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RLI Corporation (RLI - Analyst Report) reported second quarter 2012 operating earnings of $1.17 per share, surpassing the Zacks Consensus Estimate by a penny. Reported results, however, were 35% lower than the year-ago level of $1.80 per share. Operating earnings in the quarter were $25.2 million, down 34.5% year over year.

The year-over-year decline in operating earnings per share was due to lower underwriting income at Casualty and Surety, partially offset by higher income at Property.

Second quarter 2012 operating earnings include favorable development on casualty prior years’ reserves of 47 cents, favorable development on property prior years' reserves of 11 cents, favorable development on surety prior years' reserves of 22 cents, and the negative effect of 36 cents due to the impact of spring storms.

Including realized investment loss, net of tax, of $0.4 million or 2 cents per share, RLI Corp. reported net income of $24.7 million or $1.15 per share compared with $45.0 million or $2.11 per share in second quarter 2011. Net income in the year-ago quarter included realized investment gains, net of tax, of $6.5 million or 31 cents per share.

Operational Performance

Net premiums earned in the quarter were $141.6 million, up 8.3% year over year, attributable to improvements across all segments.

Underwriting income for RLI Corp. was $21.6 million, down 48.7% year over year. An increase in Surety underwriting income was more than offset by lower income from Casualty and loss at Property.

Investment income declined 2.3% year over year to $14.8 million.

RLI Corp.’s investment portfolio’s total return for the quarter was 1.5% with the bond portfolio edging up 2.0%, while the equity portfolio yielded a negative return of 0.1%.

Revenue in the quarter under review totaled $155.7 million, down 0.2% from $156.1 million in the prior-year quarter, attributable to lower net investment income and net realized investment losses. Revenue also missed the Zacks Consensus Estimate of $161 million.

Total expenses during second quarter 2012 escalated 33.7% year over year to $123.3 million. The increase was primarily driven by higher loss and settlement expense, higher policy acquisition costs and interest expenses.

The combined ratio in the reported quarter deteriorated 1690 basis points year over year to 84.7%. Higher combined ratio at Casualty and Property was partially offset by a lower Surety combined ratio.

Financial Update

RLI Corp. exited the quarter with cash and cash equivalents of $1.9 billion, down 6.7% from 2011 end level.

Long-term debt remained at par with the 2011-end level of $100 million.

RLI Corp.’s book value stood at $40.24 per share as of June 30, 2012, up 7.4% from $37.46 as of December 31, 2011. The company recorded a 12.8% return on equity, with a 16.4% return on a comprehensive basis. The return on equity was 17.1% and 20.6% on a comprehensive basis in the prior year. Statutory surplus increased 9.9% over 2011-end to $780.7 million at quarter ended June 30, 2012.

Dividend Update

In the second quarter, RLI Corp. paid a dividend of 32 cents per share, representing the 144th consecutive quarterly dividend payment.

Effects of Adoption of Accounting Standard

Due to the adoption of deferred acquisition cost (DAC) guidance, deferred policy acquisition costs augmented by $1.9 million, which reduced net earnings by 6 cents.

For the first half, policy acquisition costs recognized increased $3.5 million, which decreased net earnings by 11 cents per share.

Peer Comparison

The Travelers Companies Inc. (TRV - Analyst Report), which competes with RLI Corp., reported earnings of $1.26 per share in the second quarter of 2012, lagging the Zacks Consensus Estimate of $1.38. Results rebounded from the loss of 88 cents incurred in the year ago quarter.

The year-over-year increase stemmed from underwriting margin improvement across all segments.  Lower share count due to share repurchases during the quarter aided the bottom line.

Travelers missed the expectation due to catastrophe losses of $357 million or 90 cents per share arising from wind and hail storms in several regions of the United States in the quarter.

Our Take

With the improving pricing scenario in the insurance market supported by RLI Corp.’s strong infrastructure, we expect the company to perform well in the coming quarters. It also has a favorable loss reserve ratio when compared with the previous year along with increasing statutory reserve.

RLI Corp. scores strongly with the rating agencies and remains focused on returning value to its shareholders through incremental dividends and share buybacks.

However, continued low interest rate environment keeps us on the sidelines.

We retain our ‘Neutral’ recommendation on RLI Corp. The quantitative Zacks #3 Rank (short-term Hold rating) for the company indicates no clear directional pressure on the stock over the near term.

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