 percent were revenue based. The municipal portfolio is diversified amongst 324 issues.
Eighty-eight percent of our municipal fixed income securities were rated AA or
better, while 99 percent were rated A or better. The municipal portfolio
includes 52 percent taxable and 48 percent tax-exempt securities.
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Corporate Debt Securities
As ofDecember 31, 2022 , our corporate debt portfolio comprised 39 percent of the fixed income portfolio, compared to 40 percent as ofDecember 31, 2021 . 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. Non-investment grade bonds totaled$132.7 million while non-rated Regulation D securities totaled$53.7 million at the end of 2022. While these Regulation D securities are not rated by a traditional nationally recognized statistical rating organization, they all carry an equivalent investment-grade rating from theSecurities Valuation Office of the NAIC . The corporate debt portfolio has an overall quality rating of A- diversified among 830 issues.
The table below illustrates our corporate debt exposure as of
Private placements include bank loan and Regulation D securities.
Amortized
(in thousands) Cost Fair Value % of Total
Bonds:
Corporate - industrial $ 516,841 $ 476,339 46.1 %
Corporate - financial 393,330 361,275 34.9 %
Corporate - utilities 65,636 60,116 5.8 %
Corporate industrial - private placements 99,696 94,397 9.1 % Corporate financial - private placements 45,005 40,706 4.0 % Corporate utilities - private placements 1,589 1,497
0.1 % Total$ 1,122,097 $ 1,034,330 100.0 %
We believe corporate debt investments add diversification and additional yield
to our portfolio.
EQUITY SECURITIES As ofDecember 31, 2022 , our equity portfolio comprised 15 percent of the investment portfolio, down from 19 percent at the end of the previous year. The securities within the equity portfolio are well diversified and are primarily invested in broad index ETFs that represent market indexes similar to the Russell 1000 Index, Russell 3000 Index, S&P 500 Index and S&P 600 Index. The ETF portfolio is congruent with the actively managed equity portfolios and solves for exposures that line up with our overall benchmark index, the Russell 3000. In total, the equity portfolio is comprised of 90 securities.
INTEREST AND GENERAL CORPORATE EXPENSE
We incurred$8.0 million of interest expense on outstanding debt during 2022 and$7.7 million in 2021. AtDecember 31, 2022 and 2021, our long-term debt consisted of$150.0 million in senior notes maturingSeptember 15, 2023 and paying interest semi-annually at a rate of 4.875 percent. Additionally, RLI Ins. borrowed$50.0 million from theFederal Home Loan Bank of Chicago that matures onNovember 10, 2023 and pays interest monthly at an annualized rate of 0.84 percent. We incurred$12.9 million of general corporate expense during 2022 and$13.3 million in 2021. 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 2022 and 2021, we exceeded the required return, resulting in the accrual of executive bonuses. Market declines in 2022 resulted in lower variable compensation earned than in 2021.
INVESTEE EARNINGS
We owned a 40 percent equity interest inMaui Jim , a manufacturer of high-quality sunglasses, but sold our interest in 2022. For more information on the sale, see note 13 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data. Our investment inMaui Jim was carried at theRLI Corp. holding company level, as it was not core to our insurance operations. In 2022, we recorded$0.4 million in earnings from this investment, compared to$22.8 million in 2021. The decrease in 2022 was attributable to transaction costs associated with the sale. As ofDecember 31, 2022 , we had a 23 percent interest in the equity and earnings of Prime. Prime writes business through twoIllinois domiciled insurance carriers, Prime Insurance Company, an excess and surplus lines company, andPrime Property and Casualty Insurance Inc. , an admitted insurance company. As a private company, the market for Prime's stock is limited. While we have certain rights under our shareholder agreement, we are subject to the decisions of the controlling shareholder, which may impact 46
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the value of our investment. In 2022, we recorded$13.0 million in investee earnings for Prime, compared to$17.0 million in 2021. Additionally, we maintain a quota share reinsurance treaty with Prime, which contributed$20.6 million of gross premiums written and$22.6 million of net premiums earned during 2022, compared to$22.2 million of gross premiums written and$19.1 million of net premiums earned during 2021. We did not receive a dividend from our equity method investments in 2022 or 2021. Dividends from our equity method investees have been irregular in nature, and while they provide added liquidity when received, we do not rely on those dividends to meet our liquidity needs.
