RLI Corp.is a U.S.based, specialty insurance company that underwrites select property and casualty insurance through major subsidiaries collectively known as RLI 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 2021, we achieved our 26th consecutive year of underwriting profitability. Over the 26-year period, we averaged an 88.4 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.
GAAP, NON-GAAP AND PERFORMANCE MEASURES
Throughout this annual report, we include certain non-generally accepted accounting principles (non-GAAP) financial measures. Management believes that these non-GAAP measures further explain the Company's results of operations and allow for a more complete understanding of the underlying trends in the Company's business. These measures should not be viewed as a substitute for those determined in accordance with generally accepted accounting principles in
the United States of America(GAAP). In addition, our definitions of these items may not be comparable to the definitions used by other companies. Following is a list of non-GAAP measures found throughout this report with their definitions, relationships to GAAP measures and explanations of their importance to our operations. 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) 2021 2020 Net earnings $ 279,354 $ 157,091Income tax expense 64,967 32,750 Earnings before income taxes $ 344,321 $ 189,841Equity in earnings of unconsolidated investees (37,060 ) (20,233 ) General corporate expenses 13,330 10,265 Interest expense on debt 7,677 7,603 Net unrealized gains on equity securities (65,258 ) (32,101 ) Net realized gains (64,222 ) (17,885 ) Net investment income (68,862 ) (67,893 ) Underwriting income $ 129,926 $ 69,597Combined 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. 27 --------------------------------------------------------------------------------
CRITICAL ACCOUNTING METHODS
When drawing up the consolidated accounts, we have to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and information on contingent assets and liabilities at
date of the consolidated financial statements and the amounts reported
income and expenses for the reporting period. Actual results may differ
significantly from these 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
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 take into account estimated recoveries from reinsurance, salvage and subrogation.
We record two categories of provisions for claims and LAE: provisions on a case-by-case basis and
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. 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 28 -------------------------------------------------------------------------------- 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. Emergence Expected loss Reserve Length of patterns relied ratio estimation Product line reserve tail upon Other risk factors variability variability Commercial excess Long Internal Low frequency High High High severity Loss trend volatility Exposure growth Unforeseen tort potential Exposure changes/mix Personal umbrella Medium Internal Low frequency Medium Medium High severity Loss trend volatility Exposure growth Unforeseen tort potential General liability Long Internal
Exposure/mixing changes Medium High
Unforeseen tort potential
Professional services Medium Internal & external 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 Long Internal Exposure growth/mix Medium Medium Unforeseen tort potential Small volume Executive products Long Internal & significant 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 High Other property Short Internal CAT aggregation exposure High Medium Low frequency High severity Surety Medium Internal
Economic volatility Medium Medium
Runoff including asbestos & environmental Long Internal & external Loss trend volatility High High Mass tort/latent exposure
Due to the inherent uncertainty underlying estimates of loss reserves, including, but
without limitation, the future settlement environment, the final resolution of the
the estimated liability may be different from that anticipated at the closing date
Dated. Therefore, actual losses paid in the future could result in
amount different from that currently reserved – favorable or unfavourable.
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. 29 -------------------------------------------------------------------------------- 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 lack of internal data requiring high usage of
• Unique reinsurance features, including those with global stop-loss,
reinstatement clauses, commutation provisions or clash protection,
• Longer emergence patterns with latent unforeseen mass crime exposures,
• Assumed reinsurance companies with an extended reporting lag
and/or more intensive use of data and complaints from ceding companies and products
expertise, • High severity and/or low frequency, • Operational processes undergoing significant change and/or
• High sensitivity to major fluctuations in loss trends, economic changes 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.
LAE Loss and 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. 30 -------------------------------------------------------------------------------- The process of estimating ultimate payment for claims and claim expenses begins with the collection and analysis of current and historical claim data. Data on individual reported claims, including paid amounts and individual claim adjuster estimates, are grouped by common characteristics. There is judgment involved in this grouping. Considerations when grouping data include the volume of the data available, the credibility of the data available, the homogeneity of the risks in each cohort and both settlement and payment pattern consistency. We use this data to determine historical claim reporting and payment patterns, which are used in the analysis of ultimate claim liabilities. In some analyses, including business without sufficiently large numbers of policies or that have not accumulated sufficient historical statistics, our own data is supplemented with external or industry average data as available and when appropriate. For 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
actuarial methods to derive an estimate of the ultimate level of loss and LAE
payments necessary for the settlement of all claims occurring at the end of
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.
Pros: The method only reflects the claim dollars that have been paid and is
not subject to case-by-case reserve changes or changes in reserve practices on a case-by-case basis.
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: The method involves additional estimation risk if significant changes
case booking practices took place.
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. 31 -------------------------------------------------------------------------------- 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 actually emerge and thus produces the same
estimation of ultimate loss regardless of favorable/unfavourable 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 underestimate a favorable or unfavorable development in
give weight to the expected loss rate.
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. 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. Considerable risk
factors in the reserve estimate include, but are not limited to, contingencies or
non-quantifiable changes in:
• Loss payment patterns, • Loss reporting patterns, 32
• Frequency and severity trends, • Underlying policy terms and conditions, • Business or exposure mix,
• Business or internal processes affecting 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. A review of the resulting variance between the indicated reserves and the carried reserves takes place. Our actuaries make a recommendation to management in regards 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, the LRC determines whether the reserve balances require adjustment. Resulting reserve balances have always fallen within our actuaries' reasonable range of estimates.