INCOME TAXES
Our effective tax rates were 19.0 percent and 18.9 percent for 2022 and 2021, respectively. Effective rates are dependent upon components of pretax earnings, which is impacted by the volatility of unrealized gains and losses, and the related tax effects. The effective rate was higher in 2022 due to higher levels of pretax earnings, which decreased the impact of tax-favored adjustments, such as investment tax credits and excess tax benefits on share-based compensation. Dividends paid to our Employee Stock Ownership Plan (ESOP) result in a tax deduction. Dividends paid to the ESOP in 2022 and 2021 resulted in tax benefits of$4.2 million and$1.6 million , respectively. These tax benefits reduced the effective tax rate for 2022 and 2021 by 0.6 percent and 0.5 percent, respectively.
NET UNPAID LOSSES AND SETTLEMENT EXPENSES
The primary liability on our balance sheet relates to unpaid losses and settlement expenses, which represents our estimated liability for losses and related settlement expenses before considering offsetting reinsurance balances recoverable. The largest asset on our balance sheet, outside of investments, is the reinsurance balances recoverable on unpaid losses and settlement expenses, which serves to offset this liability. 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 the Company. 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$1.6 billion atDecember 31, 2022 , from$1.4 billion as ofDecember 31, 2021 . This reflects incurred losses of$514.4 million in 2022 offset by paid losses of$374.3 million , compared to incurred losses of$456.6 million offset by$327.5 million paid in 2021. 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. Gross reserves (liability) and the reinsurance balances recoverable (asset) are generally subject to the same influences that affect net reserves, though changes to our reinsurance agreements can cause reinsurance balances recoverable to behave differently. Total gross loss and LAE reserves increased to$2.3 billion atDecember 31, 2022 , from$2.0 billion atDecember 31, 2021 , while ceded loss and LAE reserves increased to$740.1 million from$608.1 million over the same period.
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
We have three primary types of cash flows: (1) operating cash flows, which consist mainly of cash generated by our underwriting operations and income earned on our investment portfolio, (2) investing cash flows related to the purchase, sale and maturity of investments and (3) financing cash flows that impact our capital structure, such as changes in debt, issuance of common stock and dividend payments. The following table summarizes these three cash flows over the last two years: (in thousands) 2022 2021 Net cash provided by operating activities$ 250,448 $
384,905
Net cash provided by (used in) investing activities 48,879 (274,826)
Net cash used in financing activities
(365,313)
(83,492)
We have posted positive operating cash flow in the last two years. Variations in operating cash flow between periods are largely driven by the volume and timing of premium receipt, claim payments, reinsurance and taxes. In addition, fluctuations in insurance operating expenses impact operating cash flow. During 2022, we received$686.6 million of cash proceeds from the sale of our equity method investment inMaui Jim , which were classified as investing cash flows. However, tax payments associated withMaui Jim were classified as operating activities and totaled$141.5 million . Excluding the tax payments related toMaui Jim , operating cash flows in 47
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2022 would have been similar to 2021. During 2022, the majority of cash outflows were associated with the net purchase of fixed income securities, classified as investing activities, and the payment of our regular quarterly dividends and$7.00 per share special dividend, classified as financing activities.
We have entered into certain contractual obligations that require the Company to
make recurring payments. The following table summarizes our contractual
obligations as of
Payments due by period
(in thousands) Less than 1 year 1-3
years 3-5 years More than 5 years Total
Loss and settlement expense reserves
$ 680,563$ 811,265 $ 433,770 $ 390,039$ 2,315,637 Current portion of long-term debt 200,000
- - - 200,000 Interest on debt 7,735 - - 7,735 Operating leases 5,578 5,844 2,137 1,587 15,146
Other invested assets and equity method investees 10,493
2,894 38 71 13,496 Total $ 904,369$ 820,003 $ 435,945 $ 391,697$ 2,552,014 Loss and settlement expense reserves represent our best estimate of the ultimate cost of settling reported and unreported claims and related expenses. As discussed previously, the estimation of loss and loss expense reserves is based on various complex and subjective judgments. Actual losses and settlement expenses paid may deviate, perhaps substantially, from the reserve estimates reflected in our financial statements. Similarly, the timing for payment of our estimated losses is not fixed and is not determinable on an individual or aggregate basis. The assumptions used in estimating the payments due by periods are based on our historical claims payment experience. Due to the uncertainty inherent in the process of estimating the timing of such payments, there is a risk that the amounts paid in any period can be significantly different than the amounts disclosed above. Amounts disclosed above are gross of anticipated amounts recoverable from reinsurers. Reinsurance balances recoverable on unpaid loss and settlement reserves are reported separately as assets, instead of being netted with the related liabilities, since reinsurance does not discharge the Company of its liability to policyholders. Reinsurance balances recoverable on unpaid loss and settlement reserves totaled$740.1 million atDecember 31, 2022 , compared to$608.1 million in 2021. The next largest contractual obligation relates to debt outstanding. OnOctober 2, 2013 , we completed a public debt offering of$150.0 million in senior notes maturingSeptember 15, 2023 , (a 10-year maturity) and paying interest semi-annually at the rate of 4.875 percent. The notes were issued at a discount resulting in proceeds, net of discount and commission, of$148.6 million . Additionally, RLI Ins. borrowed$50.0 million from theFederal Home Loan Bank of Chicago onNovember 10, 2021 . The borrowing matures onNovember 10, 2023 and has an option to pay off the debt early beginning onNovember 10, 2022 . Interest is paid monthly at an annualized rate of 0.84 percent. We are not party to any off-balance sheet arrangements. See note 4 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data for more information on our long-term debt. Additionally, see note 2 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data for information on our obligations for other invested assets. Our primary objective in managing our capital is to preserve and grow shareholders' equity and statutory surplus to improve our competitive position and allow for expansion of our insurance operations. Our insurance subsidiaries must maintain certain minimum capital levels in order to meet the requirements of the states in which we are regulated. Our insurance companies are also evaluated by rating agencies that assign financial strength ratings that measure our ability to meet our obligations to policyholders over an extended period of time. We have historically grown our total capital as a result of three sources of funds: (1) earnings on underwriting and investing activities, (2) appreciation in the value of our investments and (3) the issuance of common stock and debt. AtDecember 31, 2022 , we had cash, short-term investments and other investments maturing within one year of approximately$390.9 million and an additional$908.5 million of investments maturing between 1 to 5 years. We maintain a revolving line of credit with Bank of Montreal,Chicago Branch, which permits us to borrow up to an aggregate principal amount of$60.0 million . Under certain conditions, the line may be increased up to an aggregate principal amount of$120.0 million . The facility has a three-year term that expires onMarch 27, 2023 . This facility replaced the previous$50.0 million facility withJP Morgan Chase Bank N.A. , which was set to expire onMay 24, 2020 . As of and during the year endedDecember 31, 2022 , no amounts were outstanding on these facilities.
Additionally, two of our insurance companies, RLI Ins. and Mt. Hawley, are
members of the
additional source of liquidity via a secured lending facility. Based on
qualifying assets and the
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additional aggregate borrowing capacity is approximately$14.9 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. 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 consistently generated positive operating cash flow. The primary factor in our ability to generate positive operating cash flow is underwriting profitability, which we have achieved for 27 consecutive years.
OPERATING ACTIVITIES
The following list highlights some of the major sources and uses of cash flow
from operating activities:
Sources Uses
Premiums received Claims
Loss payments from reinsurers Ceded premium to reinsurers
Investment income (interest and dividends) Commissions paid
Funds held Operating expenses
Interest expense
Income taxes
Funds held
Our largest source of cash is from premiums received from our customers, which
we receive at the beginning of the coverage period for most policies. Our
largest cash outflow is for claims that arise when a policyholder incurs an
insured loss. Because the payment of claims occurs after the receipt of the
premium, often years later, we invest the cash in various investment securities
that earn interest and dividends. We use cash to pay commissions to brokers and
agents, as well as to pay for ongoing operating expenses such as salaries, rent,
taxes and interest expense. We also utilize reinsurance to manage the risk that
we take on our policies. We cede, or pay out, part of the premiums we receive to
our reinsurers and collect cash back when losses subject to our reinsurance
coverage are paid.