As a Majority Excess and Excess Insurer and Specialty Licensed Insurer
serving niche markets, we believe we are subject to above-average variations
estimates and that this variation is not symmetrical around the
One reason for the variation is the above-average policyholder turnover and changes in the underlying mix of exposures typical of an excess and surplus lines business. This constant change can cause estimates based on prior experience to be less reliable than estimates for more stable, admitted books of business. Also, as a niche market insurer, there is little industry-level information for direct comparisons of current and prior experience and other reserving parameters. These unknowns create greater-than-average variation in the actuarial central estimates. 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 quantitative information. In the cases where these risks fail to materialize, 33 -------------------------------------------------------------------------------- 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 reports
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 of
December 31, 2021.
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 22 percent favorable and our management liability emergence has ranged from 34 percent adverse to 61 percent favorable over the last three years, while our overall emergence for all products combined has ranged from 27 percent to 33 percent favorable. The numbers below are the changes in estimated ultimate loss and ALAE in millions of dollars as of
December 31, 2021, resulting from the change in the parameters shown. These parameters were applied to a general liability net loss and LAE reserve balance of $227.7 million, in addition to associated ULAE and latent liability reserves, at December 31, 2021. Result from Result from favorable unfavorable change in change in (in millions) parameter parameter +/-5 point change in expected loss ratio for all accident years $ (12.6 ) $ 13.0 +/-10% change in expected emergence patterns $ (5.9 ) $ 6.0 +/-30% change in actual loss emergence over a calendar year $ (8.0 ) $ 8.4
Simultaneous change in the expected loss ratio (5pts),
emergence patterns (10%) and actual loss emergence (30%). $ (26.6 ) $ 27.4 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 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. 34 -------------------------------------------------------------------------------- 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 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.
RECOVERABILITY OF REINSURANCE BALANCE
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 and
Securities 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 and Standard & 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.
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. We also have a significant amount of deferred tax liabilities from unrealized gains on the investment 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. 35 --------------------------------------------------------------------------------
Additional discussion of other significant accounting policies can be found in
note 1 to the consolidated financial statements within Item 8, Finance
Additional Statements and Data.
IMPACT OF COVID-19
Our processes and controls continue to operate effectively and we have been able to maintain the highest service and support levels possible for our customers throughout the COVID-19 pandemic. It is difficult to predict how and to what extent COVID-19, and its effects on the economy, will impact our revenues in the coming quarters. In 2020, the product line that experienced the greatest impact was public transportation. Many of our passenger transportation customers were unable to effectively operate under social-distancing protocols and stay-at-home orders. Although transportation premium was up from pre-pandemic levels in total in 2021, public transportation may continue to be challenged. Additionally, a number of our products support the construction industry, and revenues may be impacted if disruption in this sector does not continue to ease. The loss exposure arising out of the spread of COVID-19 and the resulting shutdown will take time to resolve. We do not offer event cancellation, travel, trade credit or pandemic-related coverages, which would be more directly impacted by the COVID-19 pandemic. The derivative implications that COVID-19 had on the economy may have negative implications on products that are correlated with the credit cycle, including, but not limited to, some of our surety and executive products offerings. Additionally, the professional services and executive product groups may be affected by claims made against companies who are reopening or returning to work. Actuarial models base future emergence on historic experience, with adjustments for current trends, and the appropriateness of these assumptions involved greater uncertainty as of
December 31, 2021. We expect there will be impacts to the timing of loss emergence and ultimate loss ratios for certain coverages. The industry experienced new issues, including the postponement of civil court cases, the extension of various statutes of limitations 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. Investment yields decreased throughout 2020, which resulted in lower reinvestment rates through most of 2021. As investment yields rise, the fair value of the fixed income portfolio will decline, as we observed with our $58.9 millionof after-tax other comprehensive loss during 2021. We produced solid operating results in 2021 and our financial position remains strong. We generated $384.9 millionof net operating cash inflows and believe we have sufficient sources of liquidity to meet our anticipated needs over the next 12 to 24 months. Our revolving credit facility provides for a borrowing capacity of $60.0 million, which can be increased to $120.0 millionunder certain circumstances. Furthermore, our membership in the Federal Home Loan Banksystem provides a secured lending facility with additional borrowing capacity. Ultimately, the extent to which COVID-19 will affect our business will be influenced by its impact on the economy. We continue to evaluate all aspects of our operations and are making necessary adjustments to manage our business. Our diversified portfolio of products and financial strength have allowed us to remain on solid footing. We believe we have a strong and sustainable underwriting approach that will allow us to weather the economic environment and uncertainty we continue to experience.
RESULTS OF OPERATIONS
This section of this Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 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 ended
December 31, 2020, incorporated herein by reference. Consolidated revenue for 2021 increased $195.6 millionfrom 2020. Net premiums earned for the Group increased 13 percent, driven by growth from our casualty and property segments, while performance in the equity portfolio also surpassed the return generated in 2020. Net investment income increased by 1 percent in 2021, primarily due to a larger asset base. Additionally, in the normal course of portfolio rebalancing, we recorded net realized gains on our investment portfolio in both 2021 and 2020. CONSOLIDATED REVENUE Year ended December 31, (in thousands) 2021 2020 Net premiums earned $ 980,903 $ 865,747Net investment income 68,862 67,893 Net realized gains 64,222 17,885 Net unrealized gains on equity securities 65,258 32,101 Total consolidated revenue $ 1,179,245 $ 983,62636 -------------------------------------------------------------------------------- Net earnings for 2021 totaled $279.4 million, up from $157.1 millionin 2020. Improved underwriting income was bolstered by an increase in unrealized gains on equity securities. NET EARNINGS Year ended December 31, (in thousands) 2021 2020 Underwriting income $ 129,926 $ 69,597Net investment income 68,862 67,893 Net realized gains 64,222 17,885 Net unrealized gains on equity securities 65,258 32,101 Interest expense on debt (7,677 ) (7,603 ) General corporate expenses (13,330 ) (10,265 ) Equity in earnings of unconsolidated investees 37,060 20,233 Earnings before income taxes $ 344,321 $ 189,841Income tax expense (64,967 ) (32,750 ) Net earnings $ 279,354 $ 157,091UNDERWRITING RESULTS Gross premiums written increased $210.9 million, or 19 percent, in 2021 when compared to 2020. Growth was achieved in all three segments, though the increase was driven by products in the casualty and property segments. Positive rate movement across most of the casualty and property portfolio and expanded distribution provided for growth opportunities in established lines. Net premiums earned increased $115.2 million, or 13 percent, in 2021 when compared to 2020. Underwriting results for 2021 included $33.6 millionof pretax losses and $0.4 millionof reinstatement premium from hurricanes, as well as $25.0 millionof other storm losses. Comparatively, 2020 included $51.5 millionof pretax losses and $1.5 millionof reinstatement premium from hurricanes, as well as $6.5 millionof other storm and civil unrest losses. Additionally, $18.3 millionof COVID-19 related loss and defense reserves were established in 2020. Results for each period benefited, however, from favorable development on prior years' loss reserves, which provided additional pretax earnings of $125.5 millionin 2021, compared to $101.1 millionin 2020. Further discussion of reserve development can be found in note 6 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data. Incentive and profit-sharing amounts earned by executives, managers and associates are predominately influenced by corporate performance including operating return on equity, combined ratio and Market Value Potential (MVP). MVP is a compensation model that measures components of comprehensive earnings against a minimum required return on capital. MVP is the primary measure of executive bonus achievement and a significant component of manager and associate incentive targets. Incentive and profit-sharing related expenses attributable to the favorable reserve developments totaled $18.3 millionand $14.2 millionfor 2021 and 2020, respectively. These performance-related expenses impact policy acquisition, insurance operating and general corporate expenses line items in the financial statements. Partially offsetting the 2021 and 2020 increases were $8.5 millionand $11.2 million, respectively, in reductions to incentive and profit-sharing amounts earned due to losses associated with catastrophe activity, as well as the reserves that were established for COVID-19 in 2020. In total, underwriting income was $129.9 millionon an 86.8 combined ratio in 2021, compared to $69.6 millionon a 92.0 combined ratio in 2020. The loss ratio was 46.5 in 2021, compared to 51.2 in 2020. The expense ratio decreased to 40.3 in 2021, from 40.8 in 2020. While higher levels of underwriting income and net earnings led to larger levels of bonus and profit-sharing expenses, the expense ratio declined as a result of a larger earned premium base. We achieved our 26th consecutive year of underwriting profit in 2021. Our ability to continue to produce underwriting income, and to 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.
The following tables and narrative provide a more detailed overview of the
segment performance over the past two years.
GROSS PREMIUMS WRITTEN AND NET PREMIUMS EARNED
Gross Premiums Written Net Premiums Earned (in thousands) 2021 2020 % Change 2021 2020 % Change CASUALTY Commercial excess and personal umbrella
$ 283,242 $ 237,23919 % $ 219,437 $ 178,21423 % General liability 99,017 94,307 5 % 90,853 91,653 (1 ) % Professional services 96,735 91,300 6 % 88,855 85,196 4 % Commercial transportation 106,432 63,345 68 % 83,352 64,624 29 % Small commercial 68,475 65,843 4 % 64,660 63,357 2 % Executive products 136,078 121,653 12 % 21,873 26,509 (17 ) % Other casualty 81,605 75,722 8 % 64,609 59,968 8 % Total casualty $ 871,584 $ 749,40916 % $ 633,639 $ 569,52111 % PROPERTY Commercial property $ 202,855 $ 145,37140 % $ 107,941 $ 79,40636 % Marine 112,721 98,027 15 % 97,745 81,852 19 % Specialty personal 24,672 20,962 18 % 21,385 19,596 9 % Other property 7,618 4,409 73 % 4,766 2,866 66 % Total property $ 347,866 $ 268,76929 % $ 231,837 $ 183,72026 % SURETY Miscellaneous $ 46,599 $ 43,1748 % $ 43,982 $ 42,2924 % Commercial 51,529 46,426 11 % 43,738 42,872 2 % Contract 29,776 28,654 4 % 27,707 27,342 1 % Total surety $ 127,904 $ 118,2548 % $ 115,427 $ 112,5063 % Grand total $ 1,347,354 $ 1,136,43219 % $ 980,903 $ 865,74713 % Casualty Gross premiums written for the casualty segment were up $122.2 millionfor 2021. Gross premiums from commercial excess and personal umbrella increased $46.0 million, due to rate increases and an expanded distribution base. Rate increases led to a 12 percent increase in premiums for our executive products group. Growth in the amount of business written by Prime, with whom we maintain a quota share reinsurance treaty, led to an increase in other casualty premium. Commercial transportation was meaningfully affected by the stay-at-home orders associated with COVID-19, which resulted in a significant decrease in premium in 2020. Transportation premiums were up $43.1 millionin 2021, when compared to 2020, and were up from pre-pandemic levels.