The timing of our cash flows from operating activities can vary among periods
due to the timing by which payments are made or received. Some of our payments
and receipts, including loss settlements and subsequent reinsurance receipts,
can be significant, so their timing can influence cash flows from operating
activities in any given period. We are subject to the risk of incurring
significant losses on catastrophes, both natural (such as earthquakes and
hurricanes) and man-made (such as terrorism). If we were to incur such losses,
we would have to make significant claims payments in a relatively concentrated
period of time.
INVESTING ACTIVITIES
The following list highlights some of the major sources and uses of cash flow
from investing activities:
Sources Uses
Proceeds from sale, call or maturity
of bonds Purchase of bonds
Proceeds from sale of stocks Purchase of stocks
Proceeds from sale of other invested
assets Purchase of other invested assets
Acquisitions
Purchase of property and equipment
We maintain a diversified investment portfolio representing policyholder funds
that have not yet been paid out as claims, as well as the capital we hold for
our shareholders. As of December 31, 2022 , our portfolio had a carrying value of
$3.3 billion . Portfolio assets at December 31, 2022 , increased by $109.3
million , or 3 percent, from December 31, 2021 .
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 a
risk assets portfolio largely made up of equities. As of December 31, 2022 ,
42 percent of our shareholders' equity was invested in equities, a decrease from
50 percent at December 31, 2021 .
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The fixed income portfolio is structured to meet policyholder obligations and
optimize the generation of after-tax investment income and total return.
FINANCING ACTIVITIES
In addition to the previously discussed operating and investing activities, we also engage in financing activities to manage our capital structure. The following list highlights some of the major sources and uses of cash flow from financing activities: Sources Uses Proceeds from stock offerings Shareholder dividends Proceeds from debt offerings Debt repayment Short-term borrowing Share buy-backs
Shares issued under stock option plans
Our capital structure is comprised of equity and debt obligations. As ofDecember 31, 2022 , our capital structure consisted of$199.9 million in debt and$1.2 billion of shareholders' equity. Debt outstanding comprised 15 percent of total capital as ofDecember 31, 2022 . 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 toRLI Corp. shareholders. As discussed further below, dividend payments toRLI 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 ofIllinois . As a result, we may not be able to receive dividends from such subsidiary at times and in amounts necessary to pay desired dividends toRLI Corp. shareholders. On a GAAP basis, as ofDecember 31, 2022 , our holding company had$1.2 billion 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$240.6 million in liquid investment assets, which was elevated by the cash proceeds received from the sale ofMaui Jim . Unrestricted funds at the holding company level are available to fund debt interest, general corporate obligations and regular 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 access to the capital markets. 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 byIllinois law to the greater of 10 percent of RLI Ins. policyholder surplus, as ofDecember 31 of the preceding year, or the net income of RLI Ins. for the 12-month period endingDecember 31 of the preceding year. Ordinary dividends are further restricted by the requirement that they be paid from earned surplus. In 2022 and 2021, our principal insurance subsidiary paid ordinary dividends totaling$13.0 million and$70.0 million , respectively, toRLI Corp. Any dividend distribution in excess of the ordinary dividend limits is deemed extraordinary and requires prior approval from the IDOI. In 2021, our principal insurance subsidiary sought and received regulatory approval prior to the payment of extraordinary dividends totaling$110.0 million . No extraordinary dividends were paid in 2022. As ofDecember 31, 2022 ,$136.9 million of the net assets of our principal insurance subsidiary were not restricted and could be distributed toRLI Corp. as ordinary dividends. Because the limitations are based upon a rolling 12-month period, the amount and impact of these restrictions vary over time. In addition to restrictions from our principal subsidiary's insurance regulator, we also consider internal models and how capital adequacy is defined by our rating agencies in determining amounts available for distribution. Our 187th consecutive dividend payment was declared inFebruary 2023 and will be paid onMarch 20, 2023 , in the amount of$0.26 per share. Since the inception of cash dividends in 1976, we have increased our annual dividend every year.
PROSPECTIVE ACCOUNTING STANDARDS
Prospective accounting standards are those which we have not implemented because
the implementation date has not yet occurred. For a discussion of relevant
prospective accounting standards, see note 1.D. to the consolidated financial
statements within Item 8, Financial Statements and Supplementary Data.
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ARCH CAPITAL GROUP LTD. – 10-K – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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