Gross premiums written from our property segment were up
$79.1 millionin 2021. Our commercial property business was up $57.5 million, as rates on wind and earthquake exposures continued to increase, building valuations rose and market disruption provided an opportunity to increase market share. Rate increases and improved retention led to $14.7 millionof growth for our marine product. Other property premium increased as a result of property-exposed GBA business that continued to gain scale. Surety Gross premiums written from our surety segment were up $9.7 millionin 2021. The expansion of existing accounts and new business resulted in increased premium for commercial surety. The increase in miscellaneous surety premium is attributable to growth in existing programs and new opportunities from market disruption. Contract surety benefited from new construction opportunities. UNDERWRITING INCOME (in thousands) 2021 2020 Casualty $ 95,519 $ 44,427Property 11,300 (3,182 ) Surety 23,107 28,352 Total $ 129,926 $ 69,59738
COMBINED RATIO 2021 2020 Casualty 84.9 92.2 Property 95.1 101.7 Surety 80.0 74.8 Total 86.8 92.0 Casualty Underwriting income for the casualty segment was
$95.5 millionon an 84.9 combined ratio in 2021, compared to $44.4 millionon a 92.2 combined ratio in 2020. The improvement is the result of increased favorable development on prior accident years' reserves and 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 $108.6 millionfor 2021, which was experienced across accident years 2014 through 2020. Products which generated the majority of the favorable development include general liability, transportation, professional services, commercial excess and personal umbrella. No product experienced significant adverse development. Comparatively, results for the casualty segment in 2020 included favorable development of $75.1 million, with the bulk of the development attributable to transportation, general liability, commercial excess and professional services across accident years 2016 through 2019. Hurricane and storm losses on casualty-oriented package policies that include property coverage resulted in $4.1 millionof losses in 2021. Comparatively, $4.4 millionof hurricane losses were incurred in 2020 and $12.9 millionof reserves were established for COVID-19 loss and defense costs on financial-related product lines. The segment's loss ratio was 49.2 in 2021, compared to 56.6 in 2020. The lower loss ratio in 2021 was due to the higher amounts of favorable development on prior years' reserves. The expense ratio for the casualty segment was 35.7 in 2021, compared to 35.6 in 2020.
Underwriting income from the property segment was
$11.3 millionon a 95.1 combined ratio in 2021, compared to $3.2 millionof underwriting loss on a 101.7 combined ratio in 2020. Underwriting results for 2021 included $11.0 millionof favorable development on prior years' loss and catastrophe reserves, primarily from the marine business, $32.2 millionof hurricane losses and $22.3 millionof other storm losses. Comparatively, results for 2020 included $13.0 millionof favorable development in prior years' reserves, largely from marine, $5.0 millionof storm and civil unrest losses and $2.0 millionof reserves related to COVID-19 investigative and defense costs. Additionally, hurricane activity resulted in $47.2 millionof losses and $1.5 millionof ceded reinstatement premium. 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 56.0 in 2021, compared to 60.6 in 2020. Catastrophe losses added 24 points to the loss ratio in 2021, compared to 30 points of impact from catastrophe losses in 2020. The expense ratio for the property segment declined to 39.1 in 2021, from 41.1 in 2020. Surety Underwriting income for the surety segment totaled $23.1 millionon an 80.0 combined ratio in 2021, compared to $28.4 millionon a 74.8 combined ratio in 2020. 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 2021 included favorable development on prior accident years' reserves, which decreased loss and settlement expenses for the segment by $5.9 million. Comparatively, 2020 results included favorable development on prior accident years' loss reserves, which decreased the segment's loss and settlement expenses by $13.0 million, and offset $3.4 millionin reserves established for COVID-19 related losses. The segment's loss ratio was 13.0 in 2021, compared to 8.4 in 2020. A decreased amount of favorable development on prior years' reserves in 2021 led to a higher loss ratio. The expense ratio for the surety segment was 67.0 in 2021, compared to 66.4 in 2020. 39
NET INVESTMENT INCOME AND REALIZED INVESTMENT GAINS
In 2021, net investment income increased by 1%. The increase was
mainly due to a larger asset base. The average annual returns of our
the investments were as follows for 2021 and 2020:
RETURN BEFORE TAX
Taxable (on book value) 2.76% 3.10%
Tax exempt (on book value) 2.63% 2.69%
Equities (at fair value) 2.07% 2.33%
RETURN AFTER TAX
Taxable (on book value) 2.18% 2.45%
Tax exempt (on book value) 2.49% 2.55%
Equities (at fair value) 1.80% 2.02%
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 2021, the average after-tax yield on the taxable fixed income portfolio was 2.2 percent, a decrease from 2.5 percent in the prior year. The average after-tax yield on the tax-exempt portfolio declined slightly to 2.5 percent. The fixed income portfolio increased by
$213.3 millionduring 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 -0.3 percent. Our equity portfolio increased by $89.8 millionto $613.8 millionin 2021 as a result of the strong equity market returns during the year. The total return for the year on the equity portfolio was 26.4 percent. 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) (3)(4) Assets Assets 2017 $ 2,081,309 $ 54,876 $ 4,411 $ 53,7195.4 % 5.8 % 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 % 5-yr Avg. $ 2,464,972 $ 64,517 $ 33,489 $ 33,6455.2 % 5.4 %
(1) Average amounts at the beginning and end of the year (including cash and
(2) Investment income, net of investment expenses.
(3) Before income taxes.
(4) Relates to fixed-income securities and available-for-sale equities.
In 2021, we recognized
$62.5 millionin net realized gains in the equity portfolio, $1.9 millionin net realized gains in the fixed income portfolio and $0.2 millionin other net realized losses. In 2020, we recognized $15.8 millionin net realized gains in the equity portfolio, $3.9 millionin net realized gains in the fixed income portfolio and $1.8 millionin other net realized losses.
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 of
December 31, 2021, the portfolio had a fair value of $3.2 billion, an increase of $325.9 millionfrom the end of 2020.
We have determined the fair value of certain financial instruments based on their
underlying characteristics and relevant market transactions. We
maximize the use of observable inputs and minimize the use of unobservable inputs
inputs during fair measurement
assess. For more information, see notes 1 and 2 to the consolidated financial statements
financial statements in Section 8, Financial Statements and Supplementary Data.
distribution of allowances:
Cost or Unrealized % of Total (in thousands) Amortized Cost Fair Value Gain/(Loss) Fair Value Quality* U. S. government
$ 127,752 $ 134,554 $ 6,8024.3 % AAA U.S. agency 30,403 32,760 2,357 1.0 % AAA Non-U.S. government & agency 8,297 8,481 184 0.3 % BBB+ Agency MBS 362,861 367,187 4,326 11.6 % AAA ABS/CMBS/MBS** 264,273 264,054 (219 ) 8.3 % AA Corporate 925,394 957,095 31,701 30.3 % BBB+ Municipal 627,287 645,756 18,469 20.4 % AA Total fixed income $ 2,346,267 $ 2,409,887 $ 63,62076.2 % AA- Equities 324,501 613,776 289,275 19.4 % Other invested assets 44,435 50,501 6,066 1.6 % Cash 88,804 88,804 - 2.8 % Total portfolio $ 2,804,007 $ 3,162,968 $ 358,961100.0 %
* Quality ratings provided by Moody’s, S&P and Fitch
** Non-agency asset-backed, commercial mortgage-backed and mortgage-backed securities
The quality in the preceding table and in all subsequent tables is an average of each
the bond’s credit rating, adjusted for its relative weight in the portfolio.
Fixed income represented 76 percent of our total 2021 portfolio, down from 77 percent in 2020. As of
December 31, 2021, the fair value of our fixed income portfolio consisted of 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. This compares to 44 percent AAA-rated securities, 19 percent AA-rated securities, 21 percent A-rated securities, 10 percent BBB-rated securities and 6 percent non-investment grade or non-rated securities in 2020. In selecting the maturity of securities in which we invest, we consider the relationship between the duration of our fixed income investments and the duration of our liabilities, including the expected ultimate payout patterns of our reserves. We believe that both liquidity and interest rate risk can be minimized by such asset/liability management. As of December 31, 2021, our fixed income portfolio's duration was 5.0 years. Consistent underwriting income allows a portion of our investment portfolio to be invested in equity securities and other risk asset classes. Equities comprised 19 percent of our total 2021 portfolio, the same as 2020. 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. 41
FIXED INCOME PORTFOLIO
December 31, 2021, 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) $ 156,604 $ 10,710$ - $
- - 1,940 6,541 - 8,481 Corporate - industrial 21,126 43,343 124,150 195,645 41,606 - 425,870 Corporate - financial 3,133 38,750 215,804 68,119 11,370 - 337,176 Corporate - utilities 1,281 1,039 28,909 30,443 4,246 - 65,918 Corporate industrial - private placements - - 2,937 73,992 19,564 96,493 Corporate financial - private placements - - 6,899 22,797 29,696 Corporate utilities - private placements - - 784 1,158 1,942 Municipal 169,426 414,360 59,842 - - 2,128 645,756 Structured: GSE - RMBS 283,607 - - - - - 283,607 Non-GSE RMBS 62,488 16,009 - - - 78,497 CLO 27,362 7,000 - - - - 34,362 ABS - credit cards 567 - 21,289 - - - 21,856 ABS - auto loans 9,187 4,293 4,011 - - 17,491 All other ABS/MBS 21,381 7,430 18,813 - - 8,632 56,256 GSE - CMBS 83,580 - - - - - 83,580 CMBS 38,435 3,647 13,510 - - - 55,592 Total
$ 878,177 $ 546,581 $ 488,268 $ 303,685 $ 138,897 $ 54,279 $ 2,409,887
backed by a mortgage,
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 of
December 31: (in thousands) Amortized Cost Fair Value % of Total 2021 Pass-throughs $ 187,456 $ 190,51251.9 % Planned amortization class 95,182 93,095 25.3 % Sequential 80,223 83,580 22.8 % Total $ 362,861 $ 367,187100.0 % 2020 Pass-throughs $ 220,516 $ 230,61057.3 % Planned amortization class 67,185 67,377 16.8 % Sequential 96,314 104,084 25.9 % Total $ 384,015 $ 402,071100.0 % Agency MBS represented 15 percent of the fixed income portfolio, compared to 18 percent as of December 31, 2020. 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 (PACs) and sequential pay structures. As of December 31, 2021, all of the securities in our agency MBS portfolio were rated AAAand issued by Government Sponsored Enterprises(GSEs) such as the Governmental National Mortgage Association(GNMA), Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC). 42 -------------------------------------------------------------------------------- Variability in the average life of principal repayment is an inherent risk of owning mortgage-related securities. However, we reduce our portfolio's exposure to prepayment risk by seeking characteristics that tighten the probable scenarios for expected cash flows. As of December 31, 2021, the agency MBS portfolio contained 52 percent of pure pass-throughs, compared to 57 percent as of December 31, 2020. An additional 23 percent of the MBS portfolio was invested in sequential payer, down from 26 percent in 2020.
The following table summarizes the breakdown of our asset-backed assets and
portfolio of commercial mortgage-backed securities at
Amortized (in thousands) Cost Fair Value % of Total 2021 Non-GSE RMBS
$ 79,281 $ 78,49729.7 % CMBS 55,293 55,592 21.1 % CLO 34,305 34,362 13.0 % Equipment 22,134 21,856 8.3 % Auto 17,401 17,491 6.6 % Consumers 12,242 12,442 4.7 % Railcars 10,066 10,037 3.8 % Credit card 4,919 5,135 1.9 % Other 28,632 28,642 10.8 % Total $ 264,273 $ 264,054100.0 % 2020 Non-GSE RMBS $ 54,271 $ 55,07425.2 % CMBS 23,927 25,941 11.9 % CLO 39,315 39,244 18.0 % Equipment 9,348 9,448 4.3 % Auto 28,093 28,739 13.2 % Consumers 6,502 6,912 3.2 % Railcars 3,601 3,741 1.7 % Credit card 24,218 24,746 11.3 % Other 23,948 24,528 11.2 % Total $ 213,223 $ 218,373100.0 % 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 of December 31, 2021, ABS/CMBS/RMBS investments were 11 percent of the fixed income portfolio, compared to 10 percent as of December 31, 2020. Sixty percent of the securities in the ABS/CMBS/RMBS portfolio were rated AAAas of December 31, 2021, while 97 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 $7.3 millionin unrealized losses in these asset classes as of December 31, 2021.
December 31, 2021, municipal bonds composed 27 percent of our fixed income portfolio, compared to 24 percent as of December 31, 2020. 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 of December 31, 2021, approximately 48 percent of the municipal fixed income securities in the investment portfolio were GO and the remaining 52 percent were revenue based. The municipal portfolio is diversified amongst 336 issues with the largest single issuer representing less than 1 percent of invested assets. 43 -------------------------------------------------------------------------------- Ninety percent of our municipal fixed income securities were rated AA or better, while 99 percent were rated A or better. The municipal portfolio includes 55 percent taxable and 45 percent tax-exempt securities.
December 31, 2021, our corporate debt portfolio comprised 40 percent of the fixed income portfolio, compared to 37 percent as of December 31, 2020. 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 $123.4while non-rated Regulation D securities totaled $43.5 millionat the end of 2021. The corporate debt portfolio has an overall quality rating of BBB+ diversified among 776 issues.
The table below illustrates our exposure to corporate debt at
Private placements include bank loans and Regulation D securities.
Amortized (in thousands) Cost Fair Value % of Total Bonds: Corporate - industrial
$ 409,056 $ 425,87044.5 % Corporate - financial 324,652 337,176 35.2 % Corporate - utilities 63,913 65,918 6.9 % Corporate industrial - private placements 96,056 96,493 10.1 % Corporate financial - private placements 29,830 29,696 3.1 % Corporate utilities - private placements 1,887 1,942 0.2 % Total $ 925,394 $ 957,095100.0 % We believe corporate debt investments add diversification and additional yield to our portfolio. Because corporates make up a large portion of the fixed income opportunity set, the corporate debt investments will continue to be a significant part of our investment program.
December 31, 2021, our equity portfolio comprised 19 percent of the investment portfolio, the same as 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 87 securities with the largest single company exposure representing less than 1 percent of invested assets.
COMPANY INTEREST AND GENERAL EXPENSES
$7.7 millionof interest expense on outstanding debt during 2021 and $7.6 millionin 2020. At December 31, 2021and 2020, our long-term debt consisted of $150.0 millionin senior notes maturing September 15, 2023and paying interest semi-annually at a rate of 4.875 percent. Additionally, RLI Ins. borrowed $50.0 millionfrom the Federal Home Loan Bank of Chicagoon November 10, 2021. The borrowing matures on November 10, 2023and interest is paid monthly at an annualized rate of 0.84 percent. As discussed previously, general corporate expenses tend to fluctuate relative to our incentive compensation plans. Our compensation model measures components of comprehensive earnings against a minimum required return on our capital. Bonuses are earned as we generate earnings in excess of this required return. In 2021 and 2020, we exceeded the required return, resulting in the accrual of executive bonuses. Increased levels of net earnings in 2021 resulted in higher variable compensation earned than in 2020.
We maintain a 40 percent equity interest in
Maui Jim, a manufacturer of high-quality sunglasses. As a private company, the market for Maui Jim'sstock is limited. Our investment in Maui Jimis carried at the RLI Corp.holding company level, as it is not core to our insurance operations. While we have certain rights under our shareholder agreement with Maui Jimas a minority shareholder, we are subject to the decisions of the controlling shareholder, which may impact the value of our investment. In 2021, we recorded $22.8 millionin earnings from this investment, compared to $10.4 millionin 2020. Sales recovered from the shutdown the traditional retail sector experienced during 2020.
from the first. Prime writes business through two
carriers, Prime Insurance Company, an excess and excess lines company, and
Main 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 the value of our investment. In 2021, we recorded $17.0 millionin investee earnings for Prime, compared to $10.8 millionin 2020, reflective of their growth in revenue. Additionally, we maintain a quota share reinsurance treaty with Prime, which contributed $22.2 millionof gross premiums written and $19.1 millionof net premiums earned during 2021, compared to $15.7 millionof gross premiums written and $14.3 millionof net premiums earned during 2020. We did not receive a dividend from our equity method investments in 2021, but received a dividend from Prime in 2020. Dividends from Maui Jimand Prime have been irregular in nature and while they provide added liquidity when received, we do not rely on those dividends to meet our liquidity needs. While these dividends do not flow through the investee earnings line, they do result in the recognition of a tax benefit, which is discussed in the income tax section that follows. INCOME TAXES Our effective tax rates were 18.9 percent and 17.3 percent for 2021 and 2020, 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 2021 due to higher levels of pretax earnings, which decreased the impact of tax-favored adjustments on a percentage basis. Our net earnings include equity in earnings of unconsolidated investees, Maui Jimand Prime. The investees do not have a policy or pattern of paying dividends. As a result, we record a deferred tax liability on the earnings at the corporate capital gains rate of 21 percent in anticipation of recovering our investments through means other than through the receipt of dividends, such as a sale. We received a $4.7 milliondividend from Prime in 2020 and recognized a $0.5 milliontax benefit from applying the lower tax rate applicable to affiliated dividends paid to an insurance company (10.8 percent in 2020), as compared to the corporate capital gains rate on which the deferred tax liabilities were based. Standing alone, the dividend resulted in a 0.2 percent reduction to the 2020 effective tax rate. No dividends were declared from unconsolidated investees in 2021, therefore having no impact to the 2021 effective tax rate. Dividends paid to our Employee Stock Ownership Plan (ESOP) also result in a tax deduction. Dividends paid to the ESOP in 2021 and 2020 resulted in tax benefits of $1.6 millionand $1.1 million, respectively. These tax benefits reduced the effective tax rate for 2021 and 2020 by 0.5 percent and 0.6 percent, respectively.
UNPAID NET 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
$1.4 billionat December 31, 2021, from $1.3 billionas of December 31, 2020. This reflects incurred losses of $456.6 millionin 2021 offset by paid losses of $327.5 million, compared to incurred losses of $442.9 millionoffset by $325.1 millionpaid in 2020. 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 $2.0 billionat December 31, 2021, from $1.8 billionat December 31, 2020, while ceded loss and LAE reserves increased to $608.1 millionfrom $443.7 millionover the same period.
CASH AND CAPITAL RESOURCES
We have three main types of cash flow: (1) operating cash flow, which
consist primarily of cash generated from our underwriting operations and income
earned on our investment portfolio, (2) invest the cash flows related to the
buying, selling and
45 -------------------------------------------------------------------------------- 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) 2021 2020 Operating cash flows
$ 384,905 $ 263,259Investing cash flows (uses) (274,826 ) (167,987 ) Financing cash flows (uses) (83,492 ) (79,258 ) 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 2021, the majority of cash flow uses were related to financing and investing activities and associated with the payments of dividends and net purchases of investments, respectively.
We have entered into certain contractual obligations that require the Company to
make recurring payments. The following table summarizes our contracts
Payments due by period More than (in thousands) Less than 1 year 1-3 years 3-5 years 5 years Total Loss and settlement expense reserves $ 580,730
$ 735,027 $ 391,900 $ 335,898 $ 2,043,555Long-term debt - 200,000 - - 200,000 Interest on long-term debt 7,733 5,546 - - 13,279 Operating leases 5,353 7,670 2,365 2,283 17,671 Other invested assets and equity method investees 13,135 6,762 131 103 20,131 Total $ 606,951 $ 955,005 $ 394,396 $ 338,284 $ 2,294,636Loss 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 our liability to policyholders. Reinsurance balances recoverable on unpaid loss and settlement reserves totaled $608.1 millionat December 31, 2021, compared to $443.7 millionin 2020. The next largest contractual obligation relates to long-term debt outstanding. On October 2, 2013, we completed a public debt offering of $150.0 millionin senior notes maturing September 15, 2023, (a 10-year maturity) and paying interest semi-annually at the rate of 4.875 percent. The notes were issued at a discount resulting in proceeds, net of discount and commission, of $148.6 million. Additionally, RLI Ins. borrowed $50.0 millionfrom the Federal Home Loan Bank of Chicagoon November 10, 2021. The borrowing matures on November 10, 2023and has an option to pay off the debt early on November 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. At December 31, 2021, we had cash, short-term investments and other investments maturing within one year of approximately $146.9 millionand an additional $672.9 millionof investments maturing between 1 to 5 years. We maintain a revolving line of credit with Bank of Montreal, ChicagoBranch, 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 46 -------------------------------------------------------------------------------- that expires on March 27, 2023. This facility replaced the previous $50.0 millionfacility with JP Morgan Chase Bank N.A., which was set to expire on May 24, 2020. As of and during the year ended December 31, 2021, no amounts were outstanding on these facilities. Additionally, two of our insurance companies, RLI Ins. and Mt. Hawley, are members of the Federal Home Loan Bank of Chicago(FHLBC). Membership in the Federal Home Loan Banksystem provides both companies with access to an additional source of liquidity via a secured lending facility. Based on qualifying assets and the $50.0 millionborrowing outstanding at year-end, 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 26 consecutive years.
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
Investment income (interest and dividends) Commissions paid Unconsolidated investee dividends from affiliates Operating expenses Funds held 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
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, 2021, our portfolio had a carrying value of $3.2 billion. Portfolio assets at December 31, 2021, increased by $325.9 million, or 11 percent, from December 31, 2020. 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 47 -------------------------------------------------------------------------------- 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, 2021, 50 percent of our shareholders' equity was invested in equities, an increase from 46 percent at December 31, 2020.
The fixed income portfolio is structured to meet the obligations of policyholders and
optimize after-tax investment income generation and total return.
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 securities. From
long-term debt and
represented 14% of the total capital at
At the holding company (
RLI Corp.) level, we rely largely on dividends from our insurance company subsidiaries to meet our obligations for paying principal and interest on outstanding debt, corporate expenses and dividends to RLI Corp.shareholders. As discussed further below, dividend payments to RLI Corp.from our principal insurance subsidiary are restricted by state insurance laws as to the amount that may be paid without prior approval of the insurance regulatory authorities of Illinois. As a result, we may not be able to receive dividends from such subsidiary at times and in amounts necessary to pay desired dividends to RLI Corp.shareholders. On a GAAP basis, as of December 31, 2021, our holding company had $1.2 billionin 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 $87.9 millionin liquid investment assets, which exceeds our normal annual holding company expenditures. 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 by Illinoislaw to the greater of 10 percent of RLI Ins. policyholder surplus, as of December 31of the preceding year, or the net income of RLI Ins. for the 12-month period ending December 31of the preceding year. Ordinary dividends are further restricted by the requirement that they be paid from earned surplus. In 2021 and 2020, our principal insurance subsidiary paid ordinary dividends totaling $70.0 millionand $110.0 million, respectively, to RLI Corp.Any dividend distribution in excess of the ordinary dividend limits is deemed extraordinary and requires prior approval from the 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 2020. As of December 31, 2021, $26.1 millionof the net assets of our principal insurance subsidiary are not restricted and could be distributed to RLI Corp.as ordinary dividends. Because the limitations are based upon a rolling 12-month period, the 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 183rd consecutive dividend payment was declared in February 2022and will be paid on March 18, 2022, in the amount of $0.25per share. Since the inception of cash dividends in 1976, we have increased our annual dividend every year.
The pandemic's impact on the industry was more moderate in 2021, and it was a year of transition, with broad-based momentum fueling growth across most business lines. The current hard market cycle is being sustained by several factors, including: resurgent core inflation, significant catastrophe activity, continued low interest rates and higher reinsurance costs. Market participants are acting rationally by reducing capacity in more volatile segments and the persistent uncertainty of the frequency and severity of losses remains, especially for longer tailed exposures. Our diverse portfolio of specialty products and focus on surplus lines has afforded us the flexibility to meet the needs of insureds and navigate changing market environments. 48 -------------------------------------------------------------------------------- GDP growth should be a foundation for our industry over time, with commercial coverages expanding alongside the economy. The property and casualty industry is expected to exceed GDP growth, as market conditions continue to make up for the soft cycle in the mid-2010s. With positive rate increases entering a third or fourth year, the compounding effects for our industry are significant, and likely a reason that many carriers are citing rate in excess of loss costs. Growth through positive rate momentum should benefit industry loss ratios, and scale is an important contributor to helping absorb the fixed costs of embedded expenses.
RLI also experienced a transition in 2021, with changes in management that
award in our 56-year history. For RLI however, a change of direction
does not mean a change in philosophy and our underwriting discipline remains a
cornerstone of our corporate culture.
Our underwriting team continues to focus on improving the experience with our distribution partners, making it easier and more efficient for brokers and agents to do business with us. We recognize the importance of maintaining strong personal relationships with producers, especially in light of significant consolidation among our distribution partners and the virtual nature of today's business interactions. As we invest in technology to enhance the submission and binding of new business, we would expect written premium to increase alongside expenses. We anticipate that this would minimize any increase, and should eventually result in a decrease, to our expense ratio. Capital markets were rational in 2021, with accommodative monetary policy and fiscal stimulus supporting asset prices and consumers respectively. The prospect of continued inflation will likely require the
Federal Reserveto change course in 2022, an expectation that led to higher bond yields at year-end. We anticipate that yields will continue to move up throughout 2022, which will offer support to investment income, especially when coupled with a larger invested asset base. As of February 2022, equity prices may be in a transition of their own, as tighter financial conditions and a higher discount rate may impact future earnings. Absent a recession, those earnings should be supportive over the long term, but we expect bouts of volatility in the new year. The economy is stable with strong demand for labor, household balance sheets in a de-levered state and consumers poised to re-engage the service sector as the country continues to re-open. Supply chain issues, labor shortages and inflation in the cost of materials may offer a challenging backdrop for industries like construction, where activity might be stunted. About one third of RLI's business lines touch the construction industry, and we are watching the trends in this market closely. CASUALTY The casualty segment remains highly influenced by long term trends, inflation and the prospect for increasing damage awards for liability losses. We have seen continued momentum in rates across nearly all casualty businesses, a trend we expect to continue into 2022. The growth rate was particularly robust for our transportation and personal umbrella products in 2021, but is expected to be more temperate and closer to the growth rate of the rest of our casualty business moving forward. Supportive environments will depend on the broader capacity for risk transfer from the industry and the cadence and magnitude of loss activity. Economic activity can be correlated with more frequent losses, especially for commercial auto coverages, and we expect this trend to play out over the course of the year. Social inflation has been less prominent in recent quarters, but we are watchful for resurgent influence on court outcomes. We believe our balance sheet and underwriting model have the strength and flexibility to navigate the nuanced nature of the casualty business and growth should continue for most lines in 2022.
The industry has experienced elevated property losses, with significant levels of catastrophe activity in the last several years. This has restrained some capacity and created opportunity for RLI to continue growing. Reinsurance cost increases, wage and materials inflation, and rising building valuations have increased the probability of continued growth and rate improvement into 2022. Storm activity will be the primary driver of profitability in the near term. The industry will continue to evaluate the impacts of climate change on the frequency and severity of weather-based events. However, our approach of mitigating climate and catastrophe-related risks through aggregation management, reinsurance and pricing will remain unchanged.
In 2021, our surety business experienced meaningful growth, largely attributable to investments in technology and a growing economy. Several recession-related industry losses resulted in disruption to the market, allowing for greater opportunity in the commercial space. In contrast, smaller miscellaneous exposure remains very competitive and we expect continued demand for higher commissions in this market segment over the course of the next year. The construction industry is a large part of our surety business, and labor and materials shortages are significantly impacting the market. As the economy normalizes, these constraints should improve and we anticipate continued growth will occur. *** 49
-------------------------------------------------------------------------------- We marked our 26th consecutive year of underwriting profitability in 2021. The consistent results and value that we have delivered to our stakeholders is directly correlated to our customer focus, hallmark underwriting discipline and ownership culture. We believe this is a market we can thrive in, as rates are still moving up broadly. Achieving strong results for 2022 will require deep expertise and knowledge of the markets and insured that we serve. We believe the strong collaboration between our underwriters, claims and analytical teams will result in risk selection advantages in our favor.
FORWARD-LOOKING 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. 